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WK.1LECTURE IN GLOBAL /INTERNATIONAL TRADE

What is Globalization?

Global/International Trade is the activity that occurs when a company exports goods or
services to consumers in another country.

Named as the process of increasing connectivity and interdependence of the world’s

markets and businesses, Globalization entails two things:

1. Connectivity is the existence and affordability of a communication and

transportation network. These networks or infrastructures are vital to the creation
of an environment conducive to international trade and commerce.
2. Economic interdependence is a characteristic of a society w/a high degree of
division of labor, where people depend on each other for goods and services
required to sustain life and living. Connectivity and economic interdependence
paves the way for Global/International Trade.

To the consumer, globalization means more choices, lower prices, and an increasingly
blurred national identity for products and services. Think of the many household brand
names you can recall. E.g. Coke is a brand that does not have any singular “nationality”.
Although it was made in America, today it is a global brand. The same can be said of
brands like Japanese Sony or Finnish Nokia.

Who Benefits from Globalization?

Globalization has its winners and losers, allegedly at the cost of poorer nations. Some
argue that globalization only benefits richer nations. The answer is somewhere in the
middle. As the subsequent arguments presented will show, who benefits from
globalization will depend on a nation’s ability to build its own infrastructure prior
to trade liberalization regardless of first world/third world status.

Why do you think globalization might have adverse effects on poorer nations?

The following issues are the center of an anti-globalization argument that believes
certain groups of people are not capable of functioning within the increased competitive
pressures of globalization.

Globalization &the Monopoly Powers of Large Corporations

1. Anti-globalists believe that globalization will deprive nations of their sovereignty (their
ultimate power to lay down, modify, or invalidate their own laws of the land). How?
International organization like the WTO has officials not elected by popular vote.
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Because of this lack of accurate representation, some people believe that the real
matters of concern for respective countries will not be addressed by the international
body and that subsequently, only the concerns of rich, represented nations with veto
power like the U.S. will be addressed.
2. To some, globalization simply means Americanization because of the proliferation of
U.S. multinationals that spread their consumer culture to the rest of the world. (e.g.,
when McDonalds first entered Japan, it met with cultural opposition from the
Japanese who feared it would replace their unique culinary culture. In the early 80s,
McDonald’s also had a fairly difficult time entering the Philippine market because of
its distinctively Pinoy taste preferences that are comparatively more complex than
American taste buds.)

Is the argument valid on these two counts? Only partially.

International trade still remains a government to government domain while the WTO
assumes a conflict resolution role between those governments in terms of the systemic
reduction of tariff barriers and highly disputed non-tariff barriers that might give some
nations an unfair advantage over others. Also, despite the presence of mega
multinationals from America, relatively small firms, even those from developing nations,
still remain viable in a global economy.

Globalization &the Environment

Environmentalists cite firms that relocate their operations solely for reasons of escaping
tough pollution rules in their own country. This argument is often called “lowest
common denominator” or “race to the bottom”.

The argument is only partially valid: There will always be some firms seeking to lower
costs by finding host locations with less strict environment policies while others adhere
to strict codes of environmental protection. A good example of a multinational that seeks
to operate in an environmentally sound manner is Dow Chemicals. Dow Chemicals
enjoys international presence even up to Europe adhered in the Philippines and has
expressed commitment to reduce their greenhouse gas (GHG) emissions by developing
energy alternatives that use less carbon intensive raw material sources. It is also
credited with the cleanup of dioxin-contaminated areas near the Tittabawassee River in
Michigan, U.S.
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Globalization &the Social Balance

One man’s benefit is another man’s detriment. Globalization carries promises and
threats, advantages and disadvantages on the national, regional, organizational, and
individual level. Although globalization is credited with overall economic growth, this
reality will not mitigate the devastating community impact of a major employer moving
its operations to foreign shores. With major banks like Citibank employing thousands of
call center personnel from places like the Philippines and India, each job gained here is
another lost to someone in the U.S.

Another source of imbalance or inequity is global capital flow makes less regulated
developing countries like Mexico, Thailand, and Argentina vulnerable to volatilities of
foreign exchange markets. The financial currency crisis in these countries were
attributed to this.

Developing countries that export could lose potential economic gains because prices of
commodities of raw materials, and natural resources are undervalued due to market
control/influence by transnational cartels or barriers imposed by importing nations. For
example, some developed nations erect new entry barriers against developing
country imports when the latter are given market access.

A Balanced View of Globalization

Globalization can offer more advantages to participating economies, rich or poor, if
globalization infrastructure is better developed. Globalization infrastructure concerns
institutional frameworks and market efficiency that support fair and transparent
transactions of products and services, streamline flow of commodities, capital, labor,
knowledge, information.

International economic organizations such as the IMF, World Bank, and WTO are
fundamental in influencing such infrastructure. In exchange for country aid, these
institutions lay down fiscal rules and economic policies that the country being
aided should follow as a condition for aid received. As for whether those imposed
fiscal or economic policies area proper fit for the country in question, that issue is often
subject to debate in each respective country.

However, the economist Joseph E. Stiglitz, cited that the three institutions have
changed markedly over the decades, forcing rapid trade liberalization policies that were
not appropriate for countries in the early stages of development. He posits that when
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trade liberalization occurs before safety nets, or globalization infrastructure is set in

place, those who lose their jobs as a consequence of the domestic market’s inability to
prepare for the onslaught of increased competition are forced into poverty. It is in this
sense that globalization is not an absolute good or an absolute evil. Much of the
success of trade liberalization depends on a country’s discernment of how to
properly prepare and protect (via temporary trade concessions allowed under the
rules of the WTO to give a tariff grace period for developing nations) its domestic
industries.

Most of the industrialized nations, including the U.S. and Japan, built up their
economies by wisely and selectively protecting some key industries until they
were strong enough to compete with foreign companies. Third world economies
would do well to follow their example and look at the key industries of its country that
need attention and further support and development.

In more recent memory, many stakeholder groups lobbied for the junking of Japan
Philippine Economic Partnership Agreement (JPEPA – the bilateral agreement between
RP and Japan which, as many argue, had many inequities in its agreements that
provided for the protectionist measures for Japanese fishermen and farmers
while none were accorded for their Philippine counterparts.

International Business
International Business refers to the activities that involve the transfer of resources,
goods, services, knowledge, skills, or information across national borders. Resources
are raw materials, capital, people. Goods are semi-finished and finished
assemblies/product. Services are legal counsel, banking, insurance, management
consulting, education, healthcare, trade service, tourism, etc. Knowledge & Skills are
technology and innovation, organizational/managerial skills, intellectual property rights.

Parties involved in the transfer of the above mentioned may be individuals, company,
company clusters, government bodies, and international institutions. Of these,
companies are the dominant player, the primary economic agent facilitating and gaining
(or suffering) from globalization.

International transactions are activities crossing national boundaries manifested in two

ways:

1. International trade: when a company exports goods or services to importers in

another country.
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2. International investment: when a company invests resources in business activities

outside its home country.

An example of international trade would be independent fashion apparel/accessory

manufacturers from Cebu export their goods into the U.S. An example of international
investment would be Tony Tan Caktiong’s expansion of Jollibee into mainland China or
Figaro Coffee Company’s foray into Dubai and Beijing.

Definition of Key Players in International Business

1. International firm: any firm, regardless of size, that is engaged in international

business.
2. Multinational Enterprise (MNE): a firm that has directly invested abroad and has at
least one working affiliate in a foreign country over which it maintains effective
control.

More recently, Lamoiyan Corporation, maker of Hapee toothpaste and Dazz

dishwashing paste, has earmarked P100 million to expand business presence to
neighboring countries such as China, Vietnam, and Indonesia. Once its overseas
operations are successfully established in Vietnam, Lamoiyan will finally fit the definition
of a multinational enterprise.

International vs. Domestic Business

International business is the outgrowth of domestic business. As the magnitude of a
firm’s operations grows, it might find it profitable or necessary to build plants and
facilities in other countries. Although an offshoot of domestic business, international
business differs from domestic business in mainly two ways:

1. Environmental dynamics refer to the diversity that exists between countries in terms
of currency, inflation, interest rates, accounting practices, cultures, social norms,
business practices, laws, government regulations, and overall political stability.
2. Operational nature refers to differences in nature, operating principles, and
managerial attitudes across borders.

Simply put, with the expansion into new territory comes the multiplication of the
number of factors that the firm will have to deal with in terms of multiple
economic conditions to monitor and study, multiple laws to abide by, multiple
government policies that can change and affect business operations, and
multiple cultures and market preferences, and managerial attitudes to adapt to
across borders. In some cases, expanding into just one other country might still
entail adapting different regionalistic cultures or practices and laws. The
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Philippines is a prime example of how different regional traits can affect language and
communication or how the Federal form of government of the U.S. with each state
having its own rules can affect a firm’s entry and adaptation into the country.
International entrepreneurs are companies or individuals that actively invest and
operate in a country without a home base. International entrepreneurs may set up
international new ventures abroad and operate them using their experience, networks,
expertise, and flexibility.

E.g. Many Hong Kong investors in mainland China do not have any home base in Hong
Kong, but are active in trade and investment on the mainland. A good example of this
form of trade and investment would be venture capitalism which provides venture
capital to promising business ventures in exchange for a share of future profits and
ownership stake and consequently, operating control.

Why Firms Expand Internationally?

Market Motives
The rationale behind why firms expand internationally can basically be explained by the
pursuit of additional gains that cannot otherwise be obtained in the domestic market. In
general, the main motives for conducting international business include market,
economic, and strategic motives.

Offensive motives are aggressive tactics like to seize market opportunities in foreign
countries through trade or investment. (E.g. Amway, Avon, and Mary Kay all entered
China in the early 1990s in search of opportunities in China’s direct marketing
business).

Defensive motives are less aggressive and often reactionary tactics in response to
changing conditions that must be adapted to in order to protect and hold a firm’s market
power or competitive position in the face of threats from domestic rivalry or changes in
government policies.(E.g., The U.S. restriction of Japanese car imports in 1980
prompted Toyota, Honda, and Nissan to build car manufacturing plants in the U.S.)

Economic Motives
Economic Motives are by definition, economic or pecuniary in nature. Some of the
examples of economic motives are as follows:
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1. To increase their return through higher revenues and/or lower costs. This is the main
reason why firms look for countries with developing market potential and or a large
population base with high per capita income or countries with low operating costs so
they can expand profit margins.
2. To benefit from differences in cost of labor, natural resources, and capital, as well as
differences in regulatory treatments of taxation between domestic-foreign countries.
E.g. More than 2,000 plants have sprung up near the U.S.-Mexican border to take
advantage of cheap labor in assembling component for re-export to the U.S.
Countries like the Philippines, China, and U.A.E. also set up special economic
zones with lower tax rate incentives and favorable economic policies to entice
multinationals to set up operations there.

Strategic Motives
Strategic Motives are mainly long-term objectives of an internationalizing firm that are
obtained through the following examples.

A. To capitalize on distinctive resources or capabilities already developed at home such

as technologies or economies of scale that can be replicated abroad to maximize
profit potential. For example, a highly efficient manufacturer of household appliances
might want to set up operation in the Philippines to take advantage of their distinctive
capabilities that are, as yet, unmatched by local manufacturers.
B. To be the first mover in the target foreign market before a competitor gets in. For
instance, the foreign pioneer of the insurance industry in the Philippines was Lloyd’s
of London which introduced the insurance concept in March of 1829through its
appointee Stracham, Murray &Co. Inc.
C. To seek vertical integration (upstream towards the supply end, or downstream
towards the distribution end). Vertical integration refers to the merger of firms at
different stages of production. Upstream vertical integration is also known as
backward integration where a firm acquires its input supplier. Downstream vertical
integration, also known as integration, is when a firm acquires another firm in its
output distribution chain.
D. To follow its major suppliers/partners abroad, i.e. “piggybacking” A prime example of
this would be Japanese tire maker Bridgestone when it followed its customers –
Japanese car makers – into the U.S. market. Other suppliers of Nissan, Honda, and
Toyota followed their example.
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WK. 2 THE INTERNATIONAL TRADE

International Trade Theories

Over the decades and centuries since the inception of international trade, various
international trade theories have sought to explain the unique and subjective rationale
behind each country’s pursuit of profit through the utilization of its own inherent resource
advantages and strengths.

The following are trade theories to be discussed:

A. Mercantilist Doctrine
B. Absolute Advantage Theory
C. Comparative Advantage Theory
D. Human Skills & Technology-Based Views
E. Product Life-Cycle Model
F. Linder’s Income-Preference Similarity Theory
G. The New Trade Theory

The Mercantilist Doctrine

The Mercantilist doctrine emerged in England during the mid-sixteenth century. It is the
first theory of international trade. This doctrine placed great faith in government’s ability
to improve the well-being of its residents using a centralized system of controls. Under
Mercantilism, the Government has two goals in foreign economic policy:

1. To increase the wealth of a nation by acquiring gold.(Mercantilists identified national

wealth as the size of a nation’s reserves of precious metals – metals which could
then be used to hire mercenary armies)
2. To extract trade gains from foreigners through regulations and controls to achieve a
surplus in the balance of trade by maximizing exports (e.g. subsidies) and
minimizing imports (e.g. tariffs and quotas.

In modern times, however, gold reserves are merely potential claims against real goods
on foreigners. An influx of gold into the economy will cause inflationary pressures on
price levels, reducing the competitive advantage in price that had allowed the company
to acquire the gold, while the loss of gold in the foreign country will reduce prices there,
thereby reinforcing its exports.

Today, gold reserves represent a minor portion of national foreign exchange reserves
which are used by governments to intervene in foreign exchange markets to influence
foreign exchange rates. An example of this is when the Central Bank of the Philippines
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sells some of its gold reserve in exchange for local currency. When an oversupply of US
dollar remittances enter the country and exert a downward pressure on the value of the
dollar in relation to the Peso, the central bank will intervene so as to prevent the
exchange rate from dropping to a level wherein Philippine exports will end up receiving
dramatically less revenue for every dollar earned. An inadequacy of Mercantilism,
however, is that it overlooks other sources of a country’s wealthaccumulation such as
capital quantity, workforce skill, and strength ofother production inputs. As such, this
theory fails to explain the rationale for modern commerce in terms of seeking cheaper
skilled labor or lower cost material sources, for example, in an age of business process
outsourcing and physical resource outsourcing.

Absolute Advantage Theory

In his 1776 landmark treaties, An Inquiry into the Nature and Causes ofWealth of
Nations, Adam Smith introduced the doctrine of Laissez-faireto international trade.
Laissez Faire means “freedom of enterprise and freedom of commerce”. The keystone
of 19th century liberalism was theelimination of ubiquitous regulation. Smith argued that
all nations would benefit from unregulated, free trade that would permit countries to
specialize in goods they were best suited to produce because of natural or acquired
advantage. Natural or acquired advantage includes abundance in natural resource
endowments or possessing the best process technologies in the production of goods.
Simply put, it assertsthat a nation benefits from manufacturing more output than other
nationsbecause it is in possession of a particular resource or commodity, e.g. if America
has an absolute advantage in producing apples, it should export its apples; if India
makes the best milled cotton in the world, it should export its cotton. This later became
known as Absolute Advantage Theory.

Smith also argued that world production would increase if both countries specialized in
the production of the good in which they have an absolute advantage and then traded to
obtain other goods in which they have an absolute disadvantage.For instance, if the
Philippines has absolute advantage as the most efficient canner of tuna, it should export
its tuna and if it is at an absolute disadvantage in terms of producing tires, it should
import its tires from, say, Japan.

Absolute Advantage Theory further states the following things:

o the market would reach an efficient end by itself

o Government intervention in the economic life and trade relationswould be
counterproductive.
o A nation would benefit from free trade simply because imports would cost less
than domestic products it otherwise would have to produce.
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This theory poses some possibly problematic scenarios. For instance, what would
happen to a country that has no absolute advantage inanything? Under this theory, no
such trade would exist if a country didnot possess an absolute advantage in the
production of any good.Furthermore, this theory assumes that international trade will
reach anefficient end but itself, free of government intervention in the form ofpolicies.
This is problematic because we know that in modern times,how well a government
protects and nurtures domestic industry in theform laws and regulations can determine
how successfully a country cancompete and survive in the face increased market
competition broughton by free trade.

According to the Comparative Advantage Theory, a country has acomparative

advantage in producing a good if the opportunity cost forproducing the good is lower at
home than in other countries.Opportunity cost is defined as “the value of the next best
alternative foregone as the result of making a decision.” Simply put, the opportunitycost
for good X is the amount of other goods which have to be given upin order to produce
one unit of X or, the opportunity cost for producing abarrel of beer is the value of, say,
whole grain cereals, that have beenforegone or given up to produce that one barrel of
beer instead.

For example, if the choice is between using a machine or scrapping it, the opportunity
cost is the scrap value.

A timely example of how opportunity cost is vital in deciding which goodsto

produce/manufacture is the bioethanol issue. While it is alwaysimportant to find
sustainable sources of energy that will not harm theenvironment, economists are at
disagreement over WHEN it would bebest to use sugar or corn for bioethanol rather
than for food. Currently, the opportunity cost for producing bioethanol with either corn or
sugar ismuch higher than the opportunity cost of simply using these agriculturalproducts
for much-needed food. The process technology for maximizingoutput of these
agricultural products in terms of creating substantialvolumes of green gas is still not
wholly efficient.

Meaning of Opportunity Cost

Opportunity cost refers to the value a person could have received but passed up in
pursuit of another option.

It is "the loss of potential gain from other alternatives when one alternative is chosen".

The loss of potential gain from other alternatives when one alternative is chosen. "idle
cash balances represent an opportunity cost in terms of lost interest"
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When economists refer to the “opportunity cost” of a resource, they mean the value of
the next-highest-valued alternative use of that resource. If, for example, you spend time
and money going to a movie, you cannot spend that time at home reading a book, and
you can't spend the money on something else.

It is vital to understand the source of Comparative Advantages. The immediate source

of trade is the differences in the price of the same commodity between different
countries. This explains the difference inopportunity costs. The reason why such
differences exist is a function ofthe law of supply and demand. On the demand side, we
observe that the greater the demand for something be it a commodity or service, this
exerts an upward pressure on price and a decrease in demand does the opposite. On
the supply side, differences in supply patterns affect production costs. We thus
conclude that comparative advantage mustbe explained by references to differences in:

a. Comparative production cost (which is further dependent onproduction process and

state of technology); and
b. Production factor cost (prices of land, labor, capital, etc., arein turn related to their
availability in the national economy.Economists refer to inputs to the production
process asproduction factors. Factor endowments are the condition (i.e.availability
and cost) of factors of production.

Despite this theory’s diminishing power in explaining modern, knowledge-based trade, it

still explains trade in natural resourceproducts.

Human Skills & Technology-Based Views

Several scholars challenged the conventional theory of trade whichassumed technology
and human skills equivalence among differentnations. We know that technology and
human skills are not equalamong nations. Rather than a separate theory, this view is
regarded asa refinement of the conventional theory of trade. The Human Skills
&Technology theory adds two new factors to the explanation ofcomparative advantage
sources:

Human skills andTechnology gaps

Human Skills theorists explain the source of comparative advantage in terms of the
comparative abundance of professional skills and other high-level human skills. In the
world of business process outsourcing and countries like Australia and Canada finding
ways to incentivize foreigners with special professional skills to emigrate to their
countries, we see how the inequalities in human skills among nations causes themto
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look to other nations that possess abundance in those professionalareas, trying to find
ways to facilitate the inflow/outflow or exchange ofsuch skills.

As seen in statistics surrounding the exchange in service trade, the mostsought-after

high level human skills are in the form of scientists andengineers, technicians and
draftsmen, managers, skilled manualworkers, and other professionals like healthcare
providers andeducators.

Technology theorists argued that certain countries have special advantage as

innovators of new products. They also assume that there is an imitation lag that
prevents other countries from immediately duplicating products of an innovating country.
These two conditions giverise to the technology gap. Technology gaps, therefore,
happen when products afford an innovating country an exportmonopoly during the
period of imitation lag.Also when a firm discovers a different and more advanced
production technique, it enjoys a cost advantage and will dominate the world market for
a while; however it is highly important to take note that the advantage that occurs in the
period of imitation lag only happens temporarily. In time, competitors are able to copy
theproduct or the unique and advanced process technology that was used to create it.
Proprietary knowledge does not last forever. Thus, continual innovation is the only
recourse of a firm that seeks to maintain its competitive advantage. As long as
technological process is made, technology gaps will serve as a major source of
comparative advantage.

This theory provides a powerful explanation on the trade of “new”products or

manufactures made by a skilled workforce usingtechnologies.

Product Life-Cycle Model

This theory was proposed by Raymond Vernon in the mid-1960s. ThePLC model further
developed the imitation-gap approach by suggestingthat changes occur in the input
requirements of a new product as itbecomes established in a market and standardized
in production.

As the product-cycle develops, cost advantages will change, and a comparative

advantage in innovative capacity may be offset by a costdisadvantage. For example,
there was a time when America was the number one innovator of automobiles and for a
time, enjoyed a comparative advantage in terms of innovative capacity. However, in
time, the Japanese caught up with the U.S. and learned from their model and improved
upon it. Ford may have invented the automobile but Toyota eventually outpaced Ford in
car manufacturing efficiency and output. Thus, the four stage model assumes that the
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export effects ofproduct innovation are undermined by technological diffusion and

lowercosts abroad.

The four stages of the Product Life-Cycle model are:

1. Export monopoly stage wherein the innovating and exporting country have a
monopoly in export markets and proceed to buildup sales with no concern for foreign
competition;
2. Foreign production stage is when producers in other industrialcountries start to
manufacture the product whose design andproduction is now standardized;
3. Foreign production becomes competitive in export markets and foreign producers
start to displace the innovating country’s exports in the remaining export markets;
and
4. Original innovator becomes an importer of the no-longer newproduct because
foreign producers achieve sufficient competitive strength arising from economies of
scale and lowerlabor costs.

The following are important facts related to PLC theory in trade:

1. Export performance of the mature, innovating country is better for new products
than it is for products reaching maturity because for obvious reasons, the
competitive advantage of theinnovating country lies in the “newness” of the product
that hasnot yet been copied or made by anyone elsewhere;
2. Technology is simplified as the maturing process continues, i.e.whatneeded skilled
labor earlier on may be produced byautomation and unskilled labor later on;
3. Relationship between innovating and imitating country changes over time because if
at first the innovating country does the exporting, in the end that same country will
eventually import from imitating countries; and
4. International trade may increase in later stages of the product life-cycleas the
consumer good matures and incomes increase.A common example of this is the use
of cell phones. At first, these were considered a luxury, but with rising incomes and
falling costs in terms of production due to increased efficiency, nearly everyone has
a cell phone to suit theirtastes and budgets and it is now considered a necessity.

Linder’s Income-Preference Similarity Theory

The Swedish economist Staffan B. Linder divided international trade intotwo different
categories:

Primary products (natural resource products andManufacturers

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He asserts that trade in natural resource products differs according to differences in

factor endowment. He additionally posits that trade in manufactures takes place among
developed nations because nationswill only export those goods they manufacture at
home and will only manufacture at home those goods for which there is strong internal
demand. The more similar the demand structures between two countries, the more
intensive is the potential trade in manufacturesbetween them. Additionally, the similar
demand structures will likely result in consumers and investors demanding the same
goods with similar degrees of quality and sophistication. This is what is referred to as
preference similarity. This similarity is what boosts trade between the two industrialized
nations like the United States and the United Kingdom, for example, or the United
Kingdom and Australia or Canada due to their shared history as former colonies of the
British monarchy. All of the above-mentioned nations enjoy a high standard of living
which also contributes to their preference similarities.

Linder argues that the most important determinant of demand structureis the average
per capita income of a country. High per capita income usually results in the high
demand for luxury goods while low per capita income results in demand for low quality
“necessity” goods. Consequently, a rich country w/a comparative advantage in high-
quality advanced manufactures will find its big export markets among other rich
countries whose markets will already have an existing demand for such goods due to
lifestyle and high income similarities.

This theory has an inadequacy, however, in that it does not explain how nations with the
same income levels can have different consumption patterns or why trade between first
and third world economies grows despite the difference in their preferences. In reality,
tastes and preferences are influenced by factors other than income. These other factors
include cultural adaptation or assimilation. For instance, the Philippines is a third world
country that is highly distinct from America ina multitude of ways, yet the Philippine
demand for Hollywood movies and American music or television shows is very high. Or
inversely, the U.S. and Japan are both very wealthy nations, yet consumer preferences
in automobiles, for instance, are very different between the two despite the high
standard of living both countries enjoy. Americans love their gas-guzzling, road hogging
Sport Utility Vehicles while theJapanese prefer compact cars.

The New Trade Theory

The New Trade Theory was originally expounded on in a series ofpapers by Dixit &
Norman, Lancaster, Krugman, Helpman, and Ethier. They argue that countries do not
necessarily trade to take advantage oftheir differences; they trade for the sake of
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increasing returns. Although this theory is not totally new, it makes the following
contributions to the understanding of international trade:

It introduces an industrial organization view into trade theory, and includes real life,
imperfect competition in international trade. They argue that because of economies of
scale, there are increasing returns to specialization in any industry. Economies of scale
refer to the reduction of manufacturing cost per unit as a result of increased production
quantity during agiven time period. For instance, the cost of manufacturing the one-
thousandth car is cheaper than making the first.

The New Trade Theory makes these following assertions:

1. Inter-industry trade (different industries in different nations) continues to be driven by

comparative advantage in factor endowments, while intra-industry trade
(international trade in the same industry) is largely driven by increasing returns from
specialization within the industry. For inter-industry trade between commercial airline
industry’s sourcing from extractive industries (metalware) will continue to be driven
by the need to find the best priced materials from nations that enjoy abundant factor
endowments that enabled them to pass these products at a competitive price. Intra-
industry trade, for example, the business process outsourcing of skilled
professionals in the I.T. industry will be driven by increasing returns resulting from
specialization within the industry;
2. It realizes the importance of externality in international specialization and trade.
Externality occurs when the actions of one agent directly affects the environments of
another agent. Changes in government policy, political relations between two
countries, import/export history, consumption differences between cultures,
accidents and luck are all examples of externality. For instance, the Chinese
government’s recent ban on direct-selling/direct-marketing schemes due to their
view of these as “pyramid scams” drastically curtailed the trade prospects of Avon,
Mary Kay (cosmetics) and Amway in the market because they all rely on direct-
selling model.

International Trade Volume & Growth

International trade continues to grow rapidly, outpacing the growth ineconomic output.
Some key facts and figures surrounding international trade include the following:

1. In 2000, global merchandise exports reached $6.2 trillion, an increase of 12.5

percent over 1999;
2. In the same year, global exports of commercial services reached $1.4 trillion, an
increase of 6 percent over the prior year;
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3. The increase slowed in 2001, and starting 2008, a great recession gripped the U.S.
economy, but if recent decades are an indication, the generally upward trend of
growth will resume.

Service Trade
Service trade accounts for about one-quarter of global trade, and as developed
countries move to service-based economies, its share is rapidly growing. However,
although the Philippines is still a developing nation, its service trade numbers are
growing each year, with a significant portion of its economy driven by the tourism,
service industry, and outsourced information technology, education, and nursing
services.

Service trade encompasses the:

o import/export of financial services

o information services
o provision of education and training
o travel and tourism
o healthcare
o Consulting and advisory services, etc.

Trade Measurement
Countries, firms and research institutions have common methods of acquiring,
recording, and classifying data on trade in terms of import and export statistics and
figures. For example, the U.S. has systematically recorded its imports and exports since
1821, and has, since 1989, used a harmonized system for classifying trade that
facilitates comparability of data with the country’s major trade partners. Like many other
countries, the U.S. uses export data compiled from Shipper’s Export Declarations filed
by exporters, forwarders, and carriers, while import data are compiled from custom
forms/custom declarations. These trade data are then used by governments, firms, and
research institutions to gauge such measures as market penetration and share the
following two exhibits show the top exporters/importers of trade in other services for the
years 2000 and 2007 respectively.
 17

Trade Balance
The balance of trade is calculated as exports minus imports of goods and services.
Internationally, the U.S. has by far the largest trade deficit of ay country though as a
percentage of GDP its deficit is much lower than that of many other nations.

In contrast to its merchandise trade, which was pegged in 2002 at minus 449.6 billion
US$, the U.S. enjoys substantial surplus in services. Between 1992-1998, U.S. exports
grew at an average rate of 8 percent, reaching $246 billion in 1998. It is this surplus that
explains why the U.S. is leading the fight to reduce barriers in service trade. The U.S.
stands to gain very much from the removal of administrative barriers in service trade, for
example, among the member countries of the North American Free Trade Agreement
(NAFTA) namely Canada and Mexico. When a nation’s economy is driven by service
trade, its government should actively participate in the reduction of trade barriers that
impedethe flow of their service exchanges. The Philippines, for example, benefits from
the US dollar remittances brought in by overseas nurses. It is only right that government
should ensure that Filipino nurses employed abroad are made subject to fair and equal
treatment to protect their best interests.

Knowledge is often the most valuable contribution toward a competitive advantage in

services. As we will discuss in future chapters, knowledge creation by intellectuals and
knowledge dissemination by educators are both vital in creating competent service
providers and maintaining sustainable competitive advantage in this regard. Some
examples of key trends in service trade volume include:

1. The U.S. exports to Europe intellectual property (e.g. paid asroyalties and license
fees) and legal services; while in the Asia Pacific region it sells mostly education and
engineering services;

2. For the Philippines, the U.S. remains its top export market for medical/healthcare,
animation/commercial art services. It will be interesting to note that as part of 2009,
Philippine service exports have outpaced merchandise exports.

In terms of bilateral trade between the U.S. and the Philippines the following tables
show the top exports and imports between the two. TheDepartment of Trade & Industry
saw the top 5 export industry opportunities for R.P. in the U.S. market are in:

o Business Process Outsourcing-(sub-contracting)

o Animation and Live Film Production
o Automotive part Sector in Agribusiness Equipment
o Food and
o Apparel Trade-(Clothing)
 18

Opposition to Free Trade

In an economy, different classification of people with different levels of income or
education levels will have different reactions towards globalization. Although trade may
be good for the overall national economy, its impact varies across regional,
occupational, and many other levels. For example, Educated and highly-skilled workers
are more open to free trade and are likely to benefit from it, at least in theshort term,
because free trade will signify that their skills, which may bein demand in other
countries, will help them land a job. Whereas unskilled workers and people with lower
incomes are more likely to oppose free trade because of the threat that their jobs will be
shifted to lower cost locals, or possibly, to machine automation thanks to process
technologies brought in by developed multinationals. However, this opposition to free
trade by people in the lower economic strata can bean ironic situation because poor
people are more likely to suffer from the adverse effects of protectionism, namely, the
higher cost of consumption goods.

To deal with the uneven impact of trade, the U.S. government provides trade
adjustment assistance in the form of extended employment benefits and remaining
funds for workers who lose their jobs due to overseas competition even when securing
a job at a lower pay level. Itis estimated that an employee who loses his/her job to
imports and gets another job will receive on average a 13 percent lower wage with
aquarter suffering a 30 percent cut.

SOUVEREIGNTY ARGUMENT
According to this Argument:

1. Shifting production to the most efficient location deprives a country that base its
needs.
2. In turn, this will make a country too dependent on nations that may challenge its
national interests.

This is why salient industries that are key to national security (e.g. arms industry,
airlines) don’t allow foreign firms to hold majority stake/ownership. Countries like the
U.S. and the Philippines don’t allow foreign nationals to own telecommunications and
airlines in case these resources are needed during times of war for the deployment of
troops or information, for example.

Similarly, countries sometimes curb exports of certain products to designated countries.

An example of this is the U.S. embargo on the exportation of technology sensitive
products to rogue states/countries like Iran, Iraq or Cuba. This same rule also extends
 19

to trade third parties like Israel being pressured by the U.S. to not export sensitive
technologies to China.

Lowest Common Denominator Argument

Another source of opposition to free trade has something to do with the negative effects
on the environment, safety, and such. Anti-globalists are wary of Multinational
Enterprises (MNEs) that shift production activities to nations with the least protection
since they will offer the lowest cost base, but in the end, everyone suffers from the
environmental degradation. For instance, within the European Union,Poland, still a
developing economy, tends to attract many multinational firms because of its low level
of environmental protectionism relative to its industrialized neighbors. In Asia, the
Philippines has become the target of more industrialized neighbors like Japan. If you
recall, the Japan-Philippines Economic Partnership Agreement (JPEPA) earned the ire
of many environmentalists who oppose the dumping of hazardous biochemical waste
from Japanese manufacturers in exchange for certain service trade concessions. For
the MNE, relocating to a low environmentally protected country can decrease
mandatory cost outlays.

Trade Reciprocity
Although trade theories assume that much gain is made by countriesthat open their
borders to free trade unilaterally, additional benefits canbe gained from reciprocity.
These additional benefits are not onlyeconomic (e.g. ability to export goods and
services) but also political andsocial in that it is difficult to build domestic support for
unilateral opening.Trebilcock& Howse distinguish two kinds of trade reciprocity:

1. Passive Reciprocityis the position taken by a country where it refuses toeliminate or

lower its trade barriers until the other party(ies) does the same, for [hypothetical]
illustration, Japanwill not eradicate its non-tariff barrier on Philippine lettuce andother
agricultural produce until the latter lifts its tariff onJapanese luxury items, and
2. Active/Aggressive reciprocity may be conducted through the threat of retaliation, e.g.
withdrawal of previous commitments/concessions until the other party fulfills its
obligations or imposing countervailing measures/subsidies.

Adam Smith proposed that retaliation should be considered only as apossible response
to protectionism, although this could also harm theretaliating nation as well.
 20

Countervailing duties are defined as “additionalimport duties imposed to offset the effect
of concessions and subsidiesgranted by an exporting country to its exporters. These,
along withsubsidies, are used by nations to retaliate or compensate for the
valueproduced by preference given to foreign manufacturers or serviceproviders.

Types of Trade Barriers

Trade barriers are typically divided into two classifications:

o Tariffs are official constraints on the importation of certain goods and services in
the form of total/partial limitation or a special levy;
o Non-tariffs indirect measures that discriminate against foreign manufacturers in
the domestic market or otherwise distort or constrain trade.

Tariff barriers have been significantly reduced during the several decades of the
General Agreement on Tariffs and Trade (GATT).However, non-tariffs are more difficult
to measure and progress in reducing them is difficult to ascertain as importing countries
that implement these non-tariff barriers will often deny that such barriers exist. For
instance, prohibiting foreign firms from bidding on strategic defense projects is a tariff
barrier. That is, it is an official constraint thatis easily identifiable. However, the act of
preventing those firms fromwinning less sensitive projects by failing to disclose
essentialrequirements or publicizing the bids in obscure local outlets unlikely tobe seen
by foreign firms is a non-tariff barrier that is much more difficultto ascertain or measure.

Tariffs:
Tariffs are surcharges that an importer must pay above and beyond taxes levied on
domestic goods and services. Tariffs aretransparent and typically set ad valorem, that
is, based on the value ofthe product or service. For instance, if t-shirts imported by the
Philippines from China are worth Php 5 million and the ad valorem tax is set at 20%, the
ad valorem tax is then Php 1 million.

Tariffs have been on the agenda of virtually all rounds of trade negotiations through
GATT, and remarkable progress has been madeon their elimination or reduction.
Nevertheless, some particularly hightariffs still exist such as the 300 percent tariff on
butter in Canada,179 percent tariff on sweet powdered milk in the U.S., a 215 percent
 21

tariff on frozen beef in the E.U., and a 550 tariff on rice in Japan. Anotherexample of
persisting high tariffs are the ones on sugar in the U.S.prompted Heartland By-Products,
a small Michigan firm, to circumventthem by buying sugar molasses from its Canadian
sister company whichmakes it from sugar bought at world prices; it then reverses
themolasses back to sugar syrup and sells it to U.S> makers of ice cream,cereals, and
candy.

WK 3. FOREIGN DIRECT INVESTMENT AND APPLICATION

FDI occurs when a firm invests directly in production or other facilities in a foreign
country over which it has effective control. These overseas units or entities are broadly
called foreign subsidiaries/affiliates. Broadly, there are two kinds of foreign direct
investment namely.

1. Manufacturing FDI – which requires an establishment ofproduction facilities.An

example of a newly formedmultinational firm is Lamoiyan Corporation, maker of
Hapeetoothpaste and Daz dishwashing paste recently set upmanufacturing in
nearby Vietnam., and
2. Service FDI – which requires either building service facilities orestablishing an
investment foothold via capital contribution andbuilding office facilities. A good
example of this is the BusinessProcess Outsource industry that includes firms like
DeutscheBank or JP Morgan & Chase who set up call center servicefacilities in
Philippines for their international depositors.

FDI versus Portfolio Investment

Foreign portfolio investment/foreign indirect investment are investmentsby individual
firms, or public bodies in foreign financial instruments suchas government bonds,
corporate bonds, mutual funds, and foreignstocks. To compare and contrast, FDI is the
investment in real orphysical assets, whereas portfolio investment is investment in
financialassets. Additionally, FDI involves control over production/operationsundertaken
by the multinational enterprise (MNE) but portfolioinvestment does not, even though
portfolio investment in stock of acompany, for instance, entails ownership stake in the
company that wasinvested in.

As a review of basic portfolio theory undertaken in basic financialmanagement, Portfolio

theory is referred to as the behavior ofindividuals or firms administering large amounts
of financial assets insearch of the highest possible risk-adjusted net return.
Fundamental tothis theory is the idea that a guaranteed rate of return, say 8 percent
 22

perannum over the next 5 years, is better than a higher rate of return, sayan average of
8.5 percent a year but can fluctuate violently dependingon external market conditions.
Variability of the rate of return over timeis termed as the financial risk in portfolio
investment. The key task ofportfolio management is to reduce the variability (risk) of a
group ofstocks so that the variability of the whole is less than that of its parts.The idea of
portfolio investment is to “put eggs in different baskets, rather than just one basket.”
This works towards decreasing the risk of,say, losing everything in one bad investment.

We distinguish between two kinds of FDI:

1. Horizontal FDI – occurs when the MNE enters a foreign countryto produce the same
product /service that is produced at home;and
2. Vertical FDI – occurs when the MNE seeks
a. Backward Vertical FDI, also otherwise known asupstream investment,when it enters
a foreign country to produce intermediate goods that are intended for use as inputs
in its home country (or in other subsidiaries)production process. For example, Food
andBeveragegiant San Miguel might choose to invest in a bottling plant in Indonesia
to use as inputs for its beer or other alcoholic beverages.
b. Forward Vertical FDI, also known as downstream investment, when it markets its
homemade products overseas or produce final inputs in a host country using home-
supplied intermediate goods or materials. Anexample of this would be Foreign Sales
Corporationsused by companies like Cisco systems and Boeing jetmanufacturers.

All companies will incur additional costs when investing abroad. It is important to note
the “liability of foreignness” which puts foreign firms ata competitive disadvantage
against domestic ones.

Entry Modes
Entry mode is the manner in which a firm chooses to enter a foreign market or HOW.
Examples of entry mode are:

1. International Franchising- like the ones employed byGoldilocksBakeshop in North

America for instance;
2. Contractual / Strategic Alliances- are a cooperation betweentwo or more
independent firms made in contractual agreementthat allows each to remain
independent and the same timeleads to gains for both/all like in the case of
technology sharing,for instance;
3. Equity Joint Ventures- involve partnerships between two ormore firms to create an
independent single entity (whose legalidentity is apart/distinct from each of the
 23

parent company’sidentity) to carry out a productive economic activity and take

anactive decision-making role, like when Sony partnered with Ericsson Mobile; and
4. Wholly – owned subsidiaries - which involves 100% ownership by an international
firm of foreign production

Once entry mode is selected, firms determine the specific approach theywill use to
realize the chosen entry mode. These include two forms of wholly-owned subsidiaries,
namely:

o Greenfield investment whereby the firm builds everything from “scratch” and
o Cross border acquisitions where the firm obtains an already existing subsidiary.

The following two approaches:

Cross-border mergers, and Sharing/utilizing existing facilities are forms of contractual

alliance, whereby firms cooperate in order to obtain objectives they cannot accomplish
on their own, or to gain access to resources and markets they can obtain or pursue on
their own.

Strategic Logic behind FDI

Resource-seeking FDI
1. Physical resource seeking FDI is primarily done bymanufacturers of low-tech goods
such as clothing, processedfoods, etc;
2. Cheap/skilled labor seeking FDI is common among both the lowand high-tech
industries looking for an educated workforce fromdeveloping nations that does not
command the same highwages as they do in their home countries as is the case
withsemiconductor companies opening up production facilities in thePhilippines; and
3. Technological, organizational, managerial resource seeking FDIwhichare sought by
firms looking to boost their competitiveadvantage in terms of improving their
processes andorganizational and managerial methodsto add value to
theirproducts/services. An example of technological-seeking FDIwould be a
processed food manufacturer looking for and low-cost canning facility with an
improved Hall-Heroultprocess of used in aluminum smelting.

Market-seeking FDI
Market-Seeking FDI attempts to secure market share and sales growthin the target
foreign market. Reasons for market-seeking FDI include:
 24

The firm’s main suppliers/customers have set up producing facilities abroad and the firm
needs to follow them overseas, as was the case when Japanese tire-maker Bridgestone
followed it’s main clients, Toyota, Nissan, and Honda, into the U.S. market;

The firm’s products need to be adapted to local tastes or needs and to indigenous
resources or capabilities, for instance, when Nestle’s Maggi learned through failure that
continuously sensitizing itself to local tastes is necessary for success, even for a
generally homogenous product like Maggi seasoning ;

The firm may need to consider it necessary, as part of its global production/marketing
strategy, to maintain a physical presence in markets served by its competitors. This was
the case in the 1990s when U.S. car makers Ford and General Motors followed in the
footsteps of Japanese and European automakers that pioneered in the in-vehicle
Intelligent Transportation Systems (ITS) market. ITS provide in-vehicle
telecommunication applications that allow for GPRS route guidance, communications,
computing, and entertainment among others.

Efficiency-seeking FDI
Efficiency-seeking FDI aims to rationalize the structure of establishedresource-based or
marketing seeking investments in such a way that afirm can gain from the common
governance of geographically dispersedactivities. The general aims of this motive
include taking advantage of:

Different factor endowments, e.g. the cost and availability offactors of production that
incentivize MNEs to set up operationsin countries that possess abundant land, labor,
capital, andentrepreneurship;

Cultures, e.g. this is related to the psychic distance theorywhere companies will choose
to invest in host countries with asimilar culture to its own home country because of
thepotentially profitable similarities between home and host countrypreferences and
tastes;

Economic systems and policies, e.g. governments making economic policies that are
favorable to foreign investors such as tax breaks; and

Market structures. This structure refers to the state of thenumber of buyers and sellers
of a non-differentiated (homogeneous) product, degree of open and free
information,and degree of collusion. The pursuit of the “ideal or perfect”market involves
the MNE looking for a host country with highinformation transparency, and low collusion
among industryplayers apart from the presence of a large number of buyers and sellers.
 25

Strategic asset-seeking FDI

This attempts to acquire the assets of foreign firms so as to promotetheir long terms
strategic objectives, especially advancing their nationalcompetitiveness. MNES with this
intention most often,

Establish global strategic alliances, e.g. when the Philippine National OilCompany’s
(PNOC) renewable energy arm, thePNOC Renewables Corporation (PNOCRC) and
theConstellation Energy Corp. (CEC), a subsidiary of EnerasiaRenewable Corporation,
a Toronto-based Canadian company,entered into a strategic alliance to develop
renewable energyprojects in the Philippines;

Acquire local firms, or simply termed as acquisition, wherein amultinational acquires

ownership/controlling interest in analready-existing company like when local
InformationTechnology company BayanTrade acquired CITP SingaporePte. Limited and
its subsidiary, PT Columbus IT Indonesia aspart of its regional expansion.

How MNEs Benefit from FDI

Enhancing Efficiency from Location Advantages

Location advantages are the benefits arising from a host country’scomparative
advantages accrued to foreign investors. Because throughFDI firms own and control
actual operations overseas, they can capturethe entire profit margin that otherwise
might be shared between importerand exporter. Determinants of location choice
include:

Labor cost differentials, e.g. Mexico is a prime location for FDI,not just in manufacturing
operations, but increasingly more so inwhite collar operations for financial services,
telecommunications, and insurance;

Transportation costs, e.g. for U.S. companies based near theU.S.-Mexico border,
sometimes makes more sense to invest incross border operations into Mexico rather
than locate within the U.S. like in some faraway state like Ohio where the
companywould necessarily incur greater transportation costs, forinstance;

Tariff/non-tariff barriers, e.g. the cost of entering a new country market is determined in
great part by the ease/difficulty of importing into that nation. No matter how potentially
lucrative the market structure is in terms of supply and demand, if the government
erects high entry barriers to trade, business will be difficult; and
 26

Government policies. Again this will refer to the political-legal system of a host country’s
government. The less corrupt and the more transparent the government bodies’
operations, the greater the location incentive to locate in that host country.

Improved Performance from Structural Discrepancies

Structural discrepancies are the differences in industry structure attributes (e.g.
profitability, growth potential, competition, abundance of buyers/sellers, free flow of
information, degree of market collusion, if any) between home and host countries.
Through FDI, MNEs can achieve higher performance than firms operating domestically
because they benefit from structural discrepancies by investing distinct resource that
enhance competitive advantage versus rivals in indigenous markets. To illustrate this
point, the MNE will set up manufacturing operations in host countries with competitive
factor endowments; will setup innovating technological operations in host countries with
high intellectual property protection and a highly skilled / educated workforce base; or
will set up its foreign sales corporations in lucrative markets with a high demand
structure and a high average per capita income.

Increased Return from Ownership Advantages

Ownership advantages are benefits derived from proprietary knowledge which refers to
the knowledge FDI occurs when a firm invests directly in production or other facilities in
a foreign country over which it has effective control or information over which the person
(legal entity) developing it has ownership rights, resources, or intangible assets
possessed by the owner (MNE). Intangible assets include copyrights, patents,
trademarks goodwill, computer programs, capitalizedadvertising costs, organization
costs, licenses, leases, franchises,exploration permits, and import and export permits.
FDI allows firms totransfer capital, technology, and organizational skills from one
country toanother. These three things are among the more transferable assets ofa
company. Additionally, FDI expands market domain from which theMNE can deploy,
exploit, and utilize core competence. Corecompetence is skill(s) within the firm that
cannot be easily matched orimitated. This distinctive employee, product, or service
capability mustnecessarily be something that leads to long-term competitive
advantage.However, as we have mentioned before, even core competence
mustcontinually be improved upon and viewed not merely as a static sourceof inimitable
advantage but one of an evolving source of sustainablecompetitive advantage.

Ensured Growth from Organizational Learning

FDI creates the diversity of environments in which the MNE operates and learns from
multiple stimuli, develops diverse capabilities, and gains broader learning opportunities
than are available to domestic firms.Central to this thinking is the idea that is better to
 27

be a “small fish in a bigpond than a big fish in a small pond” when it comes to
organizationallearning as it is only in the broader environment, fraught with its share ofa
multiplicity of challenges, that a company can learn. FDI provideslearning opportunities
through:

1. New practices - this mainly refers to organizational modes ofpractice and managerial
behavior.
2. New ideas that are naturally borne out of a new environmentwith its unique set of
possibilities.
3. New cultures which can refer to both national and corporateculture; and
4. New competition from which many lessons can be learned bythe organization
seeking to overcome host country challenges.These new opportunities result in the
development of newcapabilities, especially for a firm with strong
corporateadaptability.

FDI Impact on Host Country

Many of the factors that make FDI attractive to the host (recipient) country may make it
detrimental to the home country. Employment andDomestic Enterprise are areas in
which FDI affects social welfare fromthe host country perspective.

Employment
In terms of employment, host governments want to attract firms that willaugment
employment. However, home governments are worried aboutlosing such jobs. For very
domestic job that is generated in the hostcountry, an opportunity for employment is lost
to someone in the homecountry. As such, home governments increasingly complain
that theloss of jobs due to FDI causes a downward pressure on wages. Forinstance,
when a person in the home country loses a job due to thebusiness process outsourcing
activities of the home country MNE, he/she will have to settle for an available job that
will pay less than whatthey had originally been paid. Lower wages mean lower per
capitaincome. The lower the per capita income, the lower the standard ofliving and a
reduction in the quality of social welfare in the home countrywith regard to the affected
industry.

Domestic Enterprises
Resource endowments are what cause Foreign Direct Investedenterprises to be more
productive than local counterparts. This isbecause FDI often gives rise to enhanced
capabilities among localcompanies. E.g. Massive flow of FDI into China improved work
practicesand standards there. Why? This is related to the fact that FDI ispursued by
firms that want to capitalize on their core competencies thatare necessarily, by
definition, sources of their competitive advantage over domestic enterprises whether
 28

they be in the form of labor, capital, process and technology ownership-related

advantages. FDI tends tocreate innovation and knowledge which are eventually
dispersedthroughout the many levels of the economy. It is important to note thatthe
extent to which local firms can take advantage of this depends on local infrastructure
and government policies. Infrastructure refers to anation’s basic system of
transportation, communication, and otheraspects of its physical plant such as roads,
bridges, sewage, and electrical systems. For agricultural societies, farm-to-market roads
are vital. To an archipelago like the Philippines, viability of the country as anFDI location
is dependent on the connectivity of its many islands andisland clusters. This explains
the need for the Strong Republic NauticalHighway (SRNH) or the Roro highway.

Current Theories on FDI

Product Life-Cycle Theory

The theory, developed by Raymond Vernon, explains whymanufacturers shift from
exporting to FDI. This theory suggests thatearly in a product's life-cycle all the parts and
labor associated with thatproduct come from the area in which it was invented. Once the
productbecomes adopted and used in the world markets, production graduallymoves
away from the point of origin, until ultimately, the productbecomes an item that is
imported by its original country of invention.The best example of this is the invention
and market commercialization of the personal computer. What started in the U.S. has
now spread to Japan and Taiwan. The main stages we tackle are as follows:

1. In the new product stage, production continues to be concentrated in the home

country even though production costs in some foreign countries may be lower. At
this point, the home country innovator seeks to expand its consumer markets by
bringing its already existing product(s) abroad. This is followed by
2. In the growth product stage. At this point, the home country has incentive to invest
abroad to exploit lower manufacturing costs and to prevent the loss of the export
market to local producers.Then
3. In the mature product stage, cost competition among all. As the industry contracts
and producers intensifies. concentrates, the lowest-cost producer is the winner here.
At this point, the home country innovator of the once-new product begins to import
from lower cost producers from abroad.

Monopolistic Advantage Theory

 29

Continue on wk. 3 page 10

WK. 6 MIDTERM

What is Culture?
Culture can actually be defined in literally hundreds of ways. Thefollowing are just some
of the key cultural definitions we have today: Culture can actually be defined in literally
hundreds of ways. Thefollowing are just some of the key cultural definitions we have
today.

The art and other manifestations of human intellectual achievement regarded

collectively;

o Customs
o Civilization
o Achievements of people
o The way of life of a particular society or group

Customs are the habitual course of action that people take, or a practice followed by a
group or region.

Civilization refers to the total culture or the way of life of peoplewithin anation, region, or
period. Culture is also defined as the“man-made partof the environment”, because it is
something thatmust be taught andlearned. A baby is born not knowing what itsparents’
“culture” is. He orshe should be taught of the ways, practices and the particular
patternsof thoughts and behaviors.

Other definitions of culture include “the collective programming of thehuman mind” and
“the way in which people solve problems andrecognize dilemmas.”

Whitely and England synthesized more than 100 definitions of culture toarrive at this
working definition, which is also what we will use for therest of this course: “The
knowledge, beliefs, art, law, customs, and othercapabilities of one group distinguishing
it from other groups.” Broadly, the consensus regarding the main features of culture are
as follows:

1. Culture is shared. It is a way of life that is common to manypeople in a society,

region or number of religious adherents. It is never a solitary system.
2. Culture is intangible. It is made up of symbols – the abstract ways of referring to and
understanding ideas, objects, feelings or behaviors – and the ability to communicate
with symbols using language.
3. Culture is confirmed/learned from others in a society.
 30

4. Culture is adaptive. People use culture to flexibly and quickly adjust to changes in
the world around them.

Culture & International Business

Culture is the key ingredient in the “liability of foreignness” describedearlier as an
obstacle to MNE success abroad. As you can recall, thisliability refers to the risks and
costs of doing business that result in acompetitive disadvantage vis a vis indigenous
firms. The greater thecultural distance or difference between a foreign firm and the
domesticmarket of its host country, the greater the need for adaptation. Theimpact of
culture at the firm level ranges from strategy formulation to FDIto organization design.

Example: Culture can affect what kinds of foods and beverages can beexported into
Israel based on Jewish laws’ very stringent rules on whatfood and beverages are
“kosher” or ritually pure. The Philippines wouldnever be able to export chicharon into
Israel because pork meat and its derivatives are considered non-kosher or impure.
Hence, a firm would have to rethink its international product strategy before engaging
thismarket.

Organization processes such as perception, motivation, and leadershipas well as

human resource management are also influenced by culture, management style,
decision making, and negotiations.

Example of how culture affects management style: Japanese preferthe supervisory

rather than hands-on approach to management becausethey emphasize the need for
information flow from the bottom to the verytop.

Culture also influences marketing, accounting, supply chainmanagement, and virtually

all other functions of businesses. Culture also plays a key role in international alliances
and mergers. One way inwhich culture affects marketing is in how the international firm
mustadapt its promotion strategy to suit the cultural mores of its intended audience.

Example: Going back to the Benetton ad depicting a priest and a nunkissing was not
received well in Roman Catholic Italy. Benetton had intended the ad to break down
barriers and promoted dialogue on the nature of religious and sexual conflict. However,
it simply offended some deeply conservative cultural groups.

According to Huntington, “culture is both a divisive and unifying force” it is a force of

cohesion among members but a source of friction between them and others. Culture
can also be a source of internalfriction, where strict adherents struggle with others
whom they see as betraying the cultural heritage. However, it is important to remember
that although we cannot ignore the importance of culture, we should not treat culture as
the explanation for anything that is different, or as a “residual variable.”
 31

Correlates of Culture

Language
Webster’s dictionary defines language as “a systematic means of communicating ideas
or feelings by the use of conventionalized signs, gestures, marks, or especially
articulate vocal sounds.”

Language is one of the defining expressions of culture, it instills basic socialization

themes (words, no matter how they are spelled out, suggest meanings for us) and
determines how values (the ideas that a given group of people considers important) and
norms (the rules that reflect the values of society and govern the behavior of its
members) are expressed and communicated.

Non-verbal language is an important means of communication that varies across

languages and cultures and is more important in some cultures than in others.
Variations in the meaning of non-verbal cues may lead to embarrassing mistakes.

Example: The hand gesture that is used in Western cultures to implore someone to
come over is reserved for pets in Korea – not a good way toleave a good impression on
a Korean executive.

There are other important fields in the study of how cultural messages ormeanings are
communicated non-verbally.In today’s businessenvironment, the following fields of
study are becoming increasingly vitalin an organization’s ability to reduce
misunderstanding orcommunication distortions in the way others perceive our non-
verbalbehavior. They are:

Proxemics– this is the study of measurable distances betweenpeople as they interact.

The respectable distance between twopeople varies from country to country. This was
humorouslyconveyed in an HSBC ad depicting the difference betweenEuropean
standards of “respectable distance” being about 4 feetas opposed to the Mexican/Latin
American standard of about 1foot. To the reserved European, such closeness would
bestifling and uncomfortable.

Kinesics – this is the interpretation of body language such as facial expressions or

gestures – more formally known as non-verbal behavior relating to the movement of
either part of the body or the body as a whole. A sub group of kinesic study deals with
“affect displays” or the showing of emotion. In Japan, the showing of strong,
unrestrained emotion in the work place is generally considered unacceptable.
 32

When dealing inter-culturally, firms must understand all aspects oflanguage, spoken
and unspoken, in order to avoid offendinginternational business colleagues.

Historically, the term lingua franca came from the Franks – peopleoriginating in
southern France who traded with other people in theMediterranean who spoke a variety
of languages – Arabic, Italian, Greek, Spanish, and Portuguese. The Franks developed
a languagethat was a mixture of the preceding languages and became thelanguage of
commerce of the Mediterranean.

Today, the term lingua franca denotes any knowledge shared by peopleof different
national and linguistic origins. A synonym for lingua franca is vehicular language, or a
language that goes beyond the boundaries ofits original community, and is used as a
second language forcommunication between countries. In contrast, vernacular
language is used as a native language in single speaker community.

English is now the world’s lingua franca, the number-one foreignlanguage taught in
Non-English speaking countries. But the dominanceof English does not imply that
knowledge of other languages is notnecessary.

Multilingualism, however, can also have its drawbacks. Multilingual states such as
Belgium (Flemish versus Walloons) and Canada are often ripe for tension and conflict.
There tends to be a correlation between multilingualism and political risk. The difficulty
with languagedifferences is that the diversity of it in a single geographical area
cancause anxiety, tension, and misunderstanding among people. In thePhilippines
alone, we have about more than 170 languages. With eachregion possessing a distinct
dialect and regional culture, inter-islandcommerce meets its own set of challenges.

Religion
o Contains key values and norms that are reflected in adherents’ way of life.
o Influences international business in many ways. National institutions (in
particular) and business firms try to adopt practices that will satisfy religious
decrees without undermining modern business practice.

Example: Under Islamic law, bank interest is generallyprohibited. Banks in Moslem

countries issue shares todepositors and charge borrowers fees and commissions
tomaintain profitability without charging interest.

o Its associated customs also affect marketing.

 33

National Culture Classifications

A. Hofstede’s Dimensions of Culture

The most used (and some would say, abused) work on culture is that ofHofstede who
studied more than 100,000 IBM employees throughoutthe world. The study was
noteworthy for its attempt to correlate findingswith a host of other predictors (e.g.
climate).

Hofstede’s survey yielded four underlying dimensions:

1. Power Distance (PD) – this is the extent to which hierarchical differences are
accepted in society and articulated, for example,in the form of deference to senior
echelons. PD should not beconfused with the actual distribution of wealth and power
in anation.
2. Uncertainty Avoidance (UA) – this refers to the extent to which uncertainty and
ambiguity are tolerated.
3. Individualism/Collectivism (I/C) – this refers to the extent towhich the self or the
group constitutes the center point ofidentification for the individual. To some
scholars, this is themost important dimension of culture.
4. Masculinity/Feminity (M/F) – this describes the extent towhichtraditional masculine
values such as aggressiveness andassertiveness are emphasized.

De Mooij found that masculinity-femininity explained differences inconsumer

behavior.

5. Long-Term Orientation (LTO) – this was originally known as“Confucian Dynamism”

because of its anchoring in theConfucian value system. Now it is known as Long-
TermOrientation. It represents values such as thrift and persistenceas well as
traditional respect of social obligations.

Organization in high LTO cultures are likely to adopt a longer planning horizon, with
individuals ready to delay gratification. Such organizations may also find it difficult to
change deeply rooted traditions and practices. MNEs from high LTO cultures are more
likely willing to defer return in investment for a long time. However, the downside to this
is the disregard of basic principles such as economic return.

Criticism of Hofstede
The following are criticisms of Hofstede’s study. We will look at eachone in turn.

1. A single company’s data. Hofstede’s survey was done at IBM, an MNE with a strong
corporate culture. As such, it is highlypossible that IBM workers may not necessarily
berepresentative of their compatriots in other firms and industries
 34

2. Time-dependent results. These results are an artifact of thetime in which the data
was analyzed and collected. Data werecollected between 1967 and 1973. These
were then analyzed inthe late 1970s. Most subsequent studies confirmed the results.
3. Business culture, not values. Some scholars argue that the dimensions reflect
business culture rather than underlying values.
4. Non-exhaustive. Schwartz argues that Hofstede’s dimensionsdo not cover the entire
spectrum of the culture phenomenon.This is true, however, the framework is meant
to provide a mereblueprint of some of culture’s building blocks. Such dimensionsas
time and spatial orientation (proxemics) are not included inHofstede’s dimensions.
5. Partial geographic coverage. Hofstede covered only a portion of the world’s
countries, possibly missing other dimensionsunderlying culture. But over the years,
information has beencollected on additional countries.
6. Western bias. The meaning of items used in Hofstede’sinstrument might vary from
one culture to another and thereforeis culturally biased.
7. Attitudinal rather than behavioral measures. The generalcriticism of attitudinal
classifications of culture objects to themaking of inferences from attitude to behavior.
Attitudes are ahypothetical construct that represents an individual’s like ordislike for
an item. Attitudes are developed on the model ofaffect, behavior, and cognition.
8. Ecological fallacy. The interpretation of Holfstede’s national level data as if it were
about individuals. This criticism appliesmore to the interpretations and uses of
Holfstede rather than tothe original framework.

B. Schwartz’s Classification
This originated in psychology and has been used to a limited extent in the business
literature. Schwartz arrived at his classification by aconceptualization of values prior to
their sampling and measurement.His data are more recent that Hofstede’s having been
collected in the1980s and 1990s. Schwartz and his colleagues collected data on a
fairlylarge number of countries. He identified three polar dimensions ofculture,
producing the following dimensions:

o Embeddedness versus Autonomy

o Embeddedness (conservatism) – implies emphasis on social relationships and
tradition.
o Autonomy implies finding meaning in one’s own uniqueness and be encouraged
to express one’s own attributes.

There are two kinds of autonomy

1. Intellectual autonomy – self-direction, creativity.

2. Affective autonomy – the pursuit of stimulation and hedonism.
 35

Hierarchy versus Egalitarianism

o Hierarchy means legitimacy of hierarchical role and resource
o Egalitarianism means transcendence of self-interests and promoting others’
welfare

Mastery versus Harmony

o Mastery implies mastering the social environment via self-assertion (success,
ambition)
o Harmony implies being “at peace” with nature and society. Organizations are
viewed as being part of the broader social system.

C. Trompenaars & Hampden-Turner’s Classification

This classification has followers especially in the practitioner community.The
classification has seven dimensions largely drawn from previousliterature and validated
by large-scale practitioner surveys. The dimensions are as follows:

1. Universalism versus Particularism (rules versus relationships):

In universal cultures, rules are assumed to apply in all situations andlegal solutions are
prominent. Countries high on universalism include“litigating” countries such as the U.S.,
Canada, United Kingdom, theNetherlands, Germany, and the Scandinavian countries.
Cultures high on particularism (e.g. Arab) typically provide more benefits to employees
in return for commitment.

2. Communitarianism versus individualism (the group versus the individual):

People see themselves primarily as individuals in individualistic cultures.In communal

cultures, people see themselves as members of a group.Highly individualistic countries
include Israel, U.S., Canada, Nigeria, Romania, Czech Republic and Den Mark. High
communitarianismcountries include Egypt, Nepal, Mexico, India, and Japan.

3. Neutral versus emotional:

In neutral cultures, interactions are impersonal and objective; inemotional cultures, they
are laden with emotions. Neutral expressioncountries include Japan, Poland, and New
Zealand; they prefer indirect, non-confrontational response, and emphasize control.
High emotionalexpression countries include Kuwait, Egypt, Oman, and Spain;
theyprefer direct, emotional response, and avoid social distance.

4. Diffuse versus specific:

 36

In specific cultures, interaction is confined to a narrow domain andprivate life is kept

separate from work. Countries high on specificinvolvement include the U.S. and
Germany. They allow more outspokenexpression and encourage transparency.
Countries high on diffuseinvolvement include Japan, Mexico, and France. Such cultures
have no clear separation between different life domains. Response is situational
depending on the person and other circumstances

5. Achievement versus ascription:

In achievement cultures, status is based on achievement and people areevaluated by

performance. Countries high on achievement such as the U.S. and Canada permit
individuals to make commitments in the nameof their company, and make use of
detailed technical data to supporttheir position. Countries high on ascription such as
Kuwait and SaudiArabia make ample use of titles and show respect for superiors.

6. Attitudes toward the environment:

Countries geared toward controlling the environment such as the U.S., Israel, and
Spain, appreciate control and dominance. Countries not geared toward such control
such as Venezuela, Nepal, and Russia, accept that many life events cannot be
controlled. The Trompenaars & Hampden-Turner’s classification is similar to Holfstede’s
model. The long versus the short-term orientation is similar to the fifth dimension (LTO)
in Hofstede’s model. The communitarianism versus individualism dimension is similar to
Hofstede’s collectivism versus individualism.

Corporate Culture
Each organization or firm will eventually develop its own culture overtime. When certain
behaviors are reinforced or discouraged, accepted behavioral patterns or modes of
behavior are being set as the organization’s culture and this will in turn shape all the
attitudes of its members

Corporate culture
o Is the culture adopted, developed, and disseminated by a company. It is of vital
importance, especially for an MNE that adopts a global strategy and uses
corporate culture as an integrator of its various units.
o can be distinct and deviate from national culture

Hofstede and his colleagues found differences in values but moreconsiderable

differences in practices among the firms they’ve studied.
 37

They posit that national and corporate cultures are distinctive – if related– constructs.

Laurent proposes that corporate culture can modify two things

1. Behavior and artifacts – (referred to as social artifacts, or the product of individuals

or groups and their behaviour) and
2. Beliefs and values – but the deeper level of underlying assumptions is derived from
national culture.

Laurent also found that national differences in beliefs regarding firm practices were
considerably greater in a single MNE than in multi-firmsamples. This leads Schneider to
suggest that “a paradox that nationalculture may play a stronger role in the face of
strong corporate culture.The pressure to conform may create the need to reassert
autonomy andidentity, creating a national mosaic rather than a melting pot.” In
thelargest family-owned corporations in the Philippines today, it can beargued that this
seems to be the case. Take for instance the strong-knit,family-oriented culture of
Jollibee. This corporate culture can easily beattributed to the Chinese-Filipino family
traditions of closeness ofinteraction, even in business activities.

Classifications of Corporate Culture

A. Hofstede’s Classification

Value dimensions (factors):

1. Need for security – security is the assurance (or the lack of it) anemployee has
about the continuity of gainful employment for his/her work life. The security of this
job usually arises from theterms of the contract of employment, collective
bargainingagreements, or labor legislation that prevents arbitrarytermination, layoffs
(or retrenchment), and lockouts which are an industrial action involving the employer
withholding work andenies workers access to the place of work.
2. Work centrality – this refers to the theory surrounding work roleenter/centrality where
it is believed that the more broadlydefined worker’s job role is, the more likely he/she
is going toperform behaviours that are considered extra-role or go aboveand beyond
what is directly or explicitly recognized by a formalreward system, otherwise known
as “organizational citizenshipbehaviour” (OCB).
3. Need for authority – this is related to high uncertainty avoidance.

Practices:

1. Process-oriented vs. Results-oriented. In other words, stressand value are placed

either on the WAY in which things aredone or on WHAT isdone or accomplished.
 38

2. Employee-oriented vs. Job-oriented. In employee orientedcompanies greater value

is placed in the welfare of its workers; job-oriented organizational cultures that see
activities in theworkplace as “things or work that the employee can do”.
3. Parochial vs. Professional. Parochial cultures are whereidentity is derived from
within the organization (e.g. job status asa source of identity); professional culture is
where identity isderived from outside the organization (e.g. being a “family
man”shapes identity)
4. Open system vs. closed system. The former deals with “inclusiveness” where it is
easy to join and members quickly getup to speed; the latter pertains to
“exclusiveness” where it is difficult to join and only certain kinds of people fit in.
5. Loose control vs. tight control. Loose cultures stress casualness and improvisation;
tight cultures stress seriousness and punctuality;
6. Normative vs. Pragmatic. Normative cultures are ideologically driven; Pragmatic
cultures are market-driven.

B. Trompenaars & Hampden-Turner

1. The Family – this structure tends to be more personal, stressingthe importance of

hierarchical relationships (superior tosubordinate, mentor to protégé, etc.), and
power-oriented.
2. The Eiffel Tower – this structure is geared toward specificrelations, ascribed status,
and rational authority.
3. The Guided Missile – this organization is more egalitarian, impersonal, and task
oriented versus objective oriented.
4. The Incubator – this organization is geared more towardindividual self-fulfillment,
that is, it is highly individualistic asopposed to collectivist, personal and egalitarian
relations.

Layers of Culture

Ethnicity
Significant ethnic communities exist in many countries. In the U.S., Hispanic and Asian
communities have been growing rapidly, creatingsubcultures within the U.S. culture.
The large number of Filipinos inAmerica make up a significant portion of its growing
Asian subculture.While in Asia, the Chinese have constituted much of the business elite
inThailand, Malaysia, Indonesia, and the Philippines. Recently in thePhilippines, there is
a growing subculture of Korean emigrants into thecountry. Marketers and advertisers
are targeting these growingsubcultures and providing product variants that possess
characteristicsof their national preferences, e.g. Lucky Me JJampong noodles that
 39

aremore “Korean in flavour” and the more recent endorsement ad of RCCola featuring
Maja Salvador with a Korean teenager Kim Bum.

Such variations in demographics must be recognized by the MNE asthey are likely to
affect issues ranging from consumption patterns toemployee relations.

Industry
Industry makes up a very important layer in culture. For example, the high-tech industry
is considered flexible, informal, and innovative. It is also probably the most “global”
industry in the sense of people having shared values and (albeit electronic) interaction.
Such industries tend to have organizational patterns that are short and flat.

Profession also provides an important source of cultural affiliation. Common values and
norms shared by persons of the same professionacross markets in which an MNE
operates can facilitate global integration.

Demographics
Hofstede et al. found that education, age, seniority, and hierarchical level strongly
affected differences in values, although not differences in practices. For example,
Ralston et al. found the new generation of Chinese managers to be more individualistic
and adhere less to Confucianism than the previous generation. A concrete example of
how marketing activities have to be adapted according to the generation the firm is
targeting is the difference in interface preference between the baby boomers and the
Gen X or Gen Y. The former prefer face to faceinteraction when making purchasing
decisions. The two latter are muchmore comfortable with making purchasing decisions
on – line forexample, without the need to have a tactile or face to face interactionwith
the product they are purchasing. This explains the rise in trend ofinternet commerce
among younger people when it comes to fast movingconsumer goods.

These demographic subcultures can vary geographically, making the country unit less
homogeneous and making the MNEs integration morecomplex.

Ideology
A less stable, but nonetheless important layer of culture. For example, Maoist ideology
in China provided many beliefs and values in thecountry from the mid 1950s to mid
1970s. Ideologies are not alwaysconsistent with cultures and can vary along time and
across regions.Ideological and political differences between the communist
mainlandChina and free-market Taiwan are a prime example that countries withthe
same culture may still require the MNE to adopt different operational practices and
modes.
 40

Key Cultural Issues

Cultural Etiquette
Cultural or business etiquette refer to the manners and behavior that are expected in a
given situation, be it business negotiations, a supervisor-subordinate discussion of a
raise, or the behavior expected outside the workplace after business hours. The
violation of business culture is considered more offensive in some cultures, especially
those that are high in uncertainty avoidance or emphasize ritualistic behavior.

It is a good idea to acquire cultural knowledge, whether through formal training or

otherwise, before taking on a business assignment abroad orprior to other encounters
with foreign business people.

Cultural Stereotypes
Our view of other people’s culture is a function of our perceptions and stereotypes. To
an extent, we are ethnocentric, that is, we look at theworld from a perspective shaped
by our own culture and upbringing. Ethnocentrism, in turn, shapes our mental maps,
namely ourperceptions of the world around us and even out perceptions ofgeographic
realities.

Although we may not always believe our culture is superior, we use it asan anchor when
looking at ourselves as well as when interacting withothers. Stereotypes are our beliefs
about others, their attitudes, andbehavior. What is important to bear in mind is that,
although ourpredisposition to “judge a book by its cover” is never completelyremoved
from us, we should seek to cultivate an open mind to seek tounderstand the reasons or
the rationale behind the cultural expression.

Culture is all about meaning and harmonious inter-cultural relationshipsthat can only
spring from in increased understanding of each other’scultural context and values.

Auto-stereotypes are how we see ourselves as a groups and distinguished from others.
The following are examples of auto-stereotypes of U.S. Culture according to Adler and
Jelinek:

1. Distrust of others with a belief that individual change is possible.

2. Man mastering a predictable environment. Situations are problems to be resolved.
3. The individual above all else – hence, impermanence of relationships.
4. Emphasis on doing rather than on being.
5. A present to slightly future orientation; immediate gratification butchange is constant.

Hetero-stereotypes are how we are seen by others. Those who aremost different from
us will see elements in our culture that are differentfrom theirs. An example of this is
 41

Filipinos with a strong collectivistculture will tend to notice how different Americans are
in the sense oftheir “me first” individualistic attitude.

Stereotypes are important because they affect how MNE staff atheadquarters and in
various locations perceive other MNEs.

Cultural Distance
Cultural distance is a measure of the extent to which cultures differ from each other;
however, such measures that are typically built as a collection of Hofstede’s dimensions
are problematic.

Cultural distance plays a key role in MNE strategies and foreign investment. For
instance, familiarity theory which suggests that firm incrementally invest in culturally
distant locations is the rationale behind why firms start investing in markets with the
same preference (preference similarity) as the domestic market.

Convergence and Divergence

The convergence hypothesis assumes that the combination of technology and
economics is making countries more alike, and that with global integration of markets
and the diffusion of MNC practices, convergence will accelerate. The case for
convergence is made byglobal and homogeneous brands like Coca Cola or Nike. Their
products are sold with little adaptation. However, even Trompenaars andHampden-
Tuner posit that even the most global brands will inevitably besubject to cultural
variations. Although Coke is the same, wherever andwhenever in the world you buy it,
the manner in which it is advertised has grown more locally-responsive and divergent
over the years. In the Philippines alone, Coca-Cola ads have gravitated toward the
image of the “family repast” where member convent to re-charge and re-groupafter a
hard day’s work. Thus, in a highly-collectivist culture such as the Philippines’ Coca Cola
is marketed as a socially cohesive force, making people share meaningful time in
familial love.

The divergence hypothesis assumes that countries will continue to maintain their
distinctive characteristics, and that those differences may even be accentuated over
time.

THE POLITICAL ENVIRONMENT

Political behavior is defined as “the acquisition, development, securing, and use of
power in relation to other entities, whose power is viewed as the capacity of social
actors to overcome the resistance of other factors.” The number of political
constituencies – governments, political parties, interest groups, union, and public
 42

opinion – is multiplied in the international business arena. The MNE is often viewed as a
foreign implant, prompting domestic forces to unite against the foreign invasion.

Economists consider political processes as constraints on the free flowof production

factors, intermediary and final goods that distort supplyand demand. Government
incentives, preferential subsidies, and otherpolitical acts alter the transaction costs of
the firm and influence itsstrategic decisions.

Different players in international business have different agendas: importers will seek
tariff reduction, exporters will seek to reduce limitations on high-technology exportation
and domestic firms put political pressure on government to erect entry
barriers/obstacles to foreign opponents.

The historical landscape of political institutions and relations between and within
countries make up a crucial layer of the political environment. For instance, even after
40 years after the end of French colonial rule, former colonies in western Africa still
import their needs from France. India still prefers to import its knowledge-based needs
from its former colonial ruler, Great Britain, for the training of its call center
professionals. In addition to language, cultural affinity, and knowledge of the local
market (thus lowering the liability of foreignness), the trade andinvestment advantages
of former colonial powers is often the result ofpolitical pressure, i.e. grants or economic
aid packages that come with“strings attached” or conditions that the recipient country
must meet.

Affinity or animosity between nations reflect how closely aligned, orestranged, nations
are based on both history and political reality. It is an important determinant of
international business relations.

The U.S. and the U.K. share affinity and this is reflected in the volume oftrade between
the two. Inversely, the U.S. and rogue states like Cubahave trade embargoes.
Animosity and trade barriers can also createopportunities for those that act as
middlemen between the foes or thathave special access to one of the trading partners.

Political considerations also affect third parties. The U.S. has a history ofstrained
relations with Communist China regarding nuclear policy.Because of this, the U.S. felt
impelled to lobby the Israeli government tocancel the sale of airborne aircraft warning
systems to China, threatening to withhold economic aid to Israel if it were to push
throughwith the deal.

Political considerations also affect third parties. The U.S. has a history ofstrained
relations with Communist China regarding nuclear policy.Because of this, the U.S. felt
impelled to lobby the Israeli government tocancel the sale of airborne aircraft warning
 43

systems to China, threatening to withhold economic aid to Israel if it were to push

throughwith the deal.

MNE-Government Relationship-

The Institutional Context

The most important political challenge for the MNE is its relationshipswith home and
host country governments. Governments affect theeconomic and legal environment in
which the MNE operates. Some ofthe ways in which governments affect MNEs include
the setting ofmonetary and tax policies, setting price controls, enacting, endorsing,and
enforcing legislation (e.g. Intellectual property rights laws) andinfluencing labor
relationships.

Governments are also responsible for trade and investment policies,capital and
exchange controls, and transfer-pricing policies.

MNE Relationship with the Host Government

The nature of the relationship between MNEs and host governments canperhaps be
best described as competition. That is, cooperation andcompetition simultaneously
function in increasingly interdependent MNE-government relations. Cooperation refers
to the elements of mutualaccommodation and collaboration, with the government and
MNEseeking joint pay offs and goal accomplishment from theirinterdependent activities
and resources.

Competition refers to the elements of bargaining and control andrelated conflicts with
the government and the MNE, seeking privategains at the expense of the other’s
interests.

From the government’s viewpoint, the forces that encourage cooperation with MNEs
include

1. The increasing pressure of global integration – countries areincreasingly

interdependent, especially in an age ofincreasing regionalization. Cooperation with
MNEs canmake a country more competitive in international trade.
2. Heightened competition for inbound FDI – the morecountries there are aggressively
courting MNE to locateforeign operations in theirsovereignty, the more vital it is fora
government to encourage favourable relationships withprospective investors.
 44

3. Decelerated economic growth – growth can come throughforeign investment. The

creation of jobs, the entry ofcheaper products, the improvement of knowledge and
skillsets among a country’s citizens are all benefits that comewith the growth
inducing activities of MNEs.
4. Stronger need for upgrading economic structure – probablyamong the most
important form of diffusion that comes with the territory of opening a country up for
FDI is technologicaland knowledge-based diffusion. Economic structures are
upgraded by the inflow of new expertise that work towards the development of
nation’s infrastructure and overall capital capabilities.

From the MNEs viewpoint, the educational, technological, industrial, andfinancial

structures built by host governments, as well as their ability toprovide a stable set of
rules for business players to act within andwhether the rules can be adapted to
changing conditions is vital.

1. MNE Political Objectives in the Host Country. The main goal of the MNE in the host
country is to establish favourable tradeand investment environment, i.e.non
discrimination, namelyequal (if not preferential) treatment of the foreign firm.
Exceptwhere it seeks to erect an entry barriers against other MNEs,the MNE strives
to remove limits on foreign ownership, to openaccess to local markets (i.e. few or no
tariff or non-tariffbarriers), and to have as few regulatory hurdles as possible
2. Government Objectives.Local governments areinterested in protecting national
interest, especially where vitalinterests like national security are concerned. One
example is inVenezuela where dependence on oil as the major foreignexchange
earner means considerable government interventionin the form of taxation,
government participation in the industry,the protection of external markets and
prices.

MNE & its Home Government

The home government plays a vital role in facilitating the MNE political objectives. One
example is when President Clinton personally called theSaudi king on behalf of Boeing
to encourage the kingdom of Saudi Arabia to grant a contract to Boeing. The bigger the
magnitude, visibility, and he perceived threat to national security, the more likely the
government will intervene. The home government can also applypolitical pressure in the
closure of home market to competition in effortsto protect its own industries. Some
examples of steps/measures takenby governments to assist their firms operating in
foreign markets:

o Diplomatic or political pressure

o Commercial pressure (dumping)
 45

o Favors/gifts
o Tied aid (conditional aid given in exchange for something else)
o Pressures/legal issues

Coalition-Building & Influence Tactics

Nations and governments are collections of individuals, political parties, interest groups
and agencies that negotiate internally and externally to define their objectives and that
have different agendas. Policy consensus is thus a very attractive trait in a prospective
host country. The following are examples of coalition-building and influence tactics
employed by MNEs:

1. Appointing executives with political experience and contacts is proof of the

importance of political activities. E.g., when being appointed Thomas Pickering,
former Undersecretary for political activities, as senior vice president for political
affairs.
2. Channelling investment into regions and industries supported bya political party or
an influential constituency can build good will.
3. Coalition building often involves bringing on board local constituencies, often in the
form of alliance partners. Partnering up with domestic firms for strategic alliances
can accomplish many things for the MNE such as
1) reduce the risks of having to otherwise erect a Greenfield investment and incur all
risks and costs; and
2) Generate goodwill by partnering up with an esteemed domestic industry player.

Political Risk
This refers to the probability of disruption to an MNEs operations from political forces
and events and their correlates. Political stability is alsoabout a stable society, the
economic and regulatory climate, policy, continuity, and the likelihood of unforeseen
problems for both the traderand investor, but most especially for the latter because of
the resource commitment to the country. Political risk narrows the freedom to
makedecisions of the MNE. MNEs may end up refraining from investing in thehigh-risk
environment or seek a high premium to compensate for therisk.

Political risk factors include the prospect of an arbitrary decision bygovernment (e.g.
retroactive change in investment rules) and theundermining of property rights by the
court system. It is important tonote that a country need not be democratic to be ranked
a low-riskprospect. The Philippines is democratic country, and yet by thestandards of
the international community, the democracy in the countrycannot be considered
 46

as”thriving,” thus the relatively risky political statusof the Philippines despite its
democratic status. Further, political risk isnot purely in the realm of developing nations.

Measuring Political Risk

Measuring political risk is inherently difficult because the political landscape is
notoriously difficult to forecast. Change may come as aresult of a decision made by an
autocratic ruler (e.g. Saddam’s invasionof Kuwait) or it may be a political misstep.
Political risk can also materialize as a result of shifting power or balance. For instance,
Coca-Cola partnered with the son-in-law of the President of Uzbekistan and made him
president of its bottling division. However, when the son-in-law separated from the
president’s daughter, thecompany found itself being harassed by authorities.

The importance of political risk demands its assessment. The variousways to measure
risk can be classified into five categories:

1. Qualitative approaches in terms of statistical knowledge compilation

2. Aggregates of expert opinions. This will most likely be derived from intellectuals such
as historians, anthropologists, writers, and political analysts.
3. Scenario approaches. This is a corporate tool used to preparefor various
contingencies. Hypotheses are made as to possible political outcomes and plans are
made accordingly.
4. Decision-tree methods same as the ones used for business.
5. Quantitative techniques in compiling statistical data.

Types of Political Risk

There are three types of political risk:

1. Ownership risk represents a threat to the current ownershipstructure or to the ability

of the MNE to select or to shift to agiven governance structure. AN extreme form of
this is outrightexpropriation where the MNE is forced to divest its assets as aresult of
the host nation’s government decision to nationalize.This may or may not
carrycompensation.
2. Operational risk refers to any change to the “rules of the game”underwhich the
foreign firm operates (e.g., new and arbitrarytaxation), especially when foreign firms
are singled out. Forexample, Amway recently faced an effort on the part ofJapanese
authorities to curb the direct selling practices at thecore of its business model.
 47

3. Transfer Risk involves impediments to the transfer ofproduction factors such as

newly imposed capital controls. Forinstance, if a government prohibits the placement
of expatriatesin key positions in the MNE. This may present an operationalrisk
concerning the efficient operation and most of all technologyprotection.

Strategies for Managing Political Risk

To manage political risk, MNEs can do the following:

1. Minimize outright investment, e.g. leasing rather than buying.

2. Sign bilateral or multilateral treaties that protect mutual interests.
3. Identify or create reciprocal settings, e.g. where investment fromthe host country can
be retrieved in case of expropriation.
4. Avoid high-visibility acquisitions, e.g. the acquisition of firms orassets viewed as
national treasures.
5. Reduce exposure, e.g. by utilizing home country financing.
6. Accelerate profit repatriation.
7. Develop a staggered technology transfer policy.
8. Source locally. This reduces host country incentive to harm thefirm. Opt from
strategic alliances with a local partner. This doestwo things:pacify nationalist
sentiment; andlessen foreign investment outlay
9. Utilize agencies, e.g., take advantage of Overseas PrivateInvestment Corporation
which insures companies againstpolitical risk.
10. Build political support at home and in the host nation, e.g., lobbying, public relations,
and proactive social responsibility.
11. Monitor political and economic development, e.g., making use ofquantitative,
qualitative, and other forms of data and informationassessment tools.

The Legal Environment: The Institutional Context

The U.S. and other former British colonies such as Australia and NewZealand rely on a
common law system which originated in England.Common law is associated with an
independent judiciary relying oncase precedents. Also, ownership rights are affected by
actual use andare generally better protected. Common law also limits the range
ofevents that justify noncompliance to “acts of God” such as naturaldisasters.

In most of continental Europe and Latin America, the civil law systemwhich is used
originated in the Roman Empire. Civil law relies almostexclusively on the civil code and
 48

is applied universally. It is consideredless flexible than the common law system. Civil
law is associated withhigher government intervention.

Theocratic law is a system that relies on religious code. Countries thatuse theocratic law
include Iran, Saudi Arabia, and Qatar which rely onIslamic law as the basis of their legal
system. Indonesia only useslimited elements of Islamic law.

Other important differences in legal systems include the following:

1. Independent status of the judiciary. This about theclear separation of powers

between the people who create the laws and the people who administer it.
2. Enforcement. The differences in legal enforcementacross countries are related to
the degree ofdevelopment. Less developed countries tend to haveproblems with law
enforcement whereas developednations tend to be highly stringent law
enforcingsocieties.
3. The extent of reliance on the court as primaryconflict resolution mechanism. Case in
point is thecontrast between America and Japan. The former is considered to be one
of the most litigious countries inthe world, whereas the latter resolves conflict
throughmediation outside of courts.

Legal Jurisdiction
Legal jurisdiction – refers to the legal authority under which a legal casecan be
adjudicated or settled judicially. It is often difficult to determinelegal jurisdiction in
international business, especially for the MNE that issimultaneously subject to both the
laws of its home and host countries,and sometimes even to the laws of a third country.
These laws may bein conflict, where compliance with one legal jurisdiction will
invokeviolation or non-compliance of another.

Example: Compliance with the Arab boycott of Israeli products is a violation of U.S. law.
In this day and age, resolving jurisdiction for goods traded electronically is increasingly
problematic because it has become more difficult to determine the origin of
manufacturing, distribution, and consumption.

Regional Jurisdiction
At this level of jurisdiction, the MNE is subject to the laws and regulations of the regional
entity, such as the European Union, or of a trade framework like the ASEAN. The more
 49

integrated the region, the more important are the laws enacted at that level.
Increasingly, regional bodies are taking responsibility for the enactment and
enforcement of laws. Sometimes uncertainty prevails as to whether regional jurisdiction
supersedes national jurisdiction.

Example: As what is increasingly discovered in the EU countries, existing rules, such as

the French prohibition on importation of certain products, is at odds with the EU rule that
no country could limit trade in a product imported into the EU. Such French rules
prohibiting trade were incompatible with EU laws.

National Jurisdiction
MNEs must comply with both domestic jurisdiction at home and foreign jurisdiction
abroad; many of its foreign operations fall under domestic jurisdiction. One such
example is the Foreign Corrupt Practices Act that holds U.S. MNEs responsible for
bribery and related activities in their foreign operations. Recently, a 1789 law enacted to
protect foreigners from sea pirates was resurrected to prosecute U.S-based
MNEsaccused of unethical business practices. In another case, 18 U.S.-basedretailers
and garment manufacturers were sued on behalf of 50,000garment workers in Saipan.
These alien-tort (torts refer to private and civil offenses for which law may provide
monetary compensation, or damages, to the aggrieved party) precedents may mean
that in the future, MNEs will become more vulnerable to suits filed at home concerning
foreign operations.

Legal Issues of Interest to the MNE

The following examples of legal issues that are of particular concern to the MNE include
the protection of corporate and individual property, contract law, as well as restriction on
foreign asset ownership. For instance, the U.S. does not permit foreign entities to own a
majority-share in a U.S. airline just in case the aircraft are needed for emergency
deployment of American troops. This is why the U.S. blocked BritishAirways’ attempt to
acquire a controlling stake in U.S. Air, later namedU.S. Airways. Another example would
be when the U.S. ordered an immediate halt to the operations of Discovery Airlines, to a
Hawaii-based inter-island carrier when it was discovered that this was actually owned
by a Japanese corporation.

On similar grounds, the U.S. does not permit foreigners to own television and radio
stations. Rupert Murdoch, an Australian citizen and owner of News Corporation (which
 50

operates Fox television network) has overcome the restriction by becoming a

naturalized American citizen

Rule of Origin Laws

Product origin is important for determining duties or for measuring local content, a
frequent requirement in trade and FDI. Local content is particularly important in
developing economies. For example, India requires substantial local content for cars
produced domestically by foreign manufacturers.

Determining product origin is increasingly complex. U.S. Federal Trade Commission

determined that for a product to be labelled “Made in theUSA,” it must be “all or virtually
all” made in the U.S. The EU, on its part, uses 60 percent local value as a threshold.

Competition Laws
The following are competition laws that MNE should take care to note:

1. Antitrust Legislation & Enforcement – U.S. Antitrust legislation is the most advanced
and a model emulated by several countries. The U.S. Poses the most stringent
transparency requirements and is willing to enforce its authority abroad. For
example, the Securities and Exchange Commission filed a suit alleging fraud on the
part of German-based, U.S.-traded E. On for failing to disclose merger intentions.
American car maker Chrysler’s biggest shareholder, sued DaimlerChrysler for
allegedly concealing its takeover of Chrysler as a “merger of equals.” Antitrust and
takeovers are one area in which legal provisions can vary significantly across
nations, even within the EU. For instance, France Telecom which recently
purchased a 54 percent stake in Equant NV, did not have to make the same or
better offer to all shareholders as it would have to do if it acquired affirmation located
in the United Kingdom of Germany.
2. Subsidies – EU rules prohibit government subsidies that give an unfair advantage to
a firm from once country over another. The commission tried (but failed) to prevent
the French government from providing a hefty subsidy to Air France. However, the
commission seems less concerned with infringements detrimental to non-EU firms.
An example is whenU.S. Boeing contends that Airbus, a European consortium holds
an unfair advantage because it receives subsidies from German, French, Spanish,
and British governments of its partner firms. However, Airbus counter-argues that
 51

Boeing receives subsidies in the form of the U.S. government granting Boeing
permissions to use research and development and manufacturing techniques
developed for the military in their civilian aircraft production.

MARKETING AND DISTRIBUTION LAWS

National laws determine what is allowable in distribution, advertising, and promotion.
For instance, TV cigarette advertising is prohibited or strictly monitored in certain
countries. In Singapore, law mandates warningof the health detriments of the vice.
Norway does not permit two-for-one promotion. In Germany, comparative advertising is
prohibited; in China it is prohibited if the comparison reflects negatively on the other
product. In Japan and China, direct marketing/selling is prohibited, making it a huge
problem for companies like Avon, Mary Kay, and Amway that rely on the direct selling
model.

A special ruling that would be of interest to the MNE is a recent ruling bythe European
Court in favour of San Francisco-based Levi Strauss &Co. The court ruled against
British retailer, Tesco, which imported Levi’sfrom outside the EU, where the prices are
cheaper and undercut, theprices charged are by Levi’s in the EU. Pricing is a key
strategy of MNEswhich functions as part of brand positioning in different locations
around the world.

Product Liability Laws

Product liability laws tend to be stringent in developed countries such as the U.S. and
countries in the EU, but are lax or not enforceable in many developing economies. In
Japan, product liability cases are rarely ever brought on court due to the difficulty in
proving negligence. The Bridgestone/Firestone controversy revealed how much the
U.S. and Japan differed on product liability enforcement. The U.S had 47 people on the
National Highway Traffic Society administration while Japan had only 2 on top of the
fact that they lacked the authority to investigate and press for details.

Many foreign countries accept U.S. certification of product safety as a substitute for their
own, making it easier for U.S. firms to export their products. An exception would be
Japan, which does not accept U.S.product certification, presumably a form of non-tariff
barrier. Differences in the rigor and enforcement of product liability legislation presents a
temptation to reduce standards and a possible ethical dilemma in the case of safety
standards for the MNE.
 52

Treaties
Treaties are agreement signed by two or more nations. In the U.S.,treaties require
senate approval but executive agreements do not. A multilateral treaty that is ratified by
many countries with a joint interest in the issue at hand is called a law-making treaty.
Some international institutions such as the International Labor Office (ILO) have their
origins in multilateral treaties.

Treaties of Friendship, Commerce, and Navigation (FCN) provide firms from the
signatory countries with the same rights and privileges enjoyed by domestic businesses
in the other country. Many of those treaties contain a Most Favored Nation (MFN)
clause that entitles the signatory state to a treatment as favorable as that provided to
other countries.

Other treaties of importance include the Paris Convention for the Protection of Industrial
Property of 1883 which recognizes the use of the trademark in one signatory country as
a substitute for use in another signatory country.

Example: Both the U.S. and Canada are signatories to the said convention and if a
Canadian firm has used a trademark in Canada, it be granted use of the same
trademark in the U.S. without having to show prior use of this trademark in the U.S.

Patent Laws
Patent registration is nationality-based. A patent issued in the Philippines does not
provide protection from infringement in other countries. Separate patent application
must be made in each country –a costly and time-consuming investment.

Most patent systems outside the U.S. operate on a first to file rather thana first to invent
principle which underlies U.S. patent laws. First to file principle means that the first to
file a patent in a given country is awarded the patent, without need to prove that he/she
has been the inventor. First to invent grants the patent to the person capable of proving
his/her authorship of the invention. Finally, patents are granted for a limited number of
years, which varies from country to country, granting arbitrage opportunities.

ECONOMIC INTEGRATION & INSTITUTIONS-START HERE

Motivation: Ask the students the following questions to ascertain their familiarity with
regional trading blocks and the governing bodies that regulate and resolve disputes that
arise in trade:
 53

a. What does a country gain by joining a regional trading block?

b. What are the repercussions of joining an economic treaty?
c. Has there ever been a situation where in the joining of a treaty did not result in
equal or mutual benefit? What happened?

Once the level of understanding and familiarity of the students is ascertained, proceed
with the slide presentation. Explain to the class what economic integration is and what it
entails. Proceed to enumerate the five main forms of economic integration. The first
stage in italics is not going to be discussed as it technically does not entail the removal
of trade barriers. It merely reduces the tariffs on certain products given preferential
access within the participating countries. Tell the class that for this course, stages 2
onwards will be discussed in terms of the meaning of economic integration.

International Economic Integration

1. Preferential Trading Area
2. Free Trade Area
3. Customs union
4. Common market
5. Economic Union
6. Political Union

Types of Economic Integration

Preferential Free Trade Area

Free Trade Area is a type of trade bloc, a designated group of countries that have
agreed to eliminate tariffs or hindrances (amongst themselves), quotas and preferences
on most (if not all) goods and services traded between them.

Retain their freedom concerning their policy making vis a vis non-member countries.
They do not share a common external tariff; ergo, they have different customs and
quotas with regard to non-members.

This is the second stage of economic integration and is seen in the example of the Latin
American Free Trade Area (LAFTA), or the North American Free Trade Agreement
(NAFTA).
 54

Customs Union
Customs Union is a type of trade bloc which is a free trade area plus a common
external tariff (CET) on imports from non-member countries. Generally does not allow
free movement of capital and labor among member countries.

This is the third stage of economic integration and example of Customs Union includes
the Central American Common Market (CACM) and the Caribbean Community and
Common Market (CARICOM).

Common Market
A type of trade bloc which is composed of a customs union with common policies on
product regulation, and freedom of movement of the factors of production (capital,
technology and labor) and of enterprise This is the fourth stage of economic integration
and common example includes the Southern Common Market Treaty (MERCOSUR).

Economic Union
An Economic Union is a common market with provisions for the harmonization of certain
economic policies (Macroeconomic and regulatory/fiscal).

Participants introduce a central authority to exercise control over these matters.

Members become a virtual enlarged single “country” in an economic sense.

This is the fifth stage of economic integration.

Political Union
A type of state which is composed of or created of smaller states. The individual states
share a common government and the union is recognized internationally as a single
political entity.

International Economic Integration

Multilateral cooperation is another form of global integration in which participating
nations are bound by rules, principles, or responsibilities stipulated in commonly agreed
agreements. These are used to promote worldwide economic changes designed to
 55

govern over trade, service, and investments (WTO), capital flows and financial market
stability (WB& IMF), or specific areas of trade such as dealing with particular
commodities (International Coffee Agreement, OPEC).

International economic integration is propelled by three levels of

cooperation:

Institutions Affecting Global-Level Cooperation

The WTO, established on January 1, 1995, as successor the GATT, is amultilateral
trade organization aimed at international trade liberalization.

As of January 2003, the WTO had 146 members accounting from over95% of world
trade. More than 30 applicants are negotiating to be members. China and Cuba are
already members. The WTOs main objective is the establishment of trade policy rules
that help international trade and expand living standards. It pursues these objectives by:

WTO
The WTO, established on January 1, 1995, as successor the GATT, is a multilateral
trade organization aimed at international trade liberalization. As of January 2003, the
WTO had 146 members accounting from over95% of world trade. More than 30
applicants are negotiating to be members. China and Cuba are already members. The
WTOs main objective is the establishment of trade policy rules that help international
trade and expand living standards. It pursues these objectives by:

1. Administering trade agreements

2. Acting as a forum for trade negotiations.
3. Settling trade disputes
4. Reviewing trade policies
5. Assisting developing countries on trade policy issues, through technical assistance,
and training programs.
6. Cooperating with other international organizations.

The WTO has several other functions such as:

1. The reduction of import duties. The WTO imposes stepwise tariffreduction for
developing nations in need of a little help for the protection of their infant industries.
 56

2. Elimination of discrimination through Most Favoured Nation (MFN) policy or treating

everyone equally, and national treatments (where all products are considered
“domestic” once they cross national borders).
3. Combat various forms of protection and trade barriers, e.g., dumping.
4. Provide a forum for dealing with various emergency issues such as intellectual
property, the environment, economic development, regional agreements, unfair
trade practices, government procurement, and special sectors such as agriculture,
telecommunications, financial services, and maritime service.
5. Functions as a united dispute settlement system for members through its Dispute
Settlement Body (DSB). The DSB consists of representatives from every WTO
member. The DSB has the sole authority to establish dispute settlement panels, to
adopt panel reports, to monitor the implementation of rulings, and to authorize the
suspension of rights if its rulings are not acted upon by the member(s) in a timely
fashion.

IMF
The overall objectives of the IMF are to:

a) promote international monetary cooperation and expansion of international trade to

reduce the disequilibrium in members’ balance of payments;
b) help members defend their currencies against cyclical, seasonal, and random
currency fluctuations. The IMF pursues these objectives by:
1. Seeks to promote exchange stability
2. Maintain orderly exchange arrangements
3. Avoid competitive exchange depreciation
4. Provide confidence to member states by placing the generalresources of the fund at
the disposal of nations facing an economic crisis, subject to adequate safeguards.

Of 203, the IMF had 160 members accounting for over 95% of currency exchange. It is
headed by Board of Governors, composed of representative of all member nations. The
IMF is has the largest member: United States, United Kingdom, Japan, Germany,
France, and155 others.

WB
The World Bank refers to the International Bank for Reconstruction &Development;
together with its three affiliates, the International Development Association (IDA), the
International Finance Corporation(IFC), and the Multilateral Investment Guarantee
 57

Agency (MIGA), is known as the World Bank Group. The common objective of this
group is to help raise standards of living in developing countries by channeling financial
resources to them from developed countries.

The World Bank Group is owned by the governments of 160 nations. Its capital is
provided by subscription, and it finances its operations primarily through world capital
markets ad the interest payments from borrower nations. Loans are geared toward
advanced developing nations and must be used for productive purposes like financing
infrastructure, telecommunications, ports and power.

OECD
Established in December 1960, (Organization for Economic Cooperation and
Development) replacing the former Organization for European Economic Cooperation
(OEEC). Its mission is to aid the achievement of the highest and soundest possible
growth in economies of member countries and also of non-member states. Its
emphases are placed on:

1. Economic development
2. Employment expansion
3. Living standard improvement
4. Financial stability
5. Extension of world trade on a multilateral and non-discriminatory basis

UNCTAD
Established in Geneva on June of 1964, the UNCTAD (United Nations Conference on
Trade and Development) is in many ways a forum for an examination of economic
problems plaguing developing countries as well as for formulating, negotiating, and
implementing measures to improve the development process for these countries. Three
problems that developing nations can solve via the UNCTAD are:

1. Decreasing share in world trade and the deterioration of their terms of trade with
developed countries.
2. Closed markets of developed countries to the manufactures of developing
countries.
3. Inadequate aid given to developing countries.

The UNCTAD has reported a total of 109 agreements from 1947 to1994.
 58

WK 8

Post-War Regional Integration

Three features characterize post-war regional integration:

1. Post-war regional integration has been centered primarily inwestern Europe.

2. Many developing countries have renewed their interest inregional integration since
the Uruguay Round began.
3. Level of economic integration varies widely among different agreements.
4. Level of economic integration varies widely among different agreements.

Regional-Level Cooperation

North America
The North American Free Trade Agreement (NAFTA) was signed intoaccord on
December 17, 1992, by Canada, America, and Mexico. It is the first ever reciprocal free
trade accord between industrial countries and a developing one. This explains why it is
of special interest todeveloping countries.

NAFTA helps enhance the ability of North American producers tocompete globally and
by providing companies with a larger market,enhances economic growth despite the
fact that this increase in notequal among members. NAFTA dismantled barriers for
industrial goodsin included agreements on services, investments, intellectual
propertyrights, and agriculture.

NAFTA includes side agreements on:

1. Labor adjustment – this side agreement came in response to American workers

concerns that jobs in the United States would be exported to Mexico because of
Mexico’s lower wages, weak child labor laws, and other conditions that give Mexico
an advantage over the U.S. The side agreement is an attempt to manage the terms
of the potential change in labor markets. The agreement involves such issues as
restrictions on child labor, health and safety standards, and minimum wages.
2. Environmental protection – this side agreement explicitly ensures the rights of the
United States to safeguard the environment. NAFTA upholds all existing U.S. health
and safety and environmental standards.
3. Import surges – this side agreement creates an early warning mechanism to identify
those sectors where a sudden, explosive trade growth may do significant harm to
 59

the domestic industry. It establishes that in the future, a working group can provide
for revisions in the treaty text based on the experiences with the existing safeguard
mechanisms.

Europe
The European Community (EC) was established on January 1, 1995 with 15 member
states. These states constitute the core as well as the deepest level of European
economic integration. The most fundamental step in strengthening economic and
political ties among EC was the signing of the Treaty on European Union (or the
“Maastricht” Treaty). It does the following:

1. Promotes economic and trade expansion within a common market

2. Embraces the formation of a monetary union
3. Establishes a common foreign and security policy
4. Establishes common citizenship
5. Develops cooperation on justice and social affairs

The Maastricht Treaty contains high-impact provisions:

1. It creates a common European currency, known as the European Currency Unit

(ECU)
2. Every citizen in an EU member state is eligible to obtain a European passport
granting freedom of mobility within the EU.
3. Cooperation in the fields of justice and domestic affairs.
4. Empowers the union to play a more active role in areas such as trans-European
transport and environmental protection
5. Increases the power of the European Parliament to enact legislation
6. Removes all restrictions on capital movements between member states.
7. Establishes a central European Bank responsible for monetary policy, and
transforms the European Union into the European Economic and Monetary Union
(EMU) under which the currencies of the member states are tied irrevocably to one
another under the same exchange rate.

Asia Pacific
The Asia Pacific Economic Cooperation Forum (APEC) was founded in November 1994
and consists of 18 member nations. It is cross-regional, spanning Asia, North and South
America, and the Pacific. It consists of Australia, New Zealand, Canada, Mexico, the
 60

United States, Chile,China, Hong Kong, Japan, South Korea, Papua New Guinea,
Chinese Taipei (Taiwan), Indonesia, Malaysia, the Philippines, Singapore,Thailand, and
Brunei. In the 1994 summit declaration, the members agreed to build on commitments
they made in the Uruguay Round of the GATT, by accelerating their implementation,
and broadening and deepening commitments.

The Association of Southeast Asian Nations (ASEAN) was established on August 8,

1967. Its members are Indonesia, Malaysia, the Philippines, Singapore, and Thailand.
Brunei joined it in 1984. The aim of the ASEA is to promote peace, stability, and
economic growth in the region. Since January 1995, member countries began
earmarking products for low duty status from a list of 3,141 items. ASEAN countries had
to cut tariffs on various products such as cement, ceramics, chemicals,
pharmaceuticals, and dozens of others, in order to be a freetrade zone as of 2003.d

Asia is distinctive in a number of ways:

1. Many countries in the region have accelerated their trade liberalization at the sub
national level by authorizing export processing zones or special investment areas
within each country. The Standing Committee of the National People’s Congress
approved the establishment of four special economic zones are Shenzhen, Zhuhai,
Shantou, Xiamen. Thailand, Vietnam, Indonesia, Malaysia, India, Bangladesh, and
the Philippines have also established such zones in their own territories.
2. Many geographically proximate neighbours in Asia reached less formal trade
agreements. Members of the South Asian Association for Regional Cooperation
(SAARC) – Bhutan, India, Maldives, Nepal, Pakistan, and Sri-Lanka concluded a
trade agreement in April 1993.
3. Numerous sub regional economic zones have emerged. Intense trade and
investment flows have grown among geographically contagious, yet politically-
separated borders. These take advantage of the complementarity in factor
endowment and technological capacity among the different countries which are at
different stages of economic development.

Latin America
The Latin American Free Trade Association (LAFTA) and the Central American
Common Market (CACM) were established in 1960 – the former involving Argentina,
Bolivia, Brazil, Chile, Colombia, Ecuador, Mexico, Paraguay, Peru, Uruguay, and
Venezuela, and the latter consisting of Costa Rica, El Salvador, Guatemala, Honduras,
and Nicaragua. However, both failed to achieve their goals because of different
economic conditions and policies among member countries that worked against
regional integration.
 61

The Montevideo treaty established the Latin American Integration Association (LAIA) in
1980. Its goal was to increase bilateral tradeamong member countries, carried out on a
sectoral basis.

In 1991, the Southern Common Market (MERCOSUR) was established by Argentina,

Brazil, Paraguay, and Urugay. It called for a common market among the four countries
with free circulation of goods, services, capital and labor. Laso, the member countries
aim to coordinate macroeconomic policy and to harmonize legislation to strengthen the
integration process. Since January 1, 1995, MERCOSUR has used a common tariff
structure and common external tariff rates among itsmembers.

Africa & the Middle East

The Economic Community of West African Nations (ECOWAS) was established in 1975
composed of Benin, Burkina, Faso, Cote d’Ivoire, Mali, Mauritania, Niger, Senegal,
Guinea, Liberia, Sierra Leone, Cape Verde, Gambia, Ghana, Guinea-Bissau, Nigeria
and Togo. It eliminated duties on unprocessed agricultural products and handicrafts in
1981, and implemented free trade for all unprocessed products in 1990. Other activities
involve:

1. Progressive liberalization of industrial products.

2. Steps to avoid the use of hard currencies in intra-member trade through regional
payments clearing system.
3. Cooperation on industrial and agricultural investment products.

The Central African Economic and Customs Union (UDEAC) was established in former
French Africa in 1966 consisting of Congo, Gabon, Chad, the Central African republic,
Equatorial Guinea, and Cameroon. EDEAC provides the framework for:

 free movement of capital throughout the area

 for the harmonization of fiscal incentives
 coordination of industrial development
 its common external tariff (was introduced in 1990)

A common external tariff was established by four members of the community –

Cameroon, Congo, Gabon, and the Central African Republic in 1990.

The East African Economic Community (EAEC) was established informer British East
Africa in 1967 by Kenya, Tanzania, and Uganda. Its aims were to establish a common
market and the promotion of trade and economic cooperation. The EAEC was dissolved
in 1979 and the three members later joined other states to establish the Preferential
 62

TradeArea for eastern and southern African States (PTA) in 1981. Its goals include the
establishment of a common market and the promotion of trade and economic
cooperation among its members.

The Gulf Cooperation Council (GCC) was established in the Middle Eastin 1981 by
Kuwait, Saudi Arabia, Bahrain, Oman, Qatar, and the United Arab Emirates. It is a free
trade area covering industrial and agricultural products (excluding petroleum).

The Arab Maghreb Union (AMU) was also established in 1989 to lay the foundations for
a Maghreb Economic Area – a Pan0Arab trade agreement aiming for political unity in
North Africa. Its constitutive act aims to guarantee cooperation to:

1. Take part in the enrichments of international dialogues

2. Reinforce the independence of the member states
3. Safeguard their assets (phosphate, oil, and gas)

Commodity-Level Cooperation

OPEC
The Organization of Petroleum Exporting Countries (OPEC) is an inter-governmental
organization. It is the strongest collective force impacting prices in the international oil
market; it controls the price of oil in the world by assigning import quotas that limit the
international supply of oil. Their members consist of Iran, Iraq, Kuwait, Saudi Arabia,
Venezuela, Algeria, Ecuador, Gabon, Indonesia, Libya, Nigeria, Qatar, and the United
Arab Emirates.

OPEC became a catalyst for developing countries to ensure remunerative export

earnings for raw materials and tropical products.The International Bauxite Association
(IBA), and the Inter governmental Council of Copper Exporting Countries (CIPEC) were
formed in the1970s, following the OPEC model.

The Multifiber Agreement

This was originally signed in 1972. It is an agreement between exporting and importing
countries to control exports of textiles and apparel fromdeveloping countries to
developed countries. Its short term measure was to allow developed countries to adjust
to imports from the developing ones.

The MFS takes advantage of GATT rules that allow individual exporting countries to
establish quotas and other restrictions on textile and apparel exports that are traded
internationally. At the GATT Uruguay Round, the textile trade was brought under the
 63

jurisdiction of the WTO. The agreement provided for the gradual dismantling of tariffs
and quotas under the MFA. The United States currently imposes quotas on importsfrom
41 countries.

Strategic MNEs Response to Regionalization

MNEs are profoundly affected by international economic integration. MNEs have a
number of ways to properly respond to and benefit from increasing integration in a world
where national boundaries are becoming less relevant in the definition of market spaces
and regional areas are emerging as key economic arenas.

Economic integration triggers MNE activities, which then increase FDI inthe integrated
region. These strategies can be identified in response to regional economic integration.

Defensive Export Substituting Investment

This is a strategy by which MNEs defend their pre-existing market share achieved
through exports by switching to direct production inside the region.

E.g. Japanese car manufacturers Nissan, Honda, and Toyota’s FDI entry into the U.K.
Although they were late comers to the European market, having more of a trade-based
rather than investment based commercial relationship, defensive export substituting
investment now puts them in a strong position to compete in the E.U.

Offensive Export Substituting Investment

This is a strategy by which MNEs choose to ensure market penetration by investing
directly in the region before the region is officially integrated. It is intended to gain an
early position in the market, which is anticipated to grow rapidly as a result of an
integration program.

E.g. Coca-Cola gained an early foothold in the European market through aggressive
investment of more than $100 million in new European plants

Rationalized Foreign Direct Investment

This is a strategy by which MNE increase investment in, and heighten resource
commitment to the integrated region in pursuit of greater economic efficiency through
scale economies and market expansion.

E.g. IBM’s leadership in the European data-processing market was achieved through
establishing 12 new manufacturing plants, 9 new R&D facilities, 7 new scientific centers,
and a network of sales and support offices. IBM also invested more than $1 billion to
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upgrade its Canadian facilities, and now exports all high-technology components and
software made in Canada abroad.

Reorganization Investment
This is a strategy by which MNEs realign their organizational structures and value-
added activities to reflect a regional market. Firms realign investment capital among
members of the trading bloc once protective barriers have been removed altogether.
Under this strategy, MNE cross-border investment activity rises, while the aggregate
level of investment stock may not necessarily rise.

E.g. Philips’ reorganized as a collection of autonomous national subsidiaries. It

restructured to create an integrated set of Europe-wide, product-based companies.

WK 9

MONETARY SYSTEMS & FINANCIAL MARKETS

Terms of the International Monetary System

 Foreign Exchange rate (exchange rate) – is the price of one currency expressed in
terms of another currency expressed in terms of another currency.
 Par value – is the rate at which the currency is fixed.
 Floating/Flexible rate system – is when a government does not intervene in the
valuation of its currency.
 Real exchange rate – is the exchange rate after deducting an inflation factor.
 Nominal exchange rate – is the exchange rate before deducting an inflation factor.
 Devaluation – is the drop in the foreign exchange value of a currency that is pegged
to another currency or gold. Revaluation is its inverse.
 Depreciation – is the drop in foreign exchange value of a floating currency.
Appreciation is its inverse.

History of the International Monetary System

The International Monetary System refers primarily to the set of policies, institutions,
practices, regulations, and mechanisms that determine foreign exchange rates. This
system is comprised of currencies from individual countries as well as some composite
currency units such as the European Currency Unit (ECU) and the Special Drawing
Right (SDR)

The following are periods in the history of the international monetary system that will
help appraise the strengths and weaknesses of different foreign exchange rate systems:
 65

The Gold Standard Period (1876-1914) – the Gold Standard gained acceptance as an
international monetary system in 1870s. Under this system, each country pegged its
money to gold. For instance, if the Philippines set its fixed price of gold at P1,000 per
ounce and the U.S. pegged its rate at $ 20 per ounce, then the exchange rate between
these two countries would be the ratio of P1,000/$20 = 50. The government of each
country using the gold standard agreed to buy or sell gold on demand at its own fixed
parity rate. Thus, the value of each individual currency in gold terms and the fixed parity
between countries remained stable. It was important that a country had enough gold
reserves to back its currency’s value.

The War Years and World War II (1914-1944) – during World War I and the early 1920s
currencies were allowed to fluctuate over fairly wide ranges and terms of both gold and
equal among members. NAFTA dismantled barriers for industrial goods in included
agreements on services, investments, intellectual property rights and agriculture. These
fluctuations hampered world trade in the 1920s, there by contributing to the Great
Depression in the 1930s. From 1934 –the end of World War II, exchange rates were
determined, theoretically, by its value in gold. However, in the aftermath of World War II,
many of the main trading currencies lost their convertibility into other currencies. The
dollar was the only major trading currency that continued to be convertible.

The Bretton Woods System (1944-1973) – commencing the year prior to the end of
World War II, this period was characterized by a fixed exchange system. The Bretton
Woods Agreement, signed in 1944, had the pledge of each government to maintain a
fixed or pegged exchange rate for its currency vis a vis the dollar or gold. During this
period, the U.S. dollar as the main reserve currency held by central banks and was key
to the web of exchange rate values.

The Post Bretton Woods System (1973-Present) – this periodis characterized by a

floating exchange rate system. SinceMarch 1973, exchange rates have become much
more volatile and less predictable than they were during the “fixed” exchange rate
period. The system became increasingly volatile nearing the oil crisis in the fall of 1973.
By 1974, oil prices had quadrupled. Efforts to offset the effect of higher energy bills, the
U.S. boosted spending but this only resulted in inflation and vast deficits in the balance
of payments. This caused the dollar crisisof 1977-1978. Despite the rebounding of the
dollar from 1981-1985 due to the successful economic policy of Ronald Reagan (high
interest rates, foreign capital inflow, economic expansion), the dollar resumed its
downslide. In February of 1987, theGroup of & (G-7) met and agreed to slow the dollar’s
fall. This agreement is known as the Louvre Accords and it called for the G-7 to support
the falling dollar by pegging exchange rates within a narrow, undisclosed range.
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Contemporary Exchange Rate Systems

Fixed Rate System

Under this system, governments regulate the rate at which their currency is exchanged
for other currencies. Governments buy or sell their currencies in a foreign exchange
market whenever exchange rates deviate from their stated par values. For instance, the
government of North Korea mandates that foreign exchange earnings to be surrendered
to the central bank, which in turn pays the firm a corresponding amount in local
currency. Often, the central bank allocates these foreign-exchange incomes to state-
owned users on the basis of government priority.

Advantages:

1. May help economies stabilize their economic development.

2. Emphasize priority projects that need foreign exchange.
3. Control foreign exchange reserves.

Disadvantages:

1. Resource misallocation
2. Distortion of foreign exchange demand and supply
3. Drag on company performance

Currently, a purely fixed-rate system is employed in Cuba and NorthKorea.

Crawling Peg System

This system is situated between the fixed-rate and float-rate systems. It is an automatic
system for revising the exchange rate, establishing a par value around which the rate
can vary up to a given percentage point.The par value is regularly revised according to
a formula determined by authorities. Once this is set, the central bank will intervene
whenever the market value reaches a limit point. For instance, if the hypothetical value
of the Philippine Peso is marked at P42.00 for one U.S. dollar andit can vary at +/- 2
percent around this rate, between 41.16 and 42.84.IF the peso approaches 41.16, the
Bangko Central will begin to sell pesos and buy dollars. If it hovers around a limit point
for too long, causing frequent central bank intervention, a new par value closer to this
point is established.

A government can peg its currency to either another single currency orto a “basket” of
foreign currencies. Other countries peg their currency toa composite blanket of
currencies, where the basket consists of aportfolio of currencies of their major trading
partners. The base value ofsuch a basket is more stable than any single currency. A
country can peg its currency to the standard basket such as the Special Drawing Rights,
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or SDR (e.g. Libya and Myanmar), or to its own basket, designed to fit the country’s
unique trading and investing needs (e.g. Bangladesh, Cyprus, Czech Republic, Iceland,
Jordan, Kuwait, Nepal, Thailand, and Morocco.)

Target Zone Arrangement

It is virtually a joint float system cooperatively arranged by a group ofnations sharing
some common interests and goals. Under it, countries adjust their national economic
policies to maintain their exchange rates. Such an arrangement exists in the European
Monetary System (EMS).The EMS is, in essence, a peg of each country’s currency to
all others, as well as a joint float of all member currencies together against non-EMS
currencies. If the Deutsche Mark is pegged at 2.0583 per euro and the French Franc is
6.90403 per euro, the DM is equal to 0.29816 per French franc.

The Target Zone Arrangement helps minimize exchange rate instability and enhance
economic stability in the group (zone).

Disadvantage of this system is it is difficult for every member to maintain the central
exchange rate for a long period of time and when one of the currencies in the zone is
attacked, defence is more costly. This is owing to the differences in national policies,
economic development, and tradestructure.

Managed Float Systems

This is also known as a dirty float, employed by governments to preserve an orderly
pattern of exchange rate changes and is designed to eliminate excess volatility. Each
central bank sets the nation’s exchange against a predetermined goal, but allows the
rate to vary. The rate change is not automatic based on the government’s view of an
appropriate rate in the context of the balance of payment position of the country.

The rationale for the managed float is to improve the economic and financial
environment by reducing uncertainty. Government intervention may reduce exporters’
uncertainty caused by disruptive exchange rates.The challenge behind this approach is
to define just what is “excessvolatility.” Also, it is questionable if governments are more
capable than markets in determining what is fundamental and what is temporary and
self-correcting.

Independent Float System

Also known as a clean float, under this system an exchange rate is allowed to adjust
freely to the supply and demand of this currency for another. There is no need for an
economy to undergo the adjustment process set in motion by a decrease or increase in
money supply. Examples of countries that use this system include U.S. and Peru. This
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category contains currencies of both developed and developing nations. The central
banks of these countries allow exchange rates to be determined by market forces alone.
Although some central banks may participants in the free market in an occasional, non-
continuous manner.

Advantages & Disadvantages of Float System

1. The flexible exchange rate system provides a less painful adjustment mechanism to
trade imbalances than do fixed exchange rate systems and prevents a country from
having large persistent deficits. It will only lower the exchange rate value of a
currency rather than require a recession to reduce the real income or prices when
trade deficits arise.
2. These do not require central banks to hold foreign exchange reserves because there
is no need to intervene in the foreign exchange market. Ergo, the problem of
insufficient liquidity (foreign exchange reserves) does not exist with the truly flexible
ones.
3. These avoid the need for strict import and export restrictions that are prone to
criticism and retaliation. These regulations are costly to enforce and are prone to
retaliation from partner countries.
4. These systems help ensure the independence of trade policies. If the U.S. allows
rapid growth in the money supply, this will tend to raise U.S. prices and lower
interest rates, short-term. The former will cause a deficit in the in the current account
and the latter will cause a deficit in the capital account,

Among the disadvantages are:

1. It is limited in balancing trade after a certain period of time. Depreciation or

devaluation of a currency will help the balance of trade if it reduces the relative
prices of goods and services that are locally produced. However, after a short period
of time, domestic prices of tradable goods will rise following the upward pressure on
wages. If a 1 percent depreciation/devaluation raises production cost by the same
percentage point, and if real wages are maintained, then nominal wages must rise
by the same amount of depreciation/devaluation.
2. Flexible rates could make it more difficult for government to control inflation and also
create less motivation for governments to combat it.
3. Free float rates may cause more uncertainty which may hamper the growth and
stability of economies vulnerable to international financial and export markets.
International speculators can cause wide swings in the values of different currencies.
For instance, international speculators can cause wide swings in the values of
different currencies.
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Determination of Foreign Exchange Rates

The determination of a country’s foreign exchange rate should satisfy two basic
questions:

1. How is the base rate between this country’s currency and foreign countries’
determined?
2. How does a nation’s exchange rate change over time (flows)?

No single general theory is available to forecast exchange rate under all conditions.
Nevertheless, it is widely agreed that the Purchasing Power Parity principle helps
explain both the stocks and flows of exchange rates.

The purchasing power parity approach (PPP) approach emphasizes the role of prices of
goods and services in determining exchange rates, whereas the interest rate parity
(IRP) focuses on the role of capital movements.

Purchasing Power Parity (PPP)

This principle suggests that the exchange rate between two currencies should, in the
long run, reflect purchasing power differences; that is, the exchange rate should
equalize the price of an identical basket of goods and services in the two countries. This
principle has two perspectives toward purchasing power parity:

Absolute PPP states that the exchange rate is determined by the relative prices of
similar baskets of goods and services.**

Relative PPP It suggests that if the exchange rate between two countries starts in
equilibrium, any change in the differential rate of inflation between them tends to be
offset over the long run by an equal but opposite change in exchange rate.**

Interest Rate Parity (IRP)

Weaknesses of IRP:

a. The IRP also faces deviations due to transaction costs and tax factors in financial
markets.
b. Political risks can also cause deviations because investorsexpect to be
compensated for the greater risk of investment in aforeign country.

Related to the International Fisher Effect which addresses the relationship between the
percentage change in the spot exchange rate over time and the differential between
comparable interest rates in the different national capital markets (involving securities
with maturities ofover a year). This also posits that the spot exchange rate should
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changein equal amount to (but opposite in sign of) the difference in interest ratebetween
two nations.

Exchange Rate Implications for MNEs

Because of fluctuating exchange rates, forecasting entrails the followingactivities on the
part of its managers:

 Be aware of both economic and non-economic fundamentals

 Be aware of government declarations and agreements regarding exchange rate
goals.
 Make reference to forward or black market exchange rates that are used as
reverence for managerial floating exchange.
 Look at the country’s foreign exchange rate system
 Ascertain if governments are capable of controlling domestic inflation, in order to
generate hard currency reserves to use for interventions, and to run trade surpluses
 Focus on inflationary fundamentals, PPP, and economic health indicators

Balance of Payments
The Balance of Payments is an accounting statement that summarizes all the economic
transactions between residents of the home country and those of all other countries. It
reports the country’s international performance in trading with other nations and the
volume of capital flowing in and out of the country.

Balance of payments uses the system double-entry bookkeeping which means that
every debit or credit in the account is also represented as a credit or debit somewhere
else. Currency inflows are recorded as credit (plus sign); outflows are recorded as debit
(minus sign).

A standard balance of payments includes current account, capital account, and official
reserves account.

Current Account
The current account records the flows of goods, services, and unilateral transfers (gifts).
It includes exports and imports of merchandise (trade balance) and service transactions
(also known as invisible items). The following are additional notes:

 The service account includes various service income and fees.

 Tourism income, financial charges, and transportation charges are part of service
income.
 71

 The investment income account separates investment income from service income,
and it records income receipts on the country-owned assets abroad and income
assets on foreign-owned assets within the country.
 Unilateral transfers include pensions, remittances, and other transfers for which no
services are furnished.

Capital Account
The Capital Account records private and public investment for lending activities and is
divided into portfolio and foreign direct investment. Foreign branches, wholly-owned
subsidiaries, and joint ventures are typical forms of direct investments.

Foreign bonds, notes, or mutual funds are examples of portfolio investments in so far as
they confer no management or voting rights on their owners. The portfolio account
includes both short-term and long-term investments or lending.

Government’s borrowing and lending are also included in the capital account.

Official Reserves Account

The official reserves account records net holdings of the official reserves held by a
national government. Reserves include special drawing rights (SDR), reserve positions
in the IMF, and convertible hard currencies.

To most countries, foreign currency is by far the largest component oftotal international
liquidity. Governments normally keep foreignexchange reserves in the form of foreign
treasury bills, short-term and long-term government securities, Euros, and the like.

International Foreign Exchange (Forex) Markets

International Financial markets, like international monetary systems, play a crucial role.
International monetary systems and international financial markets are inherently linked
such that the former impact company decisions or firm operations through the latter.

International firms all over the world face many opportunities and threats arising from
the international financial markets, which are determined at least partly by monetary
systems.

International financial markets are composed of two things:

1. International foreign exchange markets

2. International capital markets (in the form of
a) int’l moneymarkets;
b) int’l stock markets;
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c) int’l bond markets; and

d) int’l loan markets.

Landscape of the Foreign Exchange Market

The Foreign Exchange Market is where foreign currencies are bought and sold. It is the
physical and institutional structure through which currencies are changed, exchange
rates determined, and foreign exchange transactions completed.

A foreign exchange transaction is an agreement between a buyer and a seller for the
delivery of a certain amount of one currency at a specified rate in exchange for another
currency.

Global foreign exchange business is concentrated in four centers: London, New York,
Tokyo and Singapore. Together, they account for about two-thirds of total reported
turnover.

Market Participants & Functions

The market for foreign exchange consists of individuals, corporations, and banks and
borrowers who buy or sell currencies. Currency trading in each country is conducted
through the intermediation of foreign-exchange brokers.

The Society for Worldwide International Financial Telecommunications (SWIFT) link the
banks all around the world via telephone, internet, telex and satellite communications
network.

The exchange Market in each country has its own identity and institutional and
regulatory framework. Efficient communication systems are vital as they can substitute
for participants’ need to convene in a specific location (bourse).

The Foreign Exchange market performs three major functions:

1. It is part of the international payments system and provides a mechanism for

exchange/transfer of the national currency of one country into the currency of
another country.
2. It assists in supplying short-term credits through the Eurocurrency market and swap
arrangements.
3. Provides foreign-exchange instruments for hedging against exchange risk.

Foreign Exchange Quotations

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WK. 11

INTERNATIONAL TRADE PATTERNS & OPPOSITION TO TRADE

International Entry Strategies

International entry strategies are concerned with:

 Where (location selection),

 When (timing or entry), and
 How (entry mode selection) companies should enter and invest in a foreign territory
during international expansion.

These strategies are vital because they have consequences on the MNEs business
environment or that overall “state” of the market inwhich the MNE must contend with
unique challenges associated with early growth, or mature markets, the operational
treatment, or the internal activities of the MNE that will have to adjust in terms of
structure depending onhow the MNE chooses to enter (e.g. joint venture or Greenfield),
resource commitment, or how much money will be invested in the hot country and in
what form.

Example: A good example of this is illustrated by DuPont’s entry into China. DuPont is
one of the world’s oldest and largest industrial corporations manufacturing materials like
Lycra spandex fiber. It entered China as an early mover, establishing for itself a strong
market position and creating entry barriers for all the subsequent entrants into the
chemical and energy industries. However this entry was not sudden. Investment in
China came in incremental stages, with DuPont opting first for exporting, then followed
by minority joint ventures, then majority owned joint ventures, and eventually wholly-
owned subsidiaries. This evolutionary path blended well with the firm’s experience and
capabilities with the risks it had faced in the past.

International Location Selection (Where)

International location selection involves country selection and regional selection (e.g.,
state, province, or city) within the chosen country for an MNEs foreign direct investment
project(s). The country selection decides the macro environment for operations in a
specific site.

Example: Motorola chose the city of Tianjin as its major production base in China
instead of Beijing or Shanghai, which are more expensive, Cosmopolitan cities. The
specific regional location selection within the country of China worked well for Motorola
because this base accounted for more than 1- percent of the firm’s worldwide revenue
in 2002. Managers should first evaluate locational determinants that are likely to
 74

influence future operations and expected returns. These locational determinants and the
decision framework are generally applicable to both country selection and region
selection. Country selection should emphasize nationwide factors whereas site
selection should focus more on related factors specific to that region.

Location Determinants
The specific locational determinants managers need to consider when calculating
expected costs and payoffs from a prospective foreign location include:

 Cost/tax factors – this will naturally apply to all kinds of costs such as production
factor costs, and costs for training personnel, etc.
 Demand factors – will the host country market actually generate ample demand for
the MNEs product or service?
 Strategic factors – will entering this particular location serve the Company
strategically in terms of gaining/defending market share?
 Regulatory/economic factors – is the host country market economically stable and
are the economic policies of government contributing to its growth?
 Socio political factors – is the host government politically stable/unstable,
clean/corrupt?

The various cost/tax factors that will influence location selection for the MNE are as
follows:

Transportation costs – or country selection, these costs include the costs of transferring
materials from a home country to the host country or transporting products from a host
country to a home or international market. For site selection, the convenience and costs
of various modes of transportation (air, sea, railway, highway, etc.) from the prospective
site to destinations of major local and foreign customers should be calculated.

Example: When the Ford Motor Company entered the UnitedArab Emirates (UAE), it
chose Dubai due to its convenience andlow cost connection to the rest of the country
and the world.

Wage rate – MNEs are more likely to locate production operations abroad rather than at
home when the labor costs in the candidate host country are lower. Labor costs sway
the investment location decisions of MNEs that are especially in labor-intensive
industries like garment manufacturing.

Example: Nike has located its 13 footwear and 14 apparel factories along the Pearl
River Delta in China because of thelow wage rate of workers.
 75

Availability and cost of land – availability of suitable plantsites, cost of land/real estate,
space for expansion, local government policies on renting/purchasing land are al critical
factors in the early stages of project development and the late stages of project
operation. In some instances, this consideration may overwhelm other location factors
since it influences other costs such as transportation and construction.

Example: Mercedez Benz selected Alabama in the U.S. as its production site for sport
utility vehicles (SUVs) because the Alabama state government provided the company
with 1,000 acres of land between Tuscaloosa and Birmingham.

Construction costs – construction accounts for a substantial portion of capital

investment, especially for MNE opting for Greenfield investment rather than renting or
forming a partnership with an already existing firm with production facilities. Different
sites vary in the cost of construction materials, labor, land, equipment rental, and quality
of construction.

Example: Burger King opted to enter the European market viainternational franchising –
a strategy that entails the franchisee, or the one who purchased the franchise, to incur
the costs and capital outlay. Burger King‘s entry mode decision was affected by the high
construction costs in Europe.

Cost of raw materials and resources – MNEs are increasing the percentage of local
outsourcing in total production. Localization reduces the uncertainties associated with
foreign exchange risks and improves relationships with local governments and
indigenous firms. In these circumstances, costs of local materials and resources needed
in production will affect the firm’s gross profit margin. IKEA, for instance, buys 90
percent of what it sells from closely monitored suppliers in many countries – mainly
developing ones like Poland and China.

Financing costs – the cost and availability of local capital are of vital importance to the
MNE. Local financing provides much of the capital needed for mass production and
operations and helps MNEs mitigate possible financial risks arising from fluctuations in
foreign exchange rates and uncertain foreign exchange policies as well as political risk
in a host country.

Example: A pharmaceutical and chemical company, entered Brazil, it specifically chose

Rio de Janeiro, Sao Paolo, Recife, and Campinas because local banks were very
supportive in financing Merck’s investments or expansion.

Tax rates – both statutory and effective tax rates affect firm profitability. The former rate
determines the general level of tax burden shouldered by firms; the latter tax rate is the
statutory corporate rate adjusted for all other taxes and subsidies affecting an MNEs
taxable income (investment tax credits, tax breaks, accelerated depreciation) and
 76

determines the company’s net return from its revenues. MNEs must assess both the
statutory and effective tax rates as these two may differ among regions of the same
country as is the case in China, Brazil, and Indonesia.

Investment incentives – many countries, especially developing ones, compete against

each other in terms of attracting FDI to their domestic economies. These countries often
offer preferential incentives to foreign investors and these incentives that attract FDI can
include tax breaks or reductions on income taxes, financial assistance in terms of
financing, wage subsidies, investment grants and loans, tariff concessions such as
exemption from or reduction of duties on imports, business assistance such as
employee training, R&D support, land grants, site improvements, and site selection
assistance, and other such incentives as infrastructure development and access, legal
services, business consultation, and partner selection assistance.

Profit repatriation – repatriation is the return of a financial asset (such as earnings) from
a foreign country to a firm’s home country. Repatriation restrictions have a negative
impact on the net income or dividends remitted to foreign headquarters. Restrictions
can include a remittance tax on cash repatriated to a home country or a ceiling on the
cash amount. Other restrictions can include administrative or bureaucratic rules wherein
investors must obtain approval from the central bank or foreign exchange administration
department to repatriate dividends. Currently, profit repatriation restrictions have been
gradually removed in many developing countries, however, restrictions on foreign
exchange flows still abound in countries like Russia, China, and India where currency
conversion occurs at formally set exchange rates by government.

The following are examples of demand factors that affect the locationselection for
MNEs:

Market size and growth - At the national level, the size and growth rate of markets
signal opportunities and potential in the market.

Example: Pfizer selected India to produce multivitamins targeting India’s 300 million
middle class consumers. Similarly, Toys “R” Us chose Japan in 1990 due to its booming
economy and strong consumer spending. On the subnational level, the per capita
consumption, average income growth, and growth rate of consumption in respective
regions may be more accurate factors for measuring market potential and growth.

Presence of customers - MNEs may find it ideal to locate manufacturing sites in the
area where long standing customers are situated. The closer operations are to major
buyers, the better the cost efficiency (e.g. transport costs), and marketing effectiveness.

Local competition - The intensity of local competition in the host country or region is vital
to the MNE as it directly impacts a firm’s market position and gross profit margin from
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local sales. MNEs generally gravitate toward places with relatively low competition
unless they have the resources to face aggressive competition and ensure competitive
edge in the market against rivals both domestic and foreign.

Example: Coca-Cola made substantial new investments in the east coast provinces of
China in the 1990s and Pepsi Co. decided to expand in the inland provinces to pioneer
in this new territory.

The following are examples of strategic factors that affect the international location
decision of MNEs.

Investment infrastructure - Infrastructure conditions include transportation (highways,

ports, airports, and railroads), telecommunications, utilities, and governmental
efficiency. Most especially for international traders, infrastructure will necessarily have
to include the availability of international seaports and import/export facilities since most
FDI projects have operational linkages with home and other international markets. For
instance, when Hewlett Packard (HP) entered Mexico, it did not choose Mexico City but
chose instead Ciudad Juarez which was near the metropolitan area and had excellent
infrastructure conditions such as access to roads and airports, support from local
authorities, superb export processing environment, and the availability of information
technology industry.

Manufacturing concentration - Existing manufacturing activities is one of the major

determinants of location selection. MNEs can save money by being in close proximity to
manufacturers. A country or region with a strong concentration of manufacturing
activities in certain industries or products ismore likely to have an adequate labor pool
and supply network supporting production or operations.For instance, Otis, worldwide
leader in the manufacture of people-moving products including elevators, escalators
and moving walkways, opted for Leningrad as its primary manufacturing center in
Russia because of itiswell-established supply network for materials andcomponents, as
well as it skilled laborers and technicians that are integral to Otis ‘Just-In-Time system.

Industrial linkages - This refers to the nature and quality of complementary industries
and special services such as distribution, consulting, auditing, banking, insurance,
marketing services, etc. MNE operations interact actively with these complementary
industries in a host country and are directly affected in terms of how these industrial
linkages determine the firm’s ability to pursue value adding activities. For instance, Mary
Kay cosmetics located its business center in Buenos Aires which serves Argentina,
Uruguay, and Chile, having considered the favorable industrial linkages in the city.

Workforce productivity - International production requires high workforce productivity

and superior labor skills. The labor requirements of new systems and techniques are
driving the need for a better educated direct-labor workforce. Just-In-Time (JIT) and
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Total Quality Management (TQM) systems pace great importance on the flexibility of
workers and their ability to operate under growing autonomy. The increased complexity
of product and process technologies has also increased skill requirements. Overall, the
availability of skilled managerial, marketing, and technical workforce is also crucial as
they are important factors in determining competitive advantages in the market.

Inbound and outbound logistics - Inbound and outbound logistics include proximity to
suppliers and sources of raw materials and inputs. With the growing percentage of local
sourcing, MNEs have to critically consider these types of logistics when choosing a
location. Outbound logistics are based largely on proximity to major consumers and
buyers and this factor can heavily influence the firm’s consumer responsiveness. Strong
outbound market logistics will also affect the firm’s success in pursuing market
penetration andproduct specialization strategies. For instance, a main reasonwhy
Procter & Gamble (P&G) chose Mexico City as its majorproduction base was the
effective inbound and outboundlogistics which satisfy P&Gs need for production and
marketing.

The following are examples of regulatory and economic factors thatinfluence the
international location decision.

Industrial policies – industrial policies typically include antitrust rules, project approval
and registration, categorization of industries and treatment differences among
categories, and varying value-added tax. These policies are used to control new
entrants, net profit margins, degree of competition, structural concentration, and social
benefits. MNEs need to ensure that the target country or region allows foreign business
entry and that industrial policies are reasonably favorable or at least not a hindrance.For
instance, Lucent technologies, a telecommunications company, moved into Brazil after
the Brazilian government announced the “Real Plan” in 1994 which devalued its
currency (real), privatized telecom services, and offered more favorable treatments to
new entrants into the telecom infrastructure sector.

FDI policies – FDI policies can impact an MNEs plans and payoffs. MNEs should first
know what entry mode is allowed. MNEs might only be allowed to enter the country or
region through certain entry modes such as minority-owned joint ventures.

Secondly, a host government might mandate MNEsto locate projects in certain

geographical regions to help boostparticular regional economies.

Thirdly, MNEs should checkcontent localization requirements.The required level

oflocalization varies across countries or industries and MNErequirements on the use of
local materials, parts, semi-products,or other supplies made by indigenous firms for
production of itsfinal inputs also vary.
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Fourth, MNEs need to identify anygeographical restrictions imposed on the breadth of

the market.For instance, prior to China’s entry into the WTO, foreign bankswere allowed
to provide services only in the city in which theywere located.

Finally, MNEs must evaluate foreign exchangecontrol measures in the host country as
these may hinder thefree inflow and outflow of foreign capital and income.

Availability of special economic zones – special economic zones such as free trade
zones (FTZs), special economic zones (SEZs), economic and technological
development zones (ETDZs), high-tech development zones (HTDZs), open economic
regions (OERs), bonded areas, and so on are some examples of special economic
zones. Generally, these zones provide preferential treatment in terms of taxation, import
duties, land use, infrastructure access, and governmental assistance to MNEs.
However, many of these zones are regulated regarding eligibility for preferential
treatment. For instance, Chinese ETDZs must export 75v percent of output or bring in
advanced technologies as verified by government authorities.

The following are examples of socio-political factors that determine location selection.

Political instability- This factor reflects the uncertainty over the continuation of present
political and social conditions and government policies that are vital to the survival and
profitability of an MNEs operations in the host country. Possible changes that may affect
the international firm’s operations can include problems with the repatriation of earnings,
or in extreme cases, expropriation of assets. Today, notwithstanding the prevalence of
international lobbying, the magnitude of politically induced environmental uncertainties
still overwhelms transaction related risks that affect MNE operations.

Cultural Barriers - This factor determines the organization’s ability to adapt to the social
context of a host country. The other correlates of culture, language and religion, might
affect the location decision in varying degrees. The former will naturally affect
communications; the latter might be more influential in countries that follow theocratic
laws such as many Arab nations. Inter-subsidiary and intra-subsidiary communications
are vital to business success.

Local business practices - Some forms of business practices are culture-specific and
they constitute a form of knowledge that MNE must acquire. IT is important to note that
a prominent underlying logic of engaging in international cooperative ventures with
developing country enterprises is to gain suchcore country-specific knowledge.
Company-specific competencies like superior technological and organizational skills do
not guarantee success unless these are integrated with country-specific knowledge.
The MNEs ability to integrate country-specific knowledge with firm-specific knowledge is
integral to its survival and growth in foreign markets.
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Government efficiency and corruption - The “soft” infrastructure (e.g. regulatory

environment and government efficiency) is perceived as having a greater and more
enduring impact on an MNE than the “hard” infrastructure (transportation and
communication) of a host country. Efficient and uncorrupt governments are more
responsive to an MNE’s requests or complaints, take shorter time periods for ratifying
projects, and provide superior assistance and support in various matters. Corruption in
government implies low efficiency, red tape, high costs of bribery in setting up
governmental linkages in order to obtain project approval, infrastructure access, and
scare resource acquisition.

Attitudes towards foreign business - Social and governmental attitudes toward foreign
business often have consequences onthe MNEs operations and management. If society
and government of a host country have a somewhat friendly view of foreign businesses,
MNEs will benefit from the environment and this may have an enduring effect in the
firm’s operations and commitment of employees to the foreign firm. For instance, Burger
King selected the Dominican Republic because of itsgovernment’s positive view of the
United States and Americanproducts.

Community characteristics - Community environment aspects such as community size,

educational facilities, housing facilities, police and fire protection, climate, suitability for
expatriates and their families, facilities for children, social environment for spouses,
hotel accommodations, crime level, and other quality of life indicators are things that
should be considered in site selection. This environment is highly relevant as it will
naturally affect costs, quality, and security of living for foreign expatriates and their
families.

Pollution control - Prior to making a site selection decision, an MNE should appraise
environmental laws and regulations, assess whether the firms is able to comply with
them, and evaluate whether it is financially feasible to invest in pollution control. For
instance, Rubber maid chose to invest in Poland as it central site in Eastern Europe
because of its relatively low standard in pollution control.

Decision Framework
The preceding section covered the locational determinants that must beassessed in
choosing a location. Such determinants constitute the core in the framework of the
location decision-making process. In tandem with these, the MNE must also take into
account the strategic objectives, global integration, and market orientation.
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Location and strategic objectives

Demand factors and strategic factors appear to be the most critical considerations to the
MNE if it wishes to pursue market growth and competitive position in a host country.
These factors generally concern long-term investments and operations. If an MNE
seeks short or middle-term profitability, it should attach more value to cost and taxation
factors, as well as infrastructure conditions and investment incentives.The costsof
production factors and operational expenses affect the gross profit margin, whereas
income tax will affect the net return. Remittance taxes on profit repatriation will naturally
affect the level of dividends that the parent firm will receive. Additionally, socio-political
factors will affect the stability of the environment in which the MNE strives to operate.
Macroeconomic factors such as exchange rate and inflation are related to
environmental uncertainty, and as such, should be included in the analytical framework
of a firm that seeks to diversify risks. Finally, strategic factors such as industrial
linkages, competition intensity, cultural distance, and attitudes toward foreign
businesses are all factors affecting location choice for the MNE that wishes to secure
innovation, learning, and adaptation from international expansion.

Location and global integration

For the MNE, location selection now involves regional bloc selection, country selection,
and site selection. In selecting a regional bloc, managers can review the preceding
determinants at the integrated bloclevel (e.g. EU versus NAFTA) and find out how
removed or lessened inter-country barriers within the bloc reduce cost and tax burdens
and change the regulatory or economic framework of the region. Today, MNE use host
country sites to achieve global integration and/or regional integration. MNEs also tend to
locate labor-intensive processes in sitesthat are well-endowed with ample labor or
locate R&D facilities where abundant technological capabilities exist. It is vital for
managers to locate projects in sites that provide a conducive environment for integrating
operations with the rest of the MNE network. For instance, when Cisco entered France,
it built distribution centers in Toulouse, which serve not only France but also the Middle
East. Today, Cisco distributes it products mostly through consolidated sites in
respective regions.

Location and market orientation

Market orientation is concerned mainly with whether an MNE targets ahost country
market, export market, or both. Local market-oriented projects are highly sensitive to
demand and strategic factors in the local environment. Regulatory/economic factors
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affect a firm’s stability and exposure of its operations to environmental turbulence.

Socio-political variables as we’ve discussed will also have more of an impact on a local
market orientation than on an export orientation. By contrast, the export orientation will
rely more on cost/tax factors, along with strategic factors such as investment incentives,
input logistics, labor productivity, and infrastructure. For instance, many U.S. companies
relocate their production facilities just south in the U.S.-Mexico border. These firms
benefit from lower labor costs, reduced transportation costs, eliminated tariff burdens
and logistics inconvenience. For the dual emphasis orientation, it is influenced by all five
group factors. Dual emphasis orientation necessitates the most comprehensive
schemes in the appraisal of location determinants. This is the strategy Lei Strauss
employed when its three manufacturing facilities in Mexico were located for their
proximity to California and Mexico City.

Timing of Entry (When)

Timing of entry refers to the sequence of anMNEs entry into a foreign market vis-a-vis
other MNEs (i.e., first mover, early follower, late mover). Timing of entry will determine
the level of risks involved, the nature of the environment, and the opportunities that
MNEs might have to confront.

Transnational investors are likely to have more pre-emptive investment opportunities in

foreign markets as opposed to home markets. They are able to take advantage of
structural discrepancies. Also, a late mover inthe home country might become an early
entrant in the host country and could thus enjoy more favorable business opportunities
that exist in the early stages of the industry life-cycle.

The decision on when to invest abroad is based on an entrants' assessment of entry

barriers erected by a host government and existing firms, relative to the advantageous
factors promoting entry. Prospective market entrants weigh the expected benefits
versus the costs of entry. Entry occurs when the former outweighs the latter.

Pioneering MNEs (first mover or early follower) generally have advantages when
entering a foreign market. Such advantages include greater market power, pre-emptive
opportunities, and strategic option over late entrants.

Among the examples of market power are the following:

1. Opportunity to erect entry barriers to subsequent followers. This can come in the
form of creating strategic alliances with already existing players that will make it very
difficult and costly for a new entrant to imitate or match.
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2. Gaining technical leadership through investing in research facilities, patentable

technologies, etc.
3. Establishing customer loyalty by creating buyer switching costs, or the costs incurred
when switching between brands that are not compatible.
4. Product positioning. For instance, Citibank and Bank of America were early movers
in the Latin American market. The two erected branches or offices in Mexico City,
Buenos Aires, Sao Paolo and Santiago. They dominated these markets
largelybecause of the market power they obtained from an early-entry position. This
market power was further strengthened when they erected entry barriers against late
movers by acquiring local banks, partnering with VISA international, creating
innovative banking services via cable TV, and extending their network type presence
almost everywhere.

Pre-emptive opportunities include pre-empting of marketing, promotion, distribution

channels while gaining product image, organizational reputation, and brand recognition.
For instance, Toys “R” Us entered Japan in May 1990 after the Japanese Ministry of
International Tradeand Industry (MITI) relaxed regulations and restrictions in the retail
toy industry. The company’s success can be attributed to, in part, the first mover
opportunities it seized such as pre-emptive marketing and promotion, as well as brand
recognition and pioneer reputation.

Strategic options that are open to early movers include having more options in choosing
industry location, having priority access to natural resources, scarce materials,
distribution channels, promotional arrangements, and infrastructure. Also, early movers
have greater options to select better local firms for equity/contractual joint venture offor
supply-purchase business relations. For instance, Charoen Pokphand (CP) one of the
world’s largest agro-industrial firms from Thailand entered China in 1979 and was able
to set up joint ventures with the best local firms in their respective regions. Further, early
movers get to enjoy an environment with a relatively low level of competition. For
instance, when Wal-Mart was among the first foreign superstores to enter Korea, China,
Costa Rica, Argentina, Germany, etc., the only competition the company faced during
early years wasfrom some indigenous department stores in major metropolitan areas.

Even when not forming alliances, early movers are still in a better position to deal with
competition from local firms than late entrants asthey are able to maximize core
competencies in a market with weak competition and domestic players who cannot
match those core competencies.

Early Mover Disadvantages

Early movers also experience their share of disadvantages. Pioneer investors are
confronted with greater environmental uncertainty that comes with:
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1. Underdeveloped FDI laws and regulations – these would naturally refer to the laws
and regulations that would protect the investment interest of MNEs and contribute to
greater transactional transparency and protection from corruption in government
agencies, etc.;
2. Host government’s lack of dealing with MNEs. This can manifest itself in the host
government’sinability to provide MNEs with the support it needs to legalize and
make its activities operational in the host country; and
3. Infant or embryonic stages in the industry or market of the host country. This can
manifest itself in a market lacking “critical” demand for a novel product that would
cause a behavioral change in the consumers.

Operational risks include:

1. Learningor adaptation costs. Many earlymovers are compelled to investin the

building of industrial infrastructure (e.g. supply bases and distribution networks) and
technological or service standards.
2. Local training costs – this was the case with the earliest Business Process
Outsourced Contact Centers established inthe Philippines that had to undertake
more extensive training programs for employees.
3. Anti-imitation costs – these are the costs associated with having to fight followers
who imitate the MNEs strategies or innovations, counterfeit their products, or infringe
on their industrial or intellectual property rights.

Such was the case when Phillip Morris entered the Russian market with its under-
enforced and underdeveloped legal systems. Up to 30 percent of tobacco sold in the
streets was counterfeit and it proved very costly for Phillip Morris to protect its leading
brands.

Because of the preceding risks, uncertainties, and costs, pioneering MNEs tend to
select joint venture mode for FDI entry, although thismode of entry has its share of
challenges that come in the form of divergent objectives between partners, the pursuit
of self-interest ratherthan common goals, and lack of autonomy among local partners. In
thismanner, late entrants encounter fewer risks as that are usually able toestablish
wholly-owned subsidiaries.

Entry decisions must be made after evaluating costs versus benefits and then prudently
timed. After evaluating the advantages and disadvantages of the timing choice,
international managers must consider other factors in formulating timing strategy such
as:

1. The MNEs technological, organizational, and financial resources or capabilities.

These resources and capabilities determine an MNEs ability to reduce early-mover
risks andseize pre-emptive investment opportunities. Pioneer entrants must
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recognize investment opportunities and this depends on the investor’s foresight,

skills, resources, and good fortune.
2. Host country environment in terms of infrastructure,industry structure, market
demand and governmentalpolicies. Another set of organizational skills a pioneer
entrantmust have is the ability to cultivate relationships with localauthorities and
handle environmental changes. For instance,Motorola has been successful at being
the first mover in manyemerging markets due to its accumulated experience in a
largenumber ofdevelopingcountries, especially its experience indealing with local
governments andcommunities. Changingenvironment may also mean changing
windows of opportunity.First mover advantages may disappear and
unanticipatedopportunities may emerge. In such cases, organizationalflexibility is
integral to a firm’s success in a dynamicenvironment. An example of this is when
Philip Morris entered Russia as a first mover and built two projects: PM Izhora
inLeningrad and PM Kuban in Krasnodar. The two projects wereset in such a way
that PM Kuban would switch from producingcigarettes to processing raw tobacco for
PM Izhora if localsuppliers were unable to supply processed tobacco or if thelocal
market became more restricted.
3. Potential competition from late foreign entrants as well aslocal entrants. MNEs must
necessarily study the strengths andweaknesses of potential rivals in areas such as
technology, production, marketing, and capital.When a window ofopportunity opens
for an investor, it must decipher whether itshould enter the foreign territory as a first
mover or earlyentrant and then whether it has the capacity to sustain
competitiveadvantage from the time of its entry. If the answer is yes, thenthe next
questions that need to be answered are how to enterthe host market (what
pioneering strategy) and how will it bestexploit the opportunity. If the investor
chooses not to be anearly mover, it must decide how and when to follow.

Entry Mode Selection (How) - Any global firm that seeks to pursue aforeign market will
have to make important strategic decisionsconcerning which entry mode is best to use.
Entry modes are specificforms or ways to enter a target country to achieve strategic
goals thatunderlie the rationale of international presence in the host country.There are
three kinds of entry modes:

1. Trade-related
2. Transfer-related
3. FDI-related

Along this sequence, resource commitment levels, extent of organizational control, risks
entailed, and expected returns all increaseand within each category, the levels will also
vary between specificmodes of entry.
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Trade Related Entry Modes: Exporting

o Exporting does not require a very substantial presence in foreign countries, thus
minimizing cost outlays.
o It enables firms to gain valuable expertise about operating internationally.
o It gives firms specific knowledge about specific countries in which it operates.
o It is virtually open to any size or kind of firm.

A firm can either export goods directly to foreign customers or buyers orthrough export
intermediaries. Export intermediaries are third parties that specialize in facilitating
imports and exports. A typical example of this would be an export management
company (EMC) which is an intermediary that acts as the client’s export department.

Managers involved in exporting must know the terms of sale or the conditions stipulating
rights/responsibilities and costs/risks borne by exporter and importer. Major terms
include:

o Free on Board (FOB)– term of price in which all costs and risks up to point whereby
the goods are delivered onboard the ship in a designated shipment (export) port are
covered by the seller. Subsequently, the buyer bears all costs and risks, insurance
and freight expenses from that point on in transporting the goods from the shipment
port to the destination port.
o Free Alongside Ship (FAS)– term of price wherein the seller answers for all the
costs and risks up to the side of the ship in a designated shipment (export) port. All
risks and costs thereafter are borne by the buyer.
o Cost, Insurance, & Freight (CIF)– term of price wherein the seller covers the
insurance,cost of goods, transportation, and all miscellaneous charges all the way
up to the named foreign port in the country of final destination.
o Cost & Freight (C&F) – this is similar to CIF except for the fact that the buyer
purchases and bears the insurance.

There is also a number of key documentation used in reporting thatexport managers

should be familiar with. They are the following:

o Letter of credit (L/C)– this is a contract between an importer and a bank which
transfers liability for paying the exporter from the importer to the importer’s bank.
o Bill of lading (B/L)– this is the document issued by the shipping company or its
agent as contractual evidence for shipping the merchandise and as a claim to the
ownership of the goods.
o Bank draft– this is a bill of exchange which a bank draws on itself whereby a
customer (the drawer) requests a draft, the bank then withdraws amount of the draft
from the drawer’s account and holds it to honor the draft on its presentment by the
drawee.
 87

o Commercial invoice– this is a document required by customs todetermine the true

value of imported goods in order to assess duties and taxes.
o Insurance credit– also known as credit insurance or trade credit insurance, this is
an insurance policy and risk management product that covers the payment risk
resulting from the delivery of goods and services.
o Certificate of origin– this is a document that certifies a shipment’s country of origin.

Trade-related Entry Modes: International Subcontracting

International subcontracting generally is the process in which a foreigncompany

provides a local manufacturer with the raw material, semi-finished products,
sophisticated components, or technology forproducing final goods that will be bought
back by the foreign company.In most cases, local manufacturers are only responsible
for processingor assembly in exchange for processing fees.Thus, the localmanufacturer
does not own the property rights to the materials or partssupplied by the foreign
counterpart.For instance, Nike usessubcontracting in Vietnam, China, and Bangladesh
to name a few,where the firm provides technology and raw materials but
maintainsproprietary rights over the products, controls production, and productquality,
and gives local factories processing fees.

Original Equipment Manufacturing Method (OEM) is one specificform of international

subcontracting where a foreign firm supplies a localcompany with the technology and
sophisticated components so that thelatter can manufacture goods that the foreign firm
will market under itsown brand in international markets. For instance, Flextronics,
aSingapore-based company is the world’s third largest subcontractor inelectronics to
clients like GE, Honeywell, Compaq and Nortel to name afew.

Trade-related Entry Modes: Countertrade

Countertrade is a form of trade in which a seller and a buyer fromdifferent countries

exchange merchandise with little or no cashequivalents, changing hands. Due to its
nature, it is also viewed as aform of flexible financing or payment in international trade.
There arefour distinct types of trading arrangements under countertrade:

o Barter – this is the direct and simultaneous exchange of goods between two
parties without a cash transaction. For example, France shipped 138,067 tons of
soft wheat to Cuba in exchange for sugar and agricultural products from Alimport,
Cuba’s government-run food trading company.

Counter purchase– this is a reciprocal buying agreement where one firm sells its
products to another at one point in time and is compensated in the form of the other’s
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products at somefuture time. For instance, Russia purchased constructionmachinery

from Japan’s Komatsu in return for Komatsu’sagreement to buy Siberian timber. This
form of countertrade ismore flexible than barter because the volume of trade (i.e.
indollar value) does not have to be equal.

o Offset – this is an agreement whereby one party agrees to purchase goods

andservices with a specified percentage of its proceeds from an original sale.
Like counter purchase, this involves three contracts including sales, protocol, and
purchase, but unlike counter purchase, products taken back in offset are the
outputs processed by this party in the original contract. For instance, the
Shanghai Aircraft Manufacturing Corp, China may buy jets from Boeing, using its
proceeds from manufacturing the tail sections of the jets for Boeing.
o Buyback (or compensation) – this occurs when a firm provides a local
company with inputs for manufacturing products (mostly capital equipment) to be
sold in international markets, and agrees to take a certain percentage of the
output produced by the local firm as partial payment. This type of agreement
involves the sales contract and the purchase contract. In this arrangement, the
equipment supplier gets a cash portion in addition to the goods. For instance,
Chinatex, a Shanghai-based clothing manufacturer and Japan’s Fukusuke Corp.,
arranged a buyback whereby the latter sold 10 knitting machines and raw
materials to the Chinatex in exchange for 1 million pairs of underwear to be
produced on the knitting machines.

Transfer-related Entry Modes

Transfer-related entry modes refer to the modes that transfer ownershipor utilization of
specified property (technology or assets) from one partyto another in exchange for
royalty fees. This differs from trade-relatedentry modes in that the user in a transfer-
related entry mode “buys”certain rights of transacted property from the other party
(owner). These modes are extensively used in technology-relatedintellectual/industrial
property rights-related transactions and include thefollowing types:

o International leasing – this is where the lessor (foreign firm) leases out its new or
used machines or equipment to the domestic firm(often situated in a developing
country). Such international leases occur mainly because manufacturers from
developing nations do not have the capital to pay for the equipment. Under the
lease contract, the foreign firm lessor is paid the leasing fee by the domestic firm
and retains ownership of the property throughout the leasing period. For the MNE
lessor, this mode of entry enables it to:
 have quick market access
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 make efficient use of its superfluous or outmodedequipment

 accumulate experience in a foreign country

From the domestic firm’s point of view, this mode helps:

 Reduce the cost of using foreign machinery andequipment

 Mitigates operational and investment risks
 Increases it knowledge and experience with foreigntechnologies and facilities.

For instance, in the 1970’s Japan’s Mitsubishi leased 100 newand used heavy trucks to
Chinese companies in industries suchas mining, construction, and transportation.

International licensing – this is an entry mode wherein aforeign licensor grants a local
licensee the specified intangibleproperty rights to the local licensee for a stipulated
period oftime in exchange for a royalty fee. These property rights caninclude:

 Patents
 Trademarks
 Technology
 Managerial skills, etc.

The licensor grants the licensee the right to produce and marketa product similar to the
one the licensor has been producing inits home country without requiring the licensor to
actually createa new operation abroad.

The main pursuit of an MNE in using licensing could be anyamong the following:

 Obtain extra income for technical expertise andservices, amortize thecosts of

company research anddevelopment programs, or maximize return on
researchfindings and accumulated expertise;
 Retain established markets that are threatened by traderestrictions or have been
closed, reach new marketsthat are rendered inaccessible by export from
existingfacilities or quickly expand into foreign markets withminimum risk or effort;
 Augment limited domestic capacity and managementresources for serving foreign
markets, provide overseassources of services and supply to important
localcustomers, or to develop market outlets for components and raw materials
made by the domestic company;
 Augment limited domestic capacity and managementresources for serving foreign
markets, provide overseassources of services and supply to important
localcustomers, or to develop market outlets for components and raw materials
made by the domestic company;
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 Discourage the possibility of impairment, infringement,or loss of company patents or

trademarks, or acquirereciprocal benefits from foreign expertise, technicalservices
and research.

From the MNEs view point, these are the possible draw backs ofthis entry mode:

 Income from licenses is generally lower than that which can be derivedfrom
franchising or FDI entry modes.
 Loss of quality control because of difficulty for the licensor to monitor the licensee
manufacturing and marketing operations.
 Licensee can become potential competitor in the future due to the benefits gained
form technology improvement from licensor.

o International franchising – this is an entry mode wherein the foreign franchisor

grants the franchisee specified intangible property rights (e.g., trademarks, brand
name) in exchange for a royalty payment amounting to a percentage of the
franchisee’s revenues. The franchisor obligates the franchisee to operate the
business under the former’s proprietary rights and to adhere to the procedures
and methods of operations prescribed in the business system.

For the MNE franchisor, the implications of this mode of entry include:

 The involvement of longer commitments

 Greater control over overseas operations
 Inclusion of a broader package of rights and resources
 The possibility that the franchisee may damage the franchisor’s image bynot
upholding its standards

Among the advantages of this mode are:

 Little political risk

 Low costs
 Fast and easy avenues for leveraging assets such as brand name or trademark

o Build-operate-transfer (BOT) – this is a “turnkey” investment that involves the

assumption of responsibility for the design and construction of an entire
operation, and once the project is completed, the turning over of the project over
to the purchaser and handing over of management to local personnel trained by
the foreign investor. In exchange for project completion, the investor receives
periodic payments that are normally guaranteed. BOT is relevant in large scale,
long-term infrastructure project such as power-generation, dams, expressways,
airports, steel mills, and chemical plants.
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FDI-Related Entry Modes

FDI-related entry modes concern the ownership of assets, property, projects, and
businesses invested in a host country. In undertaking FDI, firms will control overseas
operations and economic activities. FDI-related entry modes entail continuous
contribution and commitment to investments and operations abroad. FDI-related entry
modes include:

o Branch office - These are foreign entities in a host country that exists as an
extension of the parent and is legally constituted as a branch. In some countries,
corporate law allows foreign firms to open branches that engage in production
and operating activities. Branch offices are entitles to run businesses with a
specified scope or location. Businesses that utilize branch offices are:
 Transnational banks,
 Law firms,
 Accounting or
 Consulting companies

Often, branch offices provide parent firms the means to establish or expand presence in
a target country. Because such branches do not have legal-person status, the foreign
parent company remains liable if any civil charges are brought against the bank. In
order to prevent parent firms from unlimited damage claims, foreign firms interested in
establishing branch offices may designate an offshore subsidiary that can act as parent.
For instance, the first McDonald’s restaurant in Russia was launched by its Canadian
subsidiary.

Cooperative (or Contractual) Joint Venture - This is a Collaborative agreement wherein

profits and other responsibilities are assigned to each party according to contract.
These may not necessarily accord with each partner’s percentage of the total
investment. Each partner retains its separate legal identity and bears its own liabilities.
Cooperative joint ventures normally take the form of a document (cooperative
agreement) whereas equity joint ventures take the form of a new entity. Common
examples are:

 Joint exploration (e.g., offshore oil exploration)

 Research partnership
 Co-production
 Joint marketing
 Long-term supply agreements
 Technological training or assistance
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Equity Joint Venture - This involves the establishing of a new entity that is jointly owned
and managed by two or more parent firms in different countries. In this arrangement,
each partner contributes.

 Cash
 Facilities
 Equipment
 Materials
 Intellectual property rights
 Land or land—use rights

According to joint venture laws in many countries, foreign investor’s share must exceed
a certain threshold of the total equity, e.g., 25 percent in many nations and generally
there exists no upward limit in deregulated industries in most countries. Broadly
speaking, cooperative joint ventures and equity joint ventures are called Global
Strategic Alliances(GSAs).These alliances are increasingly important as competition
intensifies.

o Wholly-owned subsidiary - This is an entry mode wherein the investing firm owns
100 percent of the new entity in a host country. It may take the form of:
 Greenfield investment – a new entity built from scratch
 Cross-border acquisition – acquiring a local business

This mode of entry allows the MNE the following advantages:

 Increased flexibility and control for foreign investors

 Allows international managers autonomy in decision-making without the burden of
an uncooperative partner
 Allow foreign investors to set up and protect their own processes and procedures

International managers must be aware of the following concernsprior to embarking on

wholly-owned subsidiary form of entry:

 Wholly-owned subsidiaries are dependent on indigenous agents to make liaisons on

their behalf and help procure land, materials, and services
 These subsidiaries may not always be allowed to invest and operate in industries
that are vital to host country economy
 These subsidiaries cannot operate without the control of local partners
 These subsidiaries are more vulnerable to criticism relating to cultural and economic
sovereignty.

There are a number of ways in which an MNE can set up a wholly-owned

subsidiary.This can be done through either:
 93

 Greenfield investment – an initial establishment of fully-owned newfacilities and

operations undertaken by the company alone.
 International acquisition – a cross border transaction in which a foreign investor
acquires an established local firm and makes the acquired local firm a subsidiary
business within its global portfolio. Additionally, international acquisition of a
domestic firm or another foreign company with local ventures is the quickest way to
expand one’s investment in a target country. Acquisition provides the following
advantages:
o Useful in entering sectors formerly restricted to state-owned enterprises
o Quicker generation of cash flow since the acquired company does not have to
be built from scratch
o Offers immediate access to a local acquiree’s existing resources such
asmanufacturing facilities, land, distribution and supply networks, skilledlabor,
and customer base
o An international merger shares the logic of equity joint ventures and is across-border
transaction in which two firms from different countries agree to integrate their
operations on a relatively co-equal basis because they have resources and
capabilities that together may create synergies in the global marketplace.For
instance, the 1998 merger of Daimler-Benz of Germany and Chrysler of the United
States was the largest international corporate marriage in history.Cross border
mergers can generate the following positive outcomes:
o Inter partner learning and resource sharing
o Elevating economies of scale or scope
o Reducing costs by eliminating expenditures for redundant resources
o Capturing greater market share by providing more comprehensive offerings
o Increasing revenue by cross-selling products to cross-border customers

The main difference between equity joint ventures and mergers is that the former
involves the creation of a third legal entity whose duration is for a limited time scope.
Joint venture parents retain their individual legal identities whereas in mergers, the
partners are combined into l one legal entity.

 Umbrella holding company - This is an investment company that unites the firm’s
existing investments under one umbrella so as to combine sales, procurement,
manufacturing, training, and maintenance within the host country. This form of
entry is particularly useful for multidivisional MNEs, where each division enters
and runs differently while the umbrella holding company coordinates them.
Advantages of this entry mode include:
o Helps improve the cash flow and capital structure of various investments by
acting as a clearing house forintra-group financing
 94

o Repatriation of profits can be more easily transferred amongdifferent strategic

business units (SBUs)
o Smooths the establishment of new investments

Foreign investors might consider this form of entry mode to achieve the following
objectives:

WK 11 p. 22of 24

WK 12 GLOBAL OPERATIONS MANAGEMENT

In global trade, it is very important that we know how to deal with different situations that
may arise on our way of penetrating the global market.

Managing Global Strategic Alliances

There are a variety of management issues that are necessarily involved in global
strategic alliances and each of these represent a vital area of concern for the parent
firms not just in terms of the success of the strategic alliance but also of the future
repercussions and long term effects, whether detrimental or beneficial, for each of the
parent firms even long after the strategic alliance has expired.
 95

The management issues that are of major concern in GSAs include the following:

o Managing inter-partner learning

o Exercising managerial learning
o Accentuating cooperation and trust
o Thinking ahead of exit

Managing Inter-Partner Learning - GSAs can create unique learning opportunities for
partner firms. Because alliances involve inter-partner sharing of resources, this access
can provide a powerful source of new knowledge. Learning opportunities can be
manifested in two areas:

1. Operational knowledge
These include the following:

o Knowledge of Technology
o Processes (including quality control)
o Production
o Marketing skills
o Operational Expertise(relationship building expertise)
2. Managerial knowledge

These include the following:

o Organizational & managerial skills (e.g., leadership, human resource

management, organizational structure, managerialefficiency,
employeeparticipation)
o Market, industrial, and collaborative experience
o Financial management (e.g., cost control, tax reduction, capital utilization,
financing, risk reduction, resource development, and asset management)

Ways to protect core knowledge from uncompensated leakage to partner firms:

o The design, development, manufacture, and service or product manufactured by

an alliance may be structured so as to protect the most sensitive technologies.
For instance, when General Electric (GE) and Snecma forged a GSA to build
commercial aircraft engines, GE tried to reduce the risk of knowledge transfer by
keeping certain sections of the production process secret. GE succeeded in
cutting off the transfer of its key competitive technology by adopting this form of
modularization without preventing Snecma from access to final assembly.
o Contractual safeguards can be written into an alliance agreement. For instance,
TRW Automotive, a global company that provides passive and active safety
 96

products for the automobile industry, has three strategic alliances with Japanese
auto component suppliers to produce safety products such as seatbelts, engine
valves, and steering gears sold to Japanese-owned auto assembly plants in the
U.S. TRW has restraint clauses in each of its GSA contracts barring the
Japanese companies from competing by introducing component parts. These
protect TRW from the possibility of these Japanese firms entering into alliances
to gain access to TRWs home market and become its competitor.
o Both parties to the GSA can agree in advance to exchange specific skills and
technologies that ensure sustainable gain. One way to achieve this is through
cross-licensing. For instance, when Motorola and Toshiba forged an alliance,
Motorola licensed some of its microprocessor technology to Toshiba and in
exchange, Toshiba licensed some of its memory chip technology to Motorola.
o Avoiding undue dependence on an alliance can help mitigate the leakage risk.
This is especially important in instances where and MNE establishes GSAs with
competitors or uses its own core knowledge in alliances. For example, GM
limited its dependence on Asian allies in its Saturn project in hopes of
independently replenishing the knowledge critical to its business. When GSAs do
not involve core knowledge, managers still have to guard against shifts in the
balance of power, political maneuvering by other parties and the taking of crucial
knowledge. Another way of reducing dependence is to create several similar
GSAs or by seeking to be the senior partner in each relationship.

Exercising Managerial Control - Parent control is defined as the process in which a

parent firm ensures that an alliance is managed in away that conforms to its own
interest. In any union, the two partners will naturally have a differing set of agendas for
forming the alliance and different objectives. For each parent, having hands-on control
over the alliance’s operations confers the right to participate in the GSAs decision
making. Through this, each partner ensures that its strategic goals will be vigorously
pursued by alliance management. Parental control is achieved through:

o Equity control in terms of majority-owned, minority-owned, or co-owned/split-over

and
o Managerial control which is the process in which a party influences alliance
activities or decisions in such a way that is consistent with its own interests
through managerial, administrative, or social tools.

In any alliance arrangement, the dominant party in the alliance is the one that
dominates managerial control. However, an exception occurs when the minority holder
may be able to exercise greater managerial control if it holds stronger bargaining power
over the majority holder.
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Mechanisms of Managerial Control

o Nomination and appointment of key personnel. Knowledge of events and
circumstances is key to control. IF alliance parents supply key personnel to run
or monitor operations or critical functions such as Marketing, R&D or corporate
finance, such knowledge will be more readily available. Appointing key staff
becomes even more vital for parents that are geographically remote or hold a
minority position.
o Meetings of board of directors. Majority equity holders are in an advantageous
position in terms of composition and representation in the board of directors.
However, a minority partner can do certain things to ensure that its interests are
protected by manipulating the frequency of meetings and agenda coverage.
Furthermore, minority partners can prevent the majority partner from unilaterally
implementing decision by negotiating into the alliance contract a veto right over
decisions important to their interests. Ultimately, control at the board level is not
just based on the number of votes but also on the ability to influence other board
members on important issues. It’s a matter of bargaining power and negotiation
skills.
o Managerial policies and procedures. Such policies and procedures influence the
behavior of executives in the GSA.Reward and report systems are especially
effective for the purpose of control. Reward systems determine the incentive
structure and performance evaluation. Report systems controls information flow,
dissemination, and accuracy.
o Budget control - There are five aspects of budget control that can be
implemented:
 Emphasis on the budget during performance evaluations
 Participation in the budget development process
 Budget incentives (i.e., linking pay and promotion prospects to meeting
budget goals)
 Budget standard setting difficulty
 Budget controllability filters (i.e., extenuating factors that are brought into
the performance evaluation process
o Provision of parent services. Parent firms may offer staff services and training to
increase the likelihood that specific tasks in the alliance are performed in
conformity with expectations. Increased control is accrued to the parent in the
following ways:
 Greater parent awareness of the conditions within theGSA due to enhanced
communication with GSAemployees.
 Increased loyalty from GSA employees who identify with the parent and
imbibe its ethos.
 98

 Increased predictability of the behaviors in the GSAdue to managerial

adherence to guidelines within which they have been trained.
o Resource allocation and control. Resource allocation and utilization contribute to
managerial control. This provides a control mechanism for a minority party trying
to exert control over the GSA’s business activities and management process.
Control of key resources makes both the GSAs success and the partner firm’s
goal accomplishment dependent upon the firm. The contribution most
consistently associated with minority share is local knowledge.
o Interpersonal relationship. Maintaining a trustworthy, enduring relationship with
upper-level managers representing partner firms will enable an MNE to increase
its control. Foreign companies are able to solidify relationships with local
executives through the following activities:
 Arranging for managers from local firms to work at foreignheadquarters
 Helping them solve personal difficulties
 Offering favors as needed

Such activities promote loyalty and promote the foreign firm’s managerial
effectiveness.Such activities promote loyalty and promote the foreign firm’s managerial
effectiveness.

1. Maintain friendly personal contact between the leaders of the cooperating

organizations. The merits of such personal contact throughfrequent visits between
partner executives at least one a year include the following:

o Ironing out any differences between partners

o Laying down broad plans for the future
o Setting an example and establishing a clime for cooperation
2. Carefully consider the length of appointment of key personnel to the alliance.
Personnel are more likely to invest in establishing relationships with the alliance if
they have longer-term arrangements for they see it as a more significant part of their
overall career path.
3. Carefully select the people who are to work in an alliance to improve prospect of
mutual bonding. People should be selected on more than just the basis of their
technical competence. They should be assessed in terms of their ability to maintain
good relationships with people from otherorganizational and national cultures.
4. Encourage socializing between the partners’ personnel. Sports and social events, as
well as charitable and sponsorship activities in the local community can be helpful in
overcoming social barriers. These activities in the community also foster an
acceptance of the alliance within its local community and strengthening its external
identity.
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Reducing Conflicts
Continue on WK 12, p6 of 17

Last Portion

Technology Transfer Across Borders

International Technology Transfer is the process in which the technology or knowledge
of one firm is passed on to another firms in a different country for economic benefits.
The frequently used methods of technology transfer include:

o International licensing
o Non-equity or equity joint ventures
o Turnkey operations
o Countertrade

Factors that need to be considered if firms want to transfer their own technology to
foreign companies are the following:

o Proprietary knowledge. How much of core knowledge will be shared or protected

from transfer?
o Competition. Will knowledge diffusion to the foreign partner possibly pave the
way for it to become a future competitor?
o Impact on a firm's existing power. Will this technology sharing improve the firm’s
standing in the market?
o Royalty earnings from remote markets. How will royalties or dues be paid to the
contributing firm

The following benefits are usually sought by firms engaging in technology transfer:

1. Increased competitiveness. Technology transfer partnerships are a fast and easy

means of gaining vital knowledge and technology to contribute to a firm’s relative
competitiveness.
2. Increased profits by reducing development costs. Firms are enabled to “piggyback”
on the already existing knowledge and research systems in place of the partner firm.
3. Enhancing technological position in the market.
4. Reducing prices while maintaining quality. Technology transfer related partnerships
significantly reduce costs incurred by individual firms that would otherwise have to
bear these R&Ddevelopment costs alone.

Effective technology transfer requires coordinating mechanisms linking two parties. The
following are three categories of such linkages:
 100

1. Human bridges. These rely on establishing direct interaction between individuals

from various organizational areas, typically through the transfer and rotation of the
personnel.
2. Procedural bridges. These bridges involve the joint planning and joint staffing of
activities, especially around the time of the technology transfer.
3. Organizational bridges. These use dedicated transfer systems to establish more
formal ties of inter-organizational areas. These groups were built for the purpose of
creating a moreformal structure and common context for the effective

WK 13

Global Financial Management

Financial management of today’s MNEs occurs in an environment punctuated with risks
in the form of volatile foreign exchange rates, restrictions on capital flows, and various
country risks, taxes systems, and institutional settings. Current events in the global
financial environment such as increasing globalization of financial markets, rise of global
e-commerce, heightened pressures for acting locally responsive while thinking globally
integrative, all have fundamental implications for corporate finance. Senior financial
managers or Chief Financial Officers(CFOs) must continually review cost structure,
orientation, and strategic roles of the finance function.

Knowledge of international financial management helps a global business in two ways:

 101

o Helps the financial manager decide how international events will affect the firm
and what steps can be taken to insulate the firm from harmful developments and
exploit positive ones.
o Helps the manager foresee or anticipate events and make profitable decisions
before such events occur.

Global financial management operations deal with the following major issues:

o International trade finance

o Financing global operations
o Managing foreign exchange risk and exposure
o Working capital management

International Trade Finance

In the course of conducting international trade, the following are widelyused methods of
payment:

o Cash in advance - This form of payment gives the exporter the greatest amount
of protection because payment is received either before shipment or upon arrival
of the goods. The common reasons for using this form of payment are:
 Country is politically unstable and buyer’s credit is shaky
 Crises of foreign exchange controls in purchaser’s country may cause delays
in payment or fund transfers
 Circumstances wherein production of contracted products requires a vast
amount of capital investment to finance production and reduce marketing
risks.

Letter of credit (L/C) - The L/C is a letter addressed to the seller, written and signed by a
bank which acts on behalf of the buyer. In this arrangement, the bank honors drafts
drawn on itself if the seller conforms to the specific conditions set forth in the L/C;
suchconditions concern those set forth in the export contract or sales agreement.

Most advantages of the L/C for the exporter include:

 L/C eliminates credit risk. It eliminates risk if the bank that opens it is of good
standing and it reduces the risk that payment will be delayed or withheld due to
exchange controls or political acts.
 102

 L/C can help stabilize production. Opening an L/C willprovide

theexporterprotectionduringthemanufacturing phase from the risks associated
with contract cancellation.
 L/C facilitates financing. It ensures that there is a ready buyer for the exporter’s
product.

The different types of L/C include:

 Documentary L/C. These are L/Cs with the requirement to submit, together with
the draft, any necessary invoices and other documents such as custom invoice,
certificate of commodity inspection, packing list, and certificate of country of
origin.
 Clean L/C. These are L/Cs without the requirement for presentation of
documents. These may be used for overseas bank guarantees, escrow
arrangements, and securitypurchases. These are rarely used in import/export
businesses.
 Revocable L/C. This is an L/C that does not carry a guarantee. TI can be revoked
any time without notice up to the time a draft is presented to the issuing bank.
 Irrevocable L/C. This L/C cannot be revoked without the specific permission of all
parties concerned, including the exporter.
 Confirmed L/C. This is a L/C issued by one bank and confirmed by another,
obligating both banks to honor any drafts issued in compliance.
 Unconfirmed L/C. This is a draft which is the obligation of only the issuing bank.
 Transferable L/C. One under which the beneficiary has the authority to instruct
the paying bank to make the credit available to one or more secondary
beneficiaries. It can only be transferred once.
 Back-to-back L/C. This is one in which the exporter, the primary beneficiary of
the first L/C, offers its credit as securityin order to finance the opening of a
second credit in favor of the exporter’s own supplier of goods needed for the
shipment under the first original credit from the advising bank. The issuing bank
of the back- to-back L/C assumes both the exporter’s risk and the risk of the bank
issuing the primary L/C.
 Revolving L/C. This exists where the maturity or amount of the L/C is
automatically renewed pursuant to its terms and conditions. A revolving L/C may
be cumulative or non-cumulative. In the former, any amount not utilized during a
given time period may be applied or added to the subsequent period. If the latter,
any unused amount is simply no longer available.
o Documentary Collection - This is a payment mechanism which allows the
exporters to retain ownership of the goods until payment for them is received or if
there is reasonable certainty that the exporter will receive it. In documentary
collection, the bank which acts as the exporter’s agent regulates the timing and
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the sequence of the exchange of goods for value by holding the title documents
until the importer pays the draft.

There are two principal control documents in the documentary collection:

 Draft. This is written by the drawer (exporter) to the drawee (importer) and
requires payment of a fixed amount at a specific determinable date to the
payee(usually the exporter himself).This is negotiable instrument that usually
requires physical presentation asa condition for payment. A sight draft is payable
upon presentation awhile a time draft is payable at a determined future date.
 Bill of lading. This is the document of title (property rights of the shipped
products), document for shipment(usually ocean transport), and the carrier’s
receipt for the goods being shipped.

Open account terms - This involves shipping goods first and billing the importer later.
In it, credit terms are arranged between the exporter and importer, although the
former has little evidence of the importer’s obligation to pay a certain amount at a
certain date. Because of the uncertainty, this form of payment only occurs between
an exporter and importer that have had a long history of favorable dealings. Its
benefits include the following:

 Greater flexibility (as no specific dates are set)

 Lower costs(fewer bank charges than with other forms of payment)

The exporter’s risk of being unable to receive an importer’s paymentincreases along this
sequence.

Additionally, the means of payment remittance include:

o Airmail payment order. Used with documentary L/Cs or collections.

o Telex/SWIFT. Banks may use Telex or Society for WorldwideInformation Funds
Transfer (SWIFT) capabilities to settle payment.
o Bank draft, money order, company check. These modes are used for cash in
advance or open account terms by importers/buyers
o Export Factoring & Forfaiting - Export Factoring technique proceeds through
factoring houses. Such houses provide:

Export Financing
Export financing is the source of capital for export projects that require a large amount
of start-up costs. Export financing normally has private sources and government
 104

sources. Of the private sources, the institutions that provide financing include the
following:

Bank Financing. Commercial bank financing for foreign trade business will include the
following:

 Bank guarantees. A financial instrument that guarantees a specified sum of

payment in the event ofnon-performance by the exporter or by the foreign
importer in the event of payment default.
 Bank line of credit. This is a sum of money allocated to an exporter by a bank or
banks that an exporter can draw from in order to finance its export business. It
can also be structured to finance an export transaction in the foreign customer’s
side.
 Buyer credit. This exists where one or more than one financial institution in an
exporter’s country extends credit to a foreign customer of the exporter.

Export Factoring & Forfaiting - Export Factoring technique proceeds through factoring
houses. Such houses provide:

 financing
 can perform credit investigations,
 guarantee commercial and political risks,
 assume collection responsibility, and
 finance accounts receivable.

Forfaiting refers to the transaction in which an exporter transfers responsibility of

commercial and political risks for the collection of a trade-related debt to a forfeiter(often
a financial institution), and subsequently receives immediate cash after the deduction of
its interest charge.

o Bankers Acceptance (BA). This is a time draft drawn on and accepted by banks.
It is a two-armed instrument with one branch handling the financing while the
other handles investment. The financing bank creates the BA by stamping
“accepted” on the face of a draft presented by the customer (drawer), then
discounts the BA (it pays the drawer less than the sum of the face value of the
draft), followed by selling the BA to an investor in the acceptance market. Upon
maturity, the bank settles the BA when it debits the drawer for the full amount of
the BA and pays the full value to the investor who presents it.
o Corporate Guarantee. This is where one company undertakes to pay if the
principal debtor does not pay a matured debt obligation to a creditor. This is
usually used by creditors who will want to ask the corporate or parent company
to guarantee an obligation of one or more of its overseas subsidiaries or offshore
 105

affiliates that the creditor might consider not credit-worthy for the export-related
financing or credit limit.

Governmental Sources

Continue on Wk 13, p 6

Last portion

Financing Decisions
There are several considerations that affect the financing decisions andchoices of an
MNE. These include the following:

1. Minimizing taxes. Activities relating to tax minimization involveselecting the tax

minimizing currency, jurisdiction, vehicle for issue, and selecting tax minimizing
mode of internal transfer of currency and/or profit.
2. Managing currency risk. Currency risk management can take the form of appropriate
inter-affiliate financing, investment of parent funds as debt rather than as equity,
arrangement of back-to-back loans, and seeking as much local financing as
possible.
3. Managing political risk. To reduce political risk, financing may be sought directly from
government-based financing institutions.
4. Exploiting financial market distortions to raise money at below market rate. Diversity
of financing sources can help the MNEain from the differences in capital markets
across nations. For instance, Novo, a Danish MNE that produces industrial enzymes
and pharmaceuticals, has cross listed both the Copenhagen Stock Exchange and
New York Stock Exchange (NYSE)and uses a multitude of other financing tools such
as Eurobonds,Euronotes, local currency loans, intercompany financing, etc.This
enabled Novo to escape the limitations of its segmented nationalcapital market and
makes the company more visible to foreign investors.

FINAL

WK. 15

FOREIGN CURRENCY TRANSLATION & TAXATION

 106

Foreign currency translation is the most prominent accounting issue that directly
impacts the results disclosed in the MNEs financial statements. This is simply because
MNEs can only prepare consolidated financial statements and those of their
subsidiaries if these are expressed in the same single currency. In the absence of
foreign currency translation,MNE headquarters cannot do the appropriate planning,
evaluation, integration and control of overseas activities that need coordination within
the network. The expanded scale of an international entity’s investment activities will
also necessitate foreign currency translation.

Translation is the process of restating accounting data in one currency into another
currency for the sake of aggregating data reporting from different reporting entities. No
physical exchange occurs in the course of translation.

This is distinct from Conversion, or the physical exchange of one currency for another.
Today, increasing globalization and heightened needs for information flow within and
beyond the MNE boundary have made consolidation much more prevalent.

Currency Translation Methods

The following are four internationally accepted and commonly usedtranslation
approaches:

o Current Rate Method– all assets and liabilities, monetary and non-monetary,
are translated at the current or closing rate. Foreign currency expenses and
revenues are translated at the exchange rate that prevailed when the items are
recognized (translated by an appropriate weighted average of current exchange
rates for a given period). The “net investment concept” or the case wherein the
foreign subsidiary is viewed as a separate entity that the parent invested into is
the basis for this method. This method consequently results in translation gains
and losses every time exchange rates change. When the current income reflects
such exchange rate adjustments, the reported measures of performance could
be significantly distorted.
o Current/non-current method– current assets and liabilities are translated at the
current rate and non-current assets and liabilities at the applicable historical rate.
Income statement terms, excluding depreciation and amortization charges, are
translated at average rates that are applicable to each month of operation or on
the basis of weighted averages that encompass the entire reporting period. The
problem with this method is in how it treats inventory and long-term debt. Here,
contrary to the General Agreed Accounting Practices (GAAP), inventory is
translated at its current cost rather than historical cost. When it comes to long-
term debt is translated at its historical value rather than current value. These can
 107

result in the misleading of users. For instance, from the perspective of a

Philippine firm, if the Peso were to weaken, it will take more money to repay this
obligation, a fact that would not be apparent from the reporting entity’s financial
statements.
o Monetary/non-monetary method– translate monetary assets and liabilities at the
current rate. Non-monetary items (e.g., fixed assets, long term investments,
inventories) are translated at historical rates. Here, income statement items are
translated under similar procedures to those described under the current/non-
current approach. A problem with this method is that not all items can be
classified as monetary or non-monetary.
o Temporal Method – monetary items such as cash, receivables, and payables
are translated at the current rate. Non-monetary items are translated at the rates
that preserve their original measurements bases, i.e. historical cost. Non-
monetary items carried abroad at current values are translated into current rate.
Revenue and expense items are translated at the prevailing rates when the
underlying transaction occurred.

It is important to remember that all translations of foreign currencies will unavoidably

result in gains and losses associated with translation adjustment.

Harmonization of Translation Methods

MNEs can avoid hindering comparison and strategic decision making brought on by
divergent consolidated financial statements by employing uniform translation
approaches. The following are the two most widely accepted standards:

1. IAS #21 prepared by International Accounting Standards Committee advocates the

current rate method in all circumstances.
2. SFAS #52 by the FASB (Financial Accounting Standard Board) emphasizes the
functional currency which will determine the applicable translation method. This
stipulates that the assets, liabilities, and operations of the foreign entity should use
the functional currency for measurement. The functional currency is generally the
currency of thatcountry for an entity with fairly self-contained operations and
integrated within a particular country. If a foreign entity uses a currency other than
the functional currency, its functional currency is the third-country currency.

Example: The German accounts of a U.S. subsidiary whose functional currency is the
British Pound. In instances where the foreign subsidiary is merely an extension of the
U.S. parent company, its functional currency is the U.S. dollar. Also an example is when
Nike’s assembly subsidiary in Thailand that assembles shoes that will be exported to
the U.S.
 108

Additionally, according to SFAS #52, if a foreign entity’s books of records are not
maintained in its functional currency, re-measurement into the functional currency is
required before translation into the reporting currency. The re-measurement process is
meant to produce the same result as if the entity’s books of record had been maintained
in the functional currency. This will entail the entity to have two sets of records, one in
the local currency and one in the functional currency when the two are different.

International Accounting Information Systems

Global coordination of MNE activities has veered away from previous rigid control
mechanism such as budget and bureaucratic control to information-based coordination.
International Accounting Information Systems (IAIS) involve the accounting-related
reporting systems, data management, and communications between various units of the
sameMNE. MNEs must make internal reporting systems in subsidiaries uniform to allow
for easy comparison. The uniform reporting system must be accommodated by the
following considerations:

o Different managerial styles will impose different standards on the design.

Example: European managers are relatively more conservative decision-makers
than their U.S. counterparts. This means that European managers need more
detailed accounting information to make decisions.
o Intra organizational independence in information, capital, resource, and product
flow will determine design. Intense communication and greater information
exchange becomes indispensable when organizations are more interdependent.
o Legislative and legal developments in home and host countries may influence
uniform reporting.
Example: In the U.S. the Freedom of Information Act and the Fair Credit
reporting Act prohibits the improper use of personal data. In Europe, countries
with data protection legislation prohibit name linked data from being transmitted
outside national boundaries.

Rationale Behind Transfer Pricing

Transfer Pricing refers to the pricing of goods and services transferred between
members of the MNE network. The following are the benefits of transfer pricing that
impel MNEs to use these intra-MNE transactions:

o Tax and tariff reduction– the main driver behind transfer pricing activities is tax
reduction. When tax rates differ between two countries, MNEs will favour low
 109

transfer prices for goods and services bought by and high transfer prices for
goods and services sold by, an affiliate in a low-tax jurisdiction

Example: Subsidiary A sews garments in the Philippines whose corporate income

tax is currently 30 percent and needs to sell these $10,000 worth of garments to
Subsidiary B in Japan where its income tax is 40 percent. If the shoes were
overpriced at $12,000, then it could lower Subsidiary B’s corporate taxable income
by $800 ($2,000@40%). Although Subsidiary A in the Philippines had to pay $600
more in taxes ($2,000@30%), The MNE still saved $200 ($800-$600) dollars. In the
same manner, an MNE can lower import duties by under prices the goods it exports
to the buying unit. An instance is when a product is normally sold for $100 has an
import price of $120 because of the 20% tariff. If the MNE were to deflate the price
by listing it at $80, it would be exported for $96 ($80@20%).

o Exchange control avoidance– transfer pricing may be used to circumvent the

effects of foreign exchange quotas (typically when they are set in value rather
than in actual units).

Example: when a host government allocates a limited amount of foreign exchange for
importing particular goods, the parent company may underprice products shipped to its
subsidiary, thus allowing a greater volume of imports. Additionally, if theMNE wishes to
move funds out of one country, it may consider charging higher prices on goods sold to
local affiliates. Also, it can indirectly finance an affiliate by lowering the prices of goods
supplied to it.

o Increasing profits from joint ventures – transfer pricing is a vehicle through which
a party can gain profit unilaterally from controlling the joint venture’s import and
export activities.

Example: Hong Kong investors are not too concerned overreporting profits derived from
joint ventures in mainland China. This is due to the noticeable returns already made
from overpricing materials imported for the joint ventures and/or by under pricing joint
venture outputs exported to headquarters. (Both of these activities serve to minimize the
reported net asset position of the company, thus minimizing taxable income). They
normally are in charge over the material importation and the product exportation for the
ventures as specified in joint venture agreements.

Transfer Pricing Techniques

From the point of view of the tax authority, all intra-MNE transfer pricing must proceed
following the arm’s length principle to ensure fairness. The arm’s length principle means
that the transfer price struck between related companies should be the same as that
negotiated between two independent entities acting in an open and unrestricted market.
 110

The following are methods used by tax authorities to determine whether transfer prices
comply with the said principle. These methods define the legitimate range of transfer
pricing that is allowed by tax authorities:

o Current open market prices – open comparable market prices are generally
viewed as the most satisfactory method as it requires the fewest adjustments.
When this cannot be used, they often compare the gross margin or operating
profit the company earns from intra-company transactions with gross margins or
operating profits earned in the open market. This form of comparison
necessitates adjustment before a true comparison can be gleaned from them for
taxation purposes.
o Gross margin method – this method relies on a range of gross margins achieved
in the course of comparable transactions between independent companies. It
includes:
 The resale price method – used for the transfer of goods to distributors which
sell them without the need for further processing. What an independent party
pays as the price of a final product is used as a baseline, on which a suitable
markup is deducted to allow for the seller’s expenses and reasonable profit.
 The cost plus method – used when the group company transfers items in
need of additional processing by the other group before they can be sold to
the final customer. This method simply marks up the cost of producing the
transferred goods and services proportionate to the functions performed by
the transferring company. Using this, the effective comparison is with the
margin earned on similar transactions occurring at arm’s length.
o Operating profit methods
 Comparable profits method – compares the period percentage operating
profit (e.g., return on sales or return on assets) in the controlled subsidiary
with percentages in similar uncontrolled entities on a whole company basis.
 Transactional net margin method – it is similar to the former but compares
operating profit on transaction rather than on a whole company basis.
 Profit split method – in a situation where intragroup trading of goods and
services are unique to a particular group and no external operating profit
comparisons can be made, the profit split method must be used. In this
method, group companies simply reach anagreementon how profits from the
final product will be between them, based on a considered evaluation of the
contribution made by each party to the transaction

Transfer Pricing Regulations & Penalties

Cross border tax authorities are mainly concerned that their countries receive their fair
share of tax revenues. These authorities are aware of potential revenue losses
 111

associated with transfer pricing policies and this is why they require more reporting and
documentation, carrying out more comprehensive audits, and introducing harsher
penalty regimes. The following are the two most important guidelines covering transfer
pricing practices:

o 1995 OECD guidelines – these provide information on the application of the

arm’s length principle. The OECD rejects the use of profit splitting between
jurisdictions on the basis of payroll and revenue. It is considered an invalid form
of transfer pricing because it goes against the arm’s length principle.
(Organization for Economic Cooperation and Development)
o US Section 482 guidelines – it is also similar to the OECD model. The basis of
section 482 is the arm’s length model and taxpayers must demonstrate that their
chosen method produces the reliable arm’s length result. This necessitates that
MNEs will have to provide full and documented consideration to all methods prior
to settling on the most appropriate. However, unlike the OECD model, this
accepts the profit-based methods or allowances between two or more members
within an organization.

In both the OECD and U.S. section 482 guidelines, taxpayers are required to provide
the supporting documentation for its transfer price ona timely basis or suffer, at worst, a
non-deductible penalty of up to 40percent in the U.S. and up to 100 percent in the
United Kingdom. The strict model of the U.S. in transfer pricing regulations is spreading
quickly to other countries around the world. Among the countries with new legislation
and rulings taking effect since 1997 are Australia, Brazil, Canada, Denmark, France,
Korea, Mexico, and the United Kingdom.

There is a way in which MNEs can reduce the risk arising from transfer pricing/tax audit.
MNEs can adopt an advance pricing agreement (APA)with the tax authorities of host
countries in which the MNE reaps taxable income. An advance pricing agreement is an
agreement between the tax authority and the tax payer on the transfer pricing
methodology to be applied to any apportionment or location of income, deductions,
credits, or allowances between two or more members within an organization.

An APA allows the MNE the following benefits

 Negotiate an understanding with one or more tax authorities thatapproves a

transfer pricing methodology for a given term
 An APA may take the form of a unilateral, bilateral, or multilateral agreement that
more are more easily negotiated with tax authorities in countries that have
existing tax treaties.
 112

 The APA is an alternative dispute resolution process that is capable of reducing

the number of transfer pricing cases requiring legal resolution. This saves both
time and money for the MNE and for the tax authority.

Tax Havens & Treaties

Tax havens are geographic locations that enjoy substantially lower taxation than that in
a home country. MNEs are forced to seek refuge in tax havens when home country
taxation is high. An MNE may incorporate or register a company in a tax haven that may
impose little or no corporate income taxes. The following are categories of tax havens:

o Traditional tax havens with virtually no taxes whatsoever. Country examples are
the Bahamas, Bermuda, the Cayman Islands, Andorra, Bahrain, Campione,
Monaco (except for French citizens), the Turks, Tonga, and Vanuatu.
o Tax havens that impose a relatively low rate. Country examples are the British
Virgin Islands, the Channel Islands, Gibraltar, Lichtenstein, Switzerland
(excluding a few regions), Angola, the Netherlands, Antilles, Kiribati and Tuvalu,
Montserrat, Norfolk Island, the Solomon Islands and several other islands.
o Tax havens that tax incomes from domestic sources but exempt all income from
foreign sources. Country/Principality examples are Hong Kong, Liberia, and
Panama.
o Tax havens that allow special privileges. Brazil, Luxembourg, the Netherlands

In order to benefit from a tax haven and MNE should typically have to set up a
subsidiary in the tax haven country through which forms of income would pass. The
whole point of this is to shift income from high tax jurisdictions to tax havens. More
specifically, MNEs can utilize tax havens through setting up offshore banking, holding
companies, captive insurance companies, shipping companies, export management
companies (EMCs) or free port manufacturing. Holding companies area type of
business organization that allows a firm (parent) to control or influence other firms
(subsidiaries). This arrangement makes it possible. to benefit from tax consolidation,
sharing of operating losses, or ease of divestiture. MNE may avoid home country taxes
by diverting their assets to a holding company which then collects the income arising
from relevant assets.

Treaties
Multiple taxation is often a problem when income earned and taxed inone country is
remitted to investors in other countries. The two common approaches used to avoid
multiple taxation are:
 113

1. Foreign tax credits – the idea of a tax credit is that a companymay reduce its tax
liability by the amount of the credit, which isdetermined by the likening of the foreign
tax to that of an incometax as defined in the U.S. for instance.
2. Tax treaties – mostly in the form of bilateral tax treaties, their major purpose is to
eliminate the international double taxation and render mutual assistance for tax
enforcement and in reducing barriers to trade and investment. Many countries avoid
international double taxation by not taxing foreign sourced income for their
taxpayers. Such tax treaties determine the amount of tax to be paid to the country
where the income is produced and the amount to be paid to the taxpayer’s country
ofresidence.

Example: According to U.S. law, interest paid by a U.S.company to a foreign recipient is

subject to a 30 percent withholding tax. However, under the Us.-U.K. tax treaty, this
taxis eliminated. Tax treaties may differ from others and results.

Set up a holding company in a host country – a technique for cash repatriation and
reducing future taxes that involves setting up a holding company in the same host
country as a high-tax operating subsidiary. That holding company is provided funding to
buy shares from the operating company from the U.S. parent, thus allowing direct future
earnings to be repatriated without withholding taxes. The consolidation of the return of
the holding company and the operating company allows not both the deduction of the
new interest and the reduction of future foreign taxes.

Establish a holding company in an integrated region – this strategy involves a regional

or multi country holding company. Intercompany dividends between European Union
countries are tax free. A subsidiary in the country (e.g., France) would borrow to buy
shares of another subsidiary in another European country (e.g., Belgium).Because of
this, MNEs need holding companies located in a country that does not levy taxes on
dividend income or capital gains and that has a low withholding rate on dividends back
to the United States.

Build a finance corporation

Example: U.S. MNEs may establish finance companies in such countries as Belgium
and Ireland (due to tax incentives given to finance companies) to manage group cash
and currency exposure to channel funds within Europe without bringing them back to
the parent.

Locate projects in a low tax region within a host country – MNEs entering developing
nations often invest a large chunk of their assets in projects involving special
technologies, investment, or trade zones which impose a substantially lower tax rate or
confer preferential tax terms. A prime example of this would be China. The Shenzhen
region enjoys a reduced 15 percent rate on corporate income tax, receive an exemption
 114

of income tax for the first two years, and a 50 percent reduction of income tax during the
third to fifth years, starting from the first profit-making year.

In conclusion, there are several tax strategies that MNEs can employ in order to
improve the firm’s net profit standing. These strategies can add value to a firm’s wealth
and determine the firm’s ability to invest overseas. Notwithstanding the complexities of
the international tax environment, MNEs can benefit from various opportunities arising
from differing tax rates and systems across borders. Realistic and viable strategies on
tax reduction are necessary components of accruing these benefits.

Challenges of International Marketing

International markets can provide vast opportunities to a firm with a product or service
that can be in potential demand abroad. With the trend of globalization, larger markets
can also mean larger chances of competition coming from anywhere in the world.

International market success depends on many skills:

1. Proper selection of the right product mix

Example:Wal-Mart decided to include new product lines to its megastores that were
traditionally only sold in specifically segregated areas department stores such as
electronics, clothing, and home furnishings and not in “grocery-type” stores that sold
food. Wal-Mart did this in response to what it perceived as a burgeoning trend in
American consumer behavior. Wal-Mart now has business as far as in South Korea
because it perceived this country as displaying market similarities to its home market.

2. Appropriate adjustments in distribution, packaging and advertising

Example: Different beer markets around the world have different packaging preferences
in terms of buying their beer in cans versus bottles. In terms of advertising, different
cultures will have either tolerant or intolerant attitudes in response to the amount of
sexual messages used in liquor ads.

3. Understanding of cultural values and social mores not just inadvertising a product,
but also in the very nature of the product itself, a country’s values and norms might
make the marketing of a product challenging of not downright unprofitable.

Example: Although Starbucks coffee was inspired by the founder’s trips around Italy and
the “coffee culture” among the neighborhood dives, as a global American brand, this
franchise will arguably not succeed in Italy due to its commercial nature that contradicts
the mores and values of Italians who like things extremely personalized and intimate.
 115

4. Familiarity with rules and regulations – these things are related to the legalistic
nature of markets as discussed in a previous topic. These rules can govern what
products can be marketed, how they can be marketed, and even to whom they can
be marketed.

Example: In America, tobacco manufacturers are increasingly challenged by the zoning

restrictions and the limitations imposed on advertisers as to how they might
conceptualize their adsin order to ensure that cigarette ads are not designed in such as
way that would make smoking appear appealing to little kids. For instance, Camel ads
in the U.S. were criticized and sanctioned for making ads appear very cartoonlike and
thus attractive to children.

5. Knowledge of economic conditions – indicators such as average per capital income

can be an economic indicator of the viability of the foreign market.

Example: A global luxury brand of clothing such as Armani did not dare venture into the
Chinese market until the fairly recent burgeoning of its new “upper-upper-middle class”
to upper class demographics enjoying the benefits of a growing market economy,
departing from its socialist, planned economic roots from previous decades under Mao
Ze Dong.

6. Awareness of political realities within any political context, international market

survival entails familiarity with political realities and the stability of regimes, but most
importantly, the openness of these regimes to an influx of international business.

Assessing Market Potential

The parameters used to assess market potential are the following:

o Aggregate for potential demand for a product or service – this can give some
idea of possible future profits stemming from the demand for the product or
service.
o Population growth – in and of itself, population size still isn’t a very accurate
indicator for market viability.

Example: A country may have a large population, but if this population has neither
the money nor the desire to use the product in question, population size matters very
little. At best, population growth can only provide a coarse estimate of future market
potential

o Economic development and disposable income – this is probably the most

important indicator of market potential. Purchasing Power Parity (PPP) is an
index that is used to adjust nominal figures to the purchasing power of local
consumers.
 116

o Consumption patterns – these patterns can be influenced by a variety of factors

that are beyond human control yet can still be derived benefits out of it.

Example: Weather conditions in a sticky, humid country will influence the

population’s spending patterns on personal hygiene products.

Assessing market potential within the corporate strategy context entails research that
will answer:

 What objectives should the firm pursue in the foreign market?

 What foreign market segments should the firm pursue?
 Which are the best product, price, promotion, and distribution strategies for the
foreign market?
 What should the product-market-company mix be?

Globalization & Localization in International Markets

As encountered in other functional areas of international business, finding the right
balance between globalization and localization is a key challenge to the MNE. Lack of
marketing globalization can have detrimental effect on MNEs operations, yet
indiscriminate standardization of marketing practices without attention to localization
can also prove detrimental.

Globalization in the marketing context, refers to the standardization of products (or

services), brands, marketing, advertising, and the supply chain across countries and
regions.

Localization is the adjustment of one or more of the above elements to be idiosyncratic

characteristics of a given national market.

The fine-tuning of the delicate balance between globalization and localization will
determine the success of an MNE. There are many different ways in which a firm can
subjectively address this fine balance that must be found in each context. Cees van der
Hoven, CEO of AholdNV, the Dutch food retailer and third largest global supermarket
chain behind the U.S.’s Wal-Mart and French Carrefour, summarizes his firm’s strategy
in this way: “Everything the customer sees, we localize, everything they don’t see,
we globalize.”Ahold prefers brand uniformity, substituting global brands for the local
brands it acquires and tailors it products to local markets. Asea Brown Bovary (ABB),
leader in automation and power technologies uses the slogan: “We are a global firm
local everywhere.” HSBC is known for its slogan: “The world’s local bank.”

Globalization Forces
 117

An assumption underlying globalization is that many industrial and (albeit to a lesser

degree) commercial products can be standardized. Globalproducts (or services) are
those that are relatively unaltered in terms of brand and appearance when sold abroad.
Gaining economies of scale is the primary motivation for the globalization of product
and service. For instance, selling the same product using the same promotional
message and using the same distribution channels reduces cost. An example of market
failure to generate economies of scale was American JC Penney which closed its home
furnishings store in Japan because so many products had to be made differently for the
Japanese market that rendered the company unprofitable to operate there. Japanese
homes and apartments are extremely small compared to their average American
counterparts due to the exorbitant cost of real estate, especially in urban areas.
Naturally, the furniture that would fit in such cramped, confined spaces would have to be
very compact and have “double-duty” or dual purposes built into each unit of furniture to
conserve space.

Among the benefits of globalization of marketing activities are:

o It permits firms to leverage experience accumulated in one market over another.

o The allure” of a global product can be an important selling point for some
consumers.

Marketing Repercussion of a Global Approach

 Rapid roll out of new products across major markets – this preempts competitors
from introducing similar products in new markets.
 Product prioritization and targeting across markets – this limits local product
offerings.
 Globally uniform branding and advertising – this creates a consistent message that
reassures customers with global reach and reduces the cost of duplication. This can
also have the added benefit of entry into increasingly crowded shelves of retailers
that only display the brands that sell most volume.
 Manufacturing relatively standardized products and services to scale economies
 Transfer of marketing best practices across borders.

Localization Forces
Localization forces compel firms towards adjustment in product or marketing or
distribution in efforts to make it more desirable or to make it meet the requirements
particular to a foreign market.
 118

Factors influencing localization

o Cross national variations in terms of income levels which influence consumer
tastes/requirements.

Example:If per capita income levels are high and the average disposable income in
households is at a comfortable level, consumers will be more greatly disposed to
buy more expensive quality/luxury good and if per capita income is lower,
consumers will opt for cheaper necessity goods.

o Diverse regulatory regimes that enforce rules on product design, packaging,

promotion, pricing, and media mix.

Example: Specific administrative (non-tariff barriers) such aslabelling requirements

will compel a firm to adapt its labels on the product if it is to be marketed in the
country. As the case of the tobacco industry in Singapore illustrates, tobacco
companies are mandated to show health warnings on 50 % of each side of cigarette
cartons as a reminder to people of the health hazards of smoking. How products are
promoted can also be affected by regulatory regimes. Example, in China,
“comparative advertising is not legal.”

o Social attitudes and public opinion – this is especially important when it comes to
marketing products that are dependent on specific behavioural outlooks or
attitudes, such as being health conscious for instance. Kellog’s Nutri-Grain
snack, a cereal bar made from corn, wheat, and oat, while successful in the U.S.,
did not achieve the same success in the U.K. as it did in its home market
because health consciousness isn’t nearly as deeply ingrained in the British
psyche as it is in American psyche.
o Cultural and social mores – culture can determine what kids of products will be
generally viable in a market. For instance, countries with high power distance
cultures like Japan will have a huge demographic of consumers willing to shell
out money for designer clothing that expresses their achieved status and
success in life. Cultural and social mores can also influence the context in which
products are used. For instance, in Hong Kong, Taiwan, and China, McDonald’s
restaurants serve as bases for social activities for seniors in the late morning and
school children in the afternoon.

Product Adaptation
Product adaptation concerns the question of whether or not the firm should alter a
product or service in order to adapt it to specific country or regional requirements. Firms
use the following models to help in the decision:
 119

o Cost/Benefit models – these assess the advantages or disadvantages of a

product or distribution mode in a givenmarket.
o User/Need models – these test the needs of potential customers, as well as the
circumstances wherein the product or service are likely to be used.

A prime example of the need for product adaptation is that of Ford Motor Company’s
decision to design “and Indian car” following the disappointing sales of the Ford Escort,
a four-door sedan, in the developingmarket. To gather vital market knowledge on the
preferences of Indian consumers, Ford’s designers and engineers drive many miles on
India’s roads with families of five – Ford’s key customer group for the sedan. Among
their findings were that:

 Rear headroom had to be raised to accommodate men in turbans.

 Doors had to be adjusted to open wider in order to avoid catching the flowing
saris of women.
 Air intake valves had to be fitted to avoid flooding during monsoon season.
 Shock absorbers had to be toughened for pock-marked city
 Air conditioning had to be revved up for the summer heat.

Global marketing requires a fine balance as illustrated in the Ford example. While it may
sometime be necessary to adjust to local tastes and customs to a certain extent, it is
equally important for the MNE to leverage its name recognition and global reputation.

2nd WK 15

GLOBAL MARKETING AND SUPPLY CHAIN

Challenges of International Marketing

 120

International markets can provide vast opportunities to a firm with a product or service
that can be in potential demand abroad. With the trend of globalization, larger markets
can also mean larger chances of competition coming from anywhere in the world.

International market success depends on many skills

1. Proper selection of the right product mix

Example: Wal-Mart decided to include new product lines to its megastores that were
traditionally only sold in specifically segregated areas department stores such as
electronics, clothing, and home furnishings and not in “grocery-type” stores that sold
food. Wal-Mart did this in response to what it perceived as a burgeoning trend in
American consumer behavior. Wal-Mart now has business as far as in South Korea
because it perceived this country as displaying market similarities to its home market.

2. Appropriate adjustments in distribution, packaging and advertising.

Example: Different beer markets around the world have different packaging preferences
in terms of buying their beer in cans versus bottles. In terms of advertising, different
cultures will have either tolerant or intolerant attitudes in response to the amount of
sexual messages used in liquor ads.

3. Understanding of cultural values and social mores not just in advertising a product,
but also in the very nature of the product itself, a country’s values and norms might
make the marketing of a product challenging of not downright unprofitable.

Example: Although Starbucks coffee was inspired by the founder’s trips around Italy and
the “coffee culture” among the neighborhood dives, as a global American brand, this
franchise will arguably not succeed in Italy due to its commercial nature that contradicts
the mores and values of Italians who like things extremely personalized and intimate.

4. Familiarity with rules and regulations – these things are related to the legalistic
nature of markets as discussed in a previous topic. These rules can govern what
products can be marketed, how they can be marketed, and even to whom they can
be marketed.

Example: In America, tobacco manufacturers are increasinglychallenged by the zoning

restrictions and the limitations imposed on advertisers as to how they might
conceptualize their adsin order to ensure that cigarette ads are not designed in such as
way that would make smoking appear appealing to little kids. For instance, Camel ads
in the U.S. were criticized and sanctioned for making ads appear very cartoonlike and
thus attractive to children.
 121

5. Knowledge of economic conditions – indicators such as average per capital income

can be an economic indicator of the viability of the foreign market.

Example: A global luxury brand of clothing such as Armani did not dare venture into the
Chinese market until the fairly recent burgeoning of its new “upper-upper-middle class”
to upper class demographics enjoying the benefits of a growing market economy,
departing from its socialist, planned economic roots from previous decades under Mao
Ze Dong.

6. Awareness of political realities within any political context, international market

survival entails familiarity with political realities and the stability of regimes, but most
importantly, the openness of these regimes to an influx of international business.

Assessing Market Potential

The parameters used to assess market potential are the following:

o Aggregate for potential demand for a product or service – thiscan give some idea
of possible future profits stemming from thedemand for the product or service.
o Estimate of costs associated with product introduction and distribution – if the
cost of entry is too high for the firm, chances are it won’t consider the market
viable.
o Population growth – in and of itself, population size still isn’t a very accurate
indicator for market viability.

Example: A country may have a large population, but if thispopulation has neither
the money nor the desire to use the product in question, population size matters very
little. At best, population growth can only provide a coarse estimate of future market
potential.

o Economic development and disposable income – this is probably the most

important indicator of market potential. Purchasing Power Parity (PPP) is an
index that is used to adjust nominal figures to the purchasing power of local
consumers.
o Consumption patterns – these patterns can be influenced by a variety of factors
that are beyond human control, yet can still be derived benefits out of it.

Example: Weather conditions in a sticky, humid country will influence the

population’s spending patterns on personal hygiene products.

Assessing market potential within the corporate strategy context entailsresearch that will
answer:

 What objectives should the firm pursue in the foreign market?

 122

 What foreign market segments should the firm pursue?

 Which are the best product, price, promotion, and distributionstrategies for the
foreign market?
 What should the product-market-company mix be?

Globalization & Localization in International Markets

As encountered in other functional areas of international business, finding the right
balance between globalization and localization is a key challenge to the MNE. Lack of
marketing globalization can have detrimental effect on MNEs operations, yet
indiscriminate standardization of marketing practices without attention to localization
can also prove detrimental.

Globalization in the marketing context, refers to the standardization of products (or

services), brands, marketing, advertising, and the supply chain across countries and
regions.

Localization is the adjustment of one or more of the above elements to be idiosyncratic

characteristics of a given national market.

The fine-tuning of the delicate balance between globalization and localization will
determine the success of an MNE. There are many different ways in which a firm can
subjectively address this fine balance that must be found in each context. Cees van der
Hoven, CEO of AholdNV, the Dutch food retailer and third largest global supermarket
chain behind the U.S.’s Wal-Mart and French Carrefour, summarizes his firm’s strategy
in this way: “Everything the customer sees, we localize, everything they don’t see,
we globalize.” Ahold prefers brand uniformity, substituting global brands for the local
brands it acquires and tailors it products to local markets. Asea Brown Bovary (ABB),
leader in automation and power technologies uses the slogan: “We are a global firm
local everywhere.” HSBC is known for its slogan: “The world’s local bank.”

Globalization Forces
An assumption underlying globalization is that many industrial and (albeit to a lesser
degree) commercial products can be standardized. Global products (or services) are
those that are relatively unaltered in terms of brand and appearance when sold abroad.
Gaining economies of scale is the primary motivation for the globalization of product
and service. For instance, selling the same product using the same promotional
message and using the same distribution channels reduces cost. An example of
market failure to generate economies of scale was American JC Penney which
closed its home furnishings store in Japan because so many products had to be
made differently for the Japanese market that rendered the company unprofitable
to operate there. Japanese homes and apartments are extremely small compared to
 123

their average American counterparts due to the exorbitant cost of real estate, especially
in urban areas. Naturally, the furniture that would fit in such cramped, confined spaces
would have to be very compact and have “double-duty” or dual purposes built into each
unit of furniture to conserve space.

Among the benefits of globalization of marketing activities are:

o It permits firms to leverage experience accumulated in one market over another.

o “The allure” of a global product can be an important selling point for some
consumers.

Marketing Repercussion of a Global Approach

 Rapid roll out of new products across major markets – this preempts competitors
from introducing similar products in new markets.
 Product prioritization and targeting across markets – this limits local product
offerings.
 Globally uniform branding and advertising – this creates a consistent message
that reassures customers with global reach, and reduces the cost of duplication.
This can also have the added benefit of entry into increasingly crowded shelves
of retailers that only display the brands that sell most volume.
 Manufacturing relatively standardized products and services to scale economies.
 Transfer of marketing best practices across borders.

Localization Forces
Localization forces compel firms towards adjustment in product or marketing or
distribution in efforts to make it more desirable or to make it meet the requirements
particular to a foreign market.

Factors influencing localization:

o Cross national variations in terms of income levels which influence consumer
tastes/requirements.

Example: If per capita income levels are high and the average disposable income in
households is at a comfortable level, consumers will be more greatly disposed to
buy more expensive quality/luxury good and if per capita income is lower,
consumers will opt for cheaper necessity goods.

o Diverse regulatory regimes that enforce rules on product design, packaging,

promotion, pricing, and media mix.
 124

Example: Specific administrative (non-tariff barriers) such as labeling requirements

will compel a firm to adapt its labels on the product if it is to be marketed in the
country. As the case of the tobacco industry in Singapore illustrates, tobacco
companies are mandated to show health warnings on 50% of each side of cigarette
cartons as a reminder to people of the health hazards of smoking. How products are
promoted can also be affected by regulatory regimes. Example, in China,
“comparative advertising is not legal.”

o Social attitudes and public opinion – this is especially important when it comes to
marketing products that are dependent on specific behavioral outlooks or
attitudes, such as being health conscious for instance. Kellog’s Nutri-Grain
snack, a cereal bar made from corn, wheat, and oat, while successful in the U.S.,
did not achieve the same success in the U.K. as it did in its home market
because health consciousness isn’t nearly as deeply ingrained in the British
psyche as it is in American psyche.
o Cultural and social mores – culture can determine what kids of products will be
generally viable in a market. For instance, countries with high power distance
cultures like Japan will have a huge demographic of consumers willing to shell
out money for designer clothing that expresses their achieved status and
success in life. Cultural and social mores can also influence the context in which
products are used. For instance, in Hong Kong, Taiwan, and China, McDonald’s
restaurants serve asbases for social activities for seniors in the late morning and
school children in the afternoon.

Product Adaptation
Product adaptation concerns the question of whether or not the firm should alter a
product or service in order to adapt it to specific country or regional requirements. Firms
use the following models to help in the decision:

o Cost/Benefit models – these assess the advantages or disadvantages of a

product or distribution mode in a given market.
o User/Need models – these test the needs of potential customers, as well as the
circumstances wherein the product or service are likely to be used.

A prime example of the need for product adaptation is that of Ford Motor

Company’s decision to design “and Indian car” following the disappointing sales of the
Ford Escort, a four-door sedan, in the developing market. To gather vital market
knowledge on the preferences of Indian consumers, Ford’s designers and engineers
drive many miles on India’s roads with families of five – Ford’s key customer group for
the sedan. Among their findings were that
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 Rear headroom had to be raised to accommodate men in turbans.

 Doors had to be adjusted to open wider in order toavoid catching the flowing
saris of women.
 Air intake valves had to be fitted to avoid flooding during monsoon season.
 Shock absorbers had to be toughened for pock-marked city streets.
 Air conditioning had to be revved up for the summer heat.

Global marketing requires a fine balance as illustrated in the Ford example. While it may
sometime be necessary to adjust to local tastes and customs to a certain extent, it is
equally important for the MNE to leverage its name recognition and global reputation.

Country-of-Origin Effect
Country-of-Origin Effect is the influence of the country of manufacturing image upon
the buying decision. The effect consists of the following three dimensions:

1. Innovativeness – refers to the use of new technology and/or engineering advances.

2. Design – refers to appearance, style, color, variety.
3. Workmanship – refers to reliability, durability, craftsmanship, and manufacturing
quality.

Evidence supports the assertion that country-of-origin affects consumer perceptions.

The impact has more to do with subjective perception than actual reality. As discussed
in the topic about cultural stereotypes, consumers ascribe meanings and values to
products based on how they see its country-of-origin. For instance, the perceived value
of buying fine leather goods from Italy is much higher than the perceived value of
leather goods coming from, say, the U.S. However, it is important to note that country-
of-origin effect can change over time. In the 1970s,Japanese products had a reputation
for shoddy quality. This changed over the years that the country concentrated on
developing high quality manufacturing techniques. The best electronic and car brands in
the world today are now from Japan.

Some strategies MNEs can adopt to maximize the fruits of country-of-Origin effect:

o Leveraging Positive Country Image – it is important to note that country image

varies across product categories

Example: German automotive firms maximize the country’s reputation for top quality
engineering, quality, and reliability. Case in point, Mercedes Benz used the slogan
“the best engineered car in the world” to fully express this German pride in their key
strengths.
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o Leveraging Nationalist Sentiments – country-of-origin can also sometimes serve

as a patriotic appeal to buy domestic products. The U.S. at one time had a “Buy
American” campaign to prevent further deterioration of the ongoing U.S. trade
deficit with Japan. Some foreign firms can attempt to disarm nationalist sentiment
by emphasizing the local content in their product.

Example: Mercedes-Benz placed an ad in a Canadian newspaper for its M-class car

touted it as a car manufactured in the U.S. and that the plant’s president is
Canadian.

Branding
Branding is the process of creating and supporting positive perceptions associated with
a product or service. The following are the principles that Procter & Gamble (P&G)
views as instrumental in the creation of successful brands in China:

1. Selecting the right (Chinese) name – it cannot be underscored enough how

getting the right name is of paramount importance to the success of a product.
Recalling the failure of the Mist Stick deodorant in Germany because “mist” in
German is slang for “manure.”
2. In-depth understanding of local market and willingness to make necessary
adaptation – as illustrated in the Ford Escort example, understanding the unique
needs of a consumer market is vital in the decision to make necessary product
adaptation. In a world as divergent as ours, a “one size fits all” policy will spell
failure.
3. Fine-tuning the right size/prize/value formulation of offerings –this is concerned
with consumer behavior and the economic circumstances that shape lifestyle and
consumption patterns. For instance, in the Philippines, most major brands of
detergent, shampoo, and fabric softener products are sold in sachet form.
Something that is rarely seen in industrialized nations.
4. Providing quality and reliability at a competitive price – doing this often requires a
closer analysis of a company’s Value Chain and in what ways the firm can obtain
scale economies that enables it to pass on its savings in the form of lower prices
to end consumers.
5. Holistic marketing using a variety of channels
6. Turning trademarks into “trust-marks” – consumers become loyal through not just
appealing to their cognitive but also throughtheir affective selves. Emotional
resonance is a very strong indicator of consumer loyalty and trust.
7. Establishing leadership brands, changing social habits if necessary– a decade
ago, the number one consumed beverage in the Philippines was soda (soft
drinks). Today, much to the delight of John Gokongwei’s Universal Robina Corp,
green tea bottled drinks are the number one consumed beverage thanks to a
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deluge of advertising and promotional events advocating a greener, healthier

lifestyle matched with the catchy slogan “Green is in.”
8. Selecting the right allies and partners – as discussed in the chapter on Global
Strategic alliances, finding the right local partner that has proven itself
cooperative in the past or finding a partner that shares the same goals and
objectives is the ideal match up.

Channel Decisions
Channel decisions involve the length (number of levels of intermediaries) and width
(number of firms in each level) of the channel used in linking manufacturing to
consumers. The following are modes of channel distribution:

o Intermediation – sometimes international sales are not made directly by firms but
by export intermediaries. Such intermediaries are firms that mediate between
firms and their export markets through providing services covering logistics,
documentation, and other related services. Hewlett Packard makes use of export
intermediaries. SED, an international distributor of microcomputer and wireless
communication products throughout the U.S. and Latin America was designated
a “Certified HP Top Value Reseller” and was given exclusive right to offer top
selling HP products in several international markets.
o Direct Marketing – direct marketing involves directly selling to customers through
individual agents who make a commission on both their sales and on the sales of
other agents they have recruited. Avon and Mary Kay use this channel mode.
Although in more recent years, direct-marketing has been outlawed in China.
o Niche Marketing – this strategy concerns narrowly directing marketing activities
toward a pre-defined segment of the market. Niche marketing can be directed not
only to product categories but also to ethnic or geographic market segments.
Shakey’s Pizza Restaurant and Carl’s Jr. In Mexico are both targeting a specific
niche in their target market.
o Pricing – pricing refers to the decision process of setting a price to a product or
service. Pricing in international markets is so much more complex due to varying
structures (e.g., transportation infrastructure, tariffs) and market positioning.
Market segmentation is facilitated by price differentials. This allows a firm to
position its product differently in different markets. For instance, firms may hike
prices where there is low competition slow or where consumers do not show
resistance to price increases.

Promotion
A compelling motivation for globalization is the substantial savings it yields in terms of
promotion activity costs, especially in advertising.Advertisingmust be adjusted to local
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tastes and norm, like othermarketing functions, in order to be effective in international

markets

As some companies learned the hard way, moving advertising across borders is difficult
culturally, linguistically, and socially. Industry examples of advertising missteps are
abundant. Example, the Chinese did not take kindly to a McDonald’s ad that showed a
person begging on the streets just to get a McDonald’s meal. DHL had to apologize to
Indonesians for an ad that likened President Suharto to a courier. Nike was criticized a
while back for showing the Brazilian soccer team playing a soccer match against the
devil.

Still, the temptation to standardize advertising is considerable as it provides a coherent

and consistent message and reduces production costs by amortizing it across multiple
markets. McKinsey, a global management consultancy firm, calculated that Gillette
saved $20 million by creating a global campaign for its Sensor razor in 19 markets out
of a total advertising expense of about $175 million.

As marketing is globalized by MNEs, firms are increasingly seeking advertising

agencies that have a global reach to provide a one-stop shop. Kellogg assigned
responsibilities for three of its global brands to Leo Burnett and two others to J. Walter
Thompson. The consolidation of advertising agencies into global networks occurs for a
reason. Network members share the reach and brand recognition of the network while
offering in-depth knowledge of the local market.

Marketing Alliances
Marketing Alliances- page 10

As discussed in the topic covering Global Strategic Alliances (GSAs),these forms

comprise a major market entry venue. Alliances andmergers and acquisitions are
greatly beneficial to firms looking for aquick way to establish presence in a foreign
market.

Marketing alliances in particular can take the form of:

1. Distribution channel cooperation

Example: Leuven (Belgium)-based Interview grew from a small family-margin specialty

brands. Similarly, Coca-Cola acquires smaller rivals and links with their distribution
channels to its own to obtain synergies.

2. Logistics cooperation – Nestle and French retailer Casino cooperate in marketing,

logistics, and sales.
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Example: They share and analyze bar code information to learn how to enhance
customer loyalty while reducing costs.

3. Sales cooperation

Example: The Generali Deutschland Group and CommerzbankAGhave a sales

cooperation whereby the traditional salesnetworks of theformer act as intermediaries for
the bankproducts of the latter.Reciprocally, Commerzbank sellsinsurance products for
the Generali Deutschland Group.

The Global Supply Chain

The Global Supply Chain refers to the activities in both logistics andoperations such as:
sourcing, procurement, order processing,manufacturing, warehousing, inventory control,
servicing and warranty,custom clearing, wholesaling, and distribution.

According to a recent Conference Board study, it is said that “in today’sworld, it is

supply chains that compete, not companies.” Today, thedecline in real costs of logistics
can be attributed to increasedeficiencies, for example, in Just in Time systems. Amdahl,
the U.S. subsidiary of Japan’s Fujitsu, reduced costs from 9 percent of revenues in
1991 to 3.5 percent in 1997.

Supply chain management influences such major decisions as plant andservice location
and is a vital component in a firm’s global strategy. Ininternational business, supply
chain management will face key issuessuch as:

o International shipping costs

o Language, currency translation,
o Customs documentation, and
o Cross border financial settlement

The Globalization of Supply Chains

Firms must move towards consolidating their production and distributionactivities in a
few strategic locations if they are to deliver a product orservice effectively. The following
three factors are responsible for theshift towards global supply chains.

1. Rapidly escalating capital costs – the more standardized thesupply chain activities,
the less the cost incurred in theperformance of these operational activities crossing
nationalboundaries.
2. Enhanced technologies – mostly in the form of data processing,dissemination, and
feedback, information technology systemsallow for greater coordination and
standardization of supplychain activitiesacross borders.
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3. Regional integration – there are many benefits a firm can enjoywhen situated in a
regionally integrated part of the world,particularly when it comes to the minimization
or (in somecases) eradication of cross border tariffs when transferringgoods for
example.

In circumstances where MNEs do not possess requisite scaleeconomies to justify a

specialized facility, they can do the following:

o Engage in mutualization – the sharing of logistic facilities by two or more

partners. Such is the case of Hawaiian airline and Korean Air in their code-
sharing agreement that will allow Hawaiian to offer non-stop service between
Hawaii and Korea as well as connecting service on flights within Korea and five
other destinations in Asia.
o Form strategic alliances with other firms, especially local firms. General Motors
(GM) uses Fritz companies to warehouse and distribute after sale parts and
accessories in Taiwan.
o Source logistics from third party providers. Marks & Spencer and Philips
Semiconductors uses third party providers whereinthe shipper takes the lead ins
strategy formulation and theprovider conducts day-to-day operations.

Global Sourcing
Global sourcing is the procurement of production and service inputsand component sin
international markets. This provides the MNE withthe opportunity to leverage its scale
and competitive advantage inspotting procurement opportunities around the globe for
use in itsvarious divisions and locations.

Example: Wal-Mart uses huge volume to extract lower prices from suppliers – a
quintessential example of the bargaining power of the firmas a buyer. Ford on the other
hand, uses the scale economies itextracts from its FDI-integrated chain activities to
supply its Brazilianoperations with low cost parts produced by its Chinese
subsidiary.MNEs can also employ global outsourcing or the buying of inputs
fromoutside their network. It is also possible to outsource the logisticfunction itself.

Logistic provider is a firm that provides a one stop shop service to itscustomers of
outsourced (or "third party") logistics services for part, orall of their supply chain
management functions. They typically specializein integrated operation, warehousing
and transportation services thatcan be scaled and customized to customer’s needs
based on marketconditions and the demands and delivery service requirements for
theirproducts and materials.

Example: TNT logistics distributed parts of Italian car maker Fiatthroughout Europe.
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Customizing the Supply Chain

Although the globalization of supply chain management proceeds, thereare three
factors that require continuous attention to localization andcustomization. Three sets of
factors that support localization:

1. Variations among national environments – size, terrain, andother characteristics

affect the supply chain among variousregions. Additionally, skill level, the quality of
supplies, processequipment availability and technology, and communications
canalso vary greatly among regions and nations.

Example: The challenges faced by the intermodal chains usedin an archipelago like the
Philippines will certainly be differentfrom the ones faced by a landlocked country like
Cambodia.

2. Product customization that triggers logistic adjustments.Product customization

challenges supply chain characteristicsdue to its impacton modularity, packaging,
transportation,tracking, shipping, and finally distribution.

Example: When McDonald’s started its business operations inRussia, it took a radical
departure from other McDonald’soperations around the globe by consolidating its
operations inone large facility. This was deemed necessary in order toovercome
bottlenecks and supply disruptions that plagued theSoviet system.

3. The existence of national borders that constrain the freeflow of goods and services
thus limiting global solutions.This may be a particular problem in countries that are
not part ofan economically integrated/cooperative region.

Packaging
Packaging decisions for the MNE will fall somewhere within thestandardization –
adaptation continuum. The standardization ofpackaging is appealing for the following
reasons:

o Logistic ease as it is easier to manage the transportation anddistribution of

uniform supplies of goods across borders, not tomention the savings in terms of
cost.
o Brand recognition as it is easier to imprint the consumer mind when a product’s
packaging is consistent across markets.

The local adaptation of packaging is made necessary for the followingreasons:

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o The need for sturdier packaging to shield products from outside elements in a
harsh environment. Weather and climate differences across markets cannot be
changed and thus needs to be adapted to.
o The need to adapt to local legal packaging requirements. Packaging
requirements mandated by law are non-negotiableand if a firm sees that the
market potential is worth the cost of adaptation, then the change in packaging
becomes non-negotiable. For instance, German Packaging Ordinance requires
that manufacturers use environmentally-friendly, recyclable packaging material
wherever feasible.
o The need to adapt to local labeling requirements. Although sometimes perceived
as a form of non-tariff barrier, labeling requirements are mandated by law and
are also non-negotiable. Firms must adapt and incur the added time and cost to
distribution if they are to legally market their goods in the foreign market. For
instance, Canada requires that product labels bear the two main languages of
Canada: English and French.
o The need to adapt to cultural and religious reasons. Although not found in explicit
laws most of the time, cultural and religious reasons are powerful influences of
consumer behaviors and preferences. For instance, Kimberly Clark’s subsidiary
in Israel, Holga-Kimberly, sells diapers to the orthodox sector in Israel in specially
designed, easy to open packaging that meets the requirements for doing no work
on theSabbath.

Transportation Modes
Globalization is a strong driving force behind intermodal transportation– the combination
of:

o Maritime transportation (i.e., ocean vessels) - Well over 90 percent of

international trade s served via maritime transportation. Today, the Transpacific
Stabilization Agreement, the world’s research and discussion forum/cooperative
for major ocean container shipping lines, seeks to exchange pertinent market
information, represent carrier interests in consultations with government
regulatory bodies, develop voluntary, non binding guidelines for rates and
changes, and establish common terms of service and standards for
documentation, information systems development and other issues of public
interest. The TSA is important, especially in the face of the issuance of “flags of
convenience” that is the registering of ships in countries with less stringent safety
regulations such as Liberia and Panama. These flag of convenience impede the
globalization of maritime transport.
o Port facilities and Inland ports - Such facilities are vital in the cost and
convenience of maritime transport. According to the Conference Board, the most
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competitive ports in the world possess the following strengths: speed of

processing in handling cargo and administration, low cost, and intermodal links.
The four types of ports are:
 Maritime hub – dedicated to transhipment from an ocean vessel to another or to
a feeder vessel;
 Gateway port – an interchange between a maritime huband/or land transport;
 Logistic-industrial port – interchange between transportmodes combined with
logistic support;
 Trade port – logistic activities plus value-addedinternational trade services.

The Inland Port is a landlocked port that has arteries to airports,highways, and rail and
coastal port access via agreements withother ports. An example of this would be the
inland port of “PortColumbus” in central Ohio (U.S.) Other countries with
vast,underdeveloped hinterland (land or district behind the borders ofa coast or river)
such as China are interested in the inland portconcept.

o Trucking (i.e., road links) - Trucks are also vital to intermodal trade routes. They
are responsible for the domestic distribution of products delivered internationally
by ship, rail, or air. An important issue surrounding the use of trucks is the
growing traffic congestion problem leading to the deterioration of service quality,
delayed shipments, high energy costs, and environmental degradation since
these trucks use up more fuel and release more carbon gases than trains. In
response to this, industrialized nations such as the U.S. and countries in the
European Union have moved to standardize truck transportation. Such
standardization procedures include safety regulations and environmental-friendly
regulations.
o Rail - Rail is an attractive alternative to trucking due to its competitive time to cost
ratio and its reduced carbon footprint (environmental waste in terms of
greenhouse gases) compared to trucking for example. Warren Buffett, one of the
world’s wealthiest men, recently invested $44 billion dollars to acquire Burlington
Northern, an American rail freight company. He justifies this acquisition by saying
that as America moves toward greener modes of transporting goods, larger
volumes of trade will continue to be made on this seemingly old-fashioned mode
of transport simply because it is so economical and more environmentally sound.
o Air-air transport, for its expedience, is the most viable mode of transfer especially
in the case of highly perishable goods or high value items. One impediment to
the globalization of air transport, however, is the stringent safety standards
imposed by developed nations vis a vis the relatively lax regimes of developing
countries.

Inter modality presents challenges in the comparing the prices ofalternative

transportation modes due to the following factors:
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o Product factors: weight, value, and space.

o Non-product factors: port of shipment, custom administrativeprocedures, etc.

Inter modality also requires modularity and standardization to permitfrequent transfer of

goods from one mode to another. Transportationmodes must be evaluated in terms of
their cost and efficacy with specialattention given to intermodal transportation.

WK 16STRATEGIC INTERNATIONAL HUMANRESOURCE MANAGEMENT

International Human Resource Management

International Human Resource Management (IHRM) is theprocurement, allocation,
utilization, and motivation of human resourcesin the international arena. The following
are distinct features of IHRM:

o Multiculturalism – this defines as the “celebration of human diversity by willingly

promoting legal, political, and social recognition of cultural, ethnic, linguistic, and
religious differences.” In the life of the MNE, multiculturalism is one of the main
issues in the global management of human resources.
o Geographic dispersion – the distribution of high-level human personnel across
geographic boundaries is the second main issue in IHRM. To many, the thought
of being transferred a great distance away from the home country is a daunting
one.
o International taxation – issues of “to whom do I pay my income tax” becomes a
complex issue here.
o Relocation – foreign re-assignment entails relocation or the change in country of
domicile and causes a great deal of stress especially when not properly prepared
for by the firm and the individual.
o Foreign culture orientation – openness to a different way oflife, social norms,
customs, mores, etc. Is a key ingredient inexpatriate success. Foreign culture
orientation encompasses allthe activities s geared towards creating a greater
understandingof different cultures and preparing the assignee for
foreigndeployment.

From the personal career perspective, international experience increasingly opens

doors from initial entry all the way up to the executive level. Highly-visible MNEs like
Johnson & Johnson explicitly seek candidates who have participated in a college
exchange program, for example, on the assumption that such individuals are better
equipped to deal with the demands of a global business environment.

Three Models of Strategic IHRM

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Strategic IHRM (SIHRM) is defined as “human resources, management issues,

functions, policies and practices that result from the strategic activities of MNEs and that
impact the international concerns and goals of these enterprises”. The SIHRM model
has the following three orientations:

1. Adaptive system – this system imitates local HRM practices.

2. Exportive System – this system replicates the HRM system inthe home country as
well as that of other affiliates.
3. Integrative system – this system emphasizes global integrationwhile permitting some
local variations.

Optimal SIHRM is one that is capable of striking the delicate balancebetween the forces
of local adaptation/responsiveness and globalintegration. The overall SIHRM strategy is
chosen by the parent inconjunction with the affiliate’s specific conditions (e.g.,
culturalsimilarity/dissimilarity from the parent). Ultimately, this will determine thedegree
of similarity in SIHRM between the affiliate and the parentheadquarters.

Phases of Internationalization & IHRM

The following are the four phases of Internationalization and IHRM:

1. Phase I Domestic: focus on home market and export. This isusually characterized by
incidental brie visit to foreignagent/sales offices or short assignment that is on a per
projectbasis.
2. Phase II International: focus on local responsiveness andtransfer of learning. During
this phase, managers are usuallyassigned to posts in foreign markets with the
purpose ofproviding general management, technical expertise, andfinancial control.
On the individual level of the assignee, thisrequires technical competence, language
skills and cross-cultural sensitivity and adaptability.
3. Phase III Multinational: focus on global strategy, low cost, andprice competition. The
selection of managers for foreignassignment in this phase focuses on recruiting the
best of thebest for international positions, regardless of country of origin.During this
phase, the training and development of all membersto embrace the same
organizational values and norms areamong HRM’s most vital tasks. This third phase
in HRM is spearheaded by management deployment, career counseling,and
periodic transfers to different assignments.
4. Phase IV Global: focus on both local responsiveness andglobalintegration. During
this phase, learning how to satisfy therequirements for global integration and
national responsivenessis the major issue. This phase is characterized by a
largemeasure of cultural diversity. Also,IHRM focuses on promising managers
career growth opportunities andgaining experience in order to facilitate a culture of
continuous learningthroughout the entire organization.
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Staffing the MNE

Globalization of the Board of Directors

A Conference Board Survey between 1998-1999 was conducted toassess how
globalization affected the composition of the board ofdirectors. It found that:

 Between 1995-1998, the percentage of firms with nationaldirectors increased

from 39 to 60%
 Companies with three or more non-national directors increased from 11 to 23%
 Between 1995- 1998, the percentage of non-national directorssurveyed went
from 6 to 10%

The same Conference Board survey found that the primary internaldrivers for seeking
non-national broad members were the entering ofnew markets and the exposure to new
demands from customers andinvestors. Often, new managers are the source of this
initiative whowish to expand international operations where the credibility
andexperience of non-national directors makes a difference.

Example: When Deutsche Telekom welcomes the addition of FranceTelecom CEO

Michael Bon to its supervisory board, this cemented theties between the two firms,
raised Deutsch Telekom’s profile in theFrench market, and brought a new perspective in
business.

Concerns involved in selecting global board members include thefollowing:

 Selecting someone who is culturally similar to existing membersbut has an

international perspective. In other words, thisprospective assignee must be the
very embodiment of the finebalance between “thinking globally, acting locally.”
 Looking for individuals with in-depth cultural and businessexperience in a given
part of the world. Actual experience in thegivencountry/region is highly valued by
the MNE in its boardassignees. This is related to the belief that no amount
ofclassroom learning can equal the knowledge that is gleanedfrom actual life
experiences.

The appointment of non-national directors undergoes certain barrierssuch as the extra

commitment involved (U.S. and U.K. average about 8-9 annual meetings when the
average in continental Europe is 4), timezone difference, language, and culture.

The Conference Board recommends the following in order to overcomebarriers in the

appointment of non-national directors:
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 Accommodating non-nationals by reducing the number of annual meetings

 Rotating locations
 Setting up orientation programs
 Widening the definition of non-national directors to include non-nationals living
and working abroad who maintain strong ties with their home country

Representation is also another obstacle for non-national directors.Institutions have a

fiduciary duty, the employees’ or directors’ legal dutyto exercise the power of their office
for the benefit f the employer or thefirm, to protect shareholder interests. As such, they
must considerlimited representation in the decision to elect directors. This isparticularly
challenging in nations like Japan where representation ismore difficult due to the
significant shareholders sitting on the board, i.e.,board members are comprised of
family members, board members ofcompanies with significant cross-shareholdings,
board members ofmajor suppliers, or labor/pension fund representatives.

Staffing the MNE Ranks

Philosophies of staffing abroad include the following:

Ethnocentric.Parent Country Nationals (PCNs) who are bydefinition expatriates are

selected for key positions regardless oflocation. Japanese and Korean MNEs tend to
follow this modemore than their U.S. or European counterparts.

Example: Samsung not only had an all-Korean seniormanagementteam until 1999, but
90 percent of those peoplegraduated from Seoul National University.

Polycentric.Host Country Nationals (HCNs) are hired for keypositions in subsidiaries

but not at corporate headquarters.Most MNE employees abroad are HCNs simply
because, inmost instances, they are the most widely available, the easiestto employ
legally and administratively, they know more aboutthe local environment and are often
cheaper to employ thanparent country nationals.

Regiocentric.Recruiting is conducted on a regional basis (e.g.,recruit within the

European Union for a position in Belgium). Toa certain extent, this ensures that
assignees are not too culturally distant from the destination country.

Geocentric.The best mangers are recruited worldwideregardless of nationality. The

advantage of this approach lies inthe fact that this introduces fresh perspectives and
modes ofoperation.
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Country-Specific Issues
Just as in other functions in international business, the MNE needs toadjust its
corporate policies and practices in order to adapt to variationsin employment conditions
and labor markets.

Employment conditions encompass the appropriateness of theemployee talent/skill pool

to the demands of the nature of theiremployment. Transition economy employees
accustomed to centralizedplanning encounter difficulty in more autonomous, higher
productivity-geared MNEs.

Developing economies may lack the requisite number of skilledemployees due to poor
education infrastructure. The employmentopportunities may exist in the market, but if
there aren’t enough skilledworkers to take those positions, this could pose a major
problem forMNEs. Also, a high level of employee turnover can cost the firm a greatdeal
of money.

However, MNE are not without solutions. For instance, Ford MotorCompany offers
retention incentives to Chinese workers such as ahousing loan that is forgiven after
seven years of service and a tuition topursue an MBA degree. Additionally, Ford has
begun to deviate from itspolicy of preventing employees who have left the company to
be rehired.

The Expatriate Workforce

The growth of global operations and increased demand for highly skilledemployees are
causing the number of expatriate workers to rise. The following are a few facts and
figures surrounding this demographictrend:

o According to the OEC, the expatriate rate among highly skilled workers is higher
than that of the average population.
o 1 in 10 highly skilled British workers are expatriates.
o Dubai’s population is predominantly composed of expatriates from India,
Pakistan, Bangladesh, and the Philippines, with only 20% of its population
composed of its own citizens.

Many MNEs like Ford Motors and Johnson &Johnson have been tryingto reduce the
number of their expatriates in efforts to reduce costs (thisis because expatriates have a
much higher average salary than non-expatriates). Yet, growing global operations and
the increased demandfor their skills cause the number of expatriates to continue to
swell. Asurvey in 1992 of 130 MNEs in the world showed that half of them hadmore
than 50 high level expatriates wand 25 percent with 200 to 2,000expatriates each.
Almost two decades later, the number is still growing.
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Types & Distribution of Expatriates

The following are the four different types of expatriates:

Traditional expatriate – such expatriates are older and moreexperienced. They are
selected for their managerial or technicalskills for a period of one to five years. They can
be furthersubdivided into the following categories:

o International cadres – individuals who seldom return totheir own countries and
who move from one foreignassignment to another.
o Permanent expatriates – stay in overseas assignments forextended periods of
time, or even permanently.
o Young, inexperienced expatriates – these are expatriates sent for six months to
five years and are usually on hire terms.
o Temporaries are expatriates who go on short assignments up to a maximum of
one year. Organization Research Councilors project that 77 of 500 MNEs it
surveyed are expected to increase temporary assignments.
o Expatriate trainee – this person is placed abroad for training purposes as part of
initiation into the MNE. Johnson& Johnson and the Deutsche Bank group are
some examples of MNEs who place new recruits in another country, often for 18-
month periods.

A new trend thanks to telecommuting is the emergence of the virtualexpatriate – one

who takes on foreign assignments without physicallyrelocating.Such virtual expatriates
are frequent fliers and usevideoconferencing and telecommunications to stay in touch.

Example: Smith Kline Beecham’s Ian Hunter manages the Middle Eastand Pakistan
from England. Virtual expatriates are able to enjoy lowcost, avoiding family adjustment,
and not having to relocate.

Pros & Cons of Using Expatriates

From the MNE point of view, the following are the benefits that justify theuse of
expatriate workforce:

o Expatriates contribute to essential knowledge and experience. Often, expatriates

are among the highly-skilled, more experienced, senior demographic of a
corporate workforce. This makes such individuals valuable to the MNEs efforts at
staffing foreign subsidiaries with professional experts that can carry out their
operations and strategic goals.
o Expatriates serve as a mechanism of control. Expatriates are expected to guide
and regulate the activities of the foreign subsidiary in a manner that is in keeping
with the overall goals and strategic objectives of the parent company. Should
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operations deviate from expected targets, Expatriates are tasked with measuring,
monitoring, and taking corrective action on operations to keep the subsidiary
back in line with HQ.
o Expatriates serve as a way to transmit corporate culture and goals. Expatriates
are often chosen for their ability to “think globally while acting locally.” That is,
they must be of one mind with the overall intentions and goals of the parent firm
while expertly disseminating this corporate HQ culture into the foreign subsidiary.

The following are reasons to not use expatriates:

1. Disincentive to the local workforce whose promotion is blockedand who feel
relatively deprived due to low wage levels. Often,employees are discouraged when
comparing their relativelylower wages to those enjoyed by expatriates.

Also, there is the notion of the corporate “glass ceiling” whereemployees know that
their ascent of the corporate ladder will be blockedby expatriates in higher positions.

2. Can rob a company of skills, insight, and initiative of localnationals.Local nationals

are more aware of the idiosyncrasiesof their domestic market. Placing expatriates in
key positionsmight possibly prevent the subsidiary from benefitting from theunique
knowledge and experience of host country nationals.
3. High rate of failure. For obvious reasons of stress and cultureshock that come with
the territory of doing a domain shift, manyexpatriates fail at their foreign assignment.
The variety ofreasons for expatriate failure will be discussed in the followingslide.

Expatriate Failure
Expatriate failure happens when the assignee prematurely returns tohome country or
when performance does not meet expectations. Thefollowing are reasons why
expatriate failure occurs:

o Unhappy spouse. Spouse willingness to relocate plays a major role in the

success of the expatriate assignment.
o Inability to adjust to unfamiliar physical and cultural environment. This is always a
huge concern with foreign assignment. Usually, MNEs will try to determine the
personal culture of the assignee. The less culturally distant from the subjective
culture of the place of foreign assignment, the better.
o Personality or emotional immaturity. If the assignee does not possess a certain
required level of emotional maturity or the temperament that is suited to the need
for constant adaptability in one’s environment, the candidate is likely to fail.
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o Inability to cope with responsibilities and stress of overseas work. This can also
be related to a slew of stressors relating to cultural adaptation and physical
adaptation in addition to the duties and responsibilities inherent to the foreign
assignment.
o Lack of technical competence. The ability to carry out all the objectives of the
foreign assignment based on one’s skill and abilities is vital. The lack of technical
competence will render the foreign assignment unsuccessful.
o Lack of motivation to work overseas. The most primary internal motivation for
expatriate assignment. If this motivation does not exist for the assignee, failure is
likely to happen.

Expatriate Selection Instruments

MNEs look for cultural empathy, adaptability, flexibility, language skills,education,
leadership, maturity, and motivation in evaluating the viabilityof a prospective expatriate.