International Business (20)

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INTERNATIONAL BUSINESS

CONTENT

CHAPTER 1

INTERNATIONAL BUSINESS

Chapter 2

INTERNATIONAL BUSINESS MANAGEMENT

CHAPTER 3

WHY GO INTERNATIONAL?

CHAPTER 4

INTERNATIONAL BUSINESS APPROACHES

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CHAPTER 1 INTERNATIONAL BUSINESS

The beverages you drink might be produced in India, but with the collaboration of a

USA company. The tea you drink is prepared from the tea powder produced in Sri Lanka. The spares and hard disk of the computer you operate might have been produced in the United States of America. The perfume you apply might have been produced in France.

The television you watch might have been produced with the Japanese technology.

The shoe you wear might have been produced in Taiwan, but remarketed by an Italian company. Air France and so on so forth might have provided your air travel services to you. Most of you have the experience of browsing Internet and visiting different web sites, knowing the products and services offered by various companies across the globe. Some of you might have the experience of „even ordering and buying the products through Internet. This process gives you the opportunity of transacting in the international business arena without visiting or knowing the various countries and companies across the globe.

You get all these even without visiting or knowing the country of the company where they are produced. All these activities have become a reality due to the operations and activities of international business.

Thus, international business is the process of focusing on the resources of the globe


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and objectives of the organizations on global business opportunities and threats. Evolution of International Business

The business across the borders of the countries had been carried on since times immemorial. But, the business had been limited to the international trade until the recent past. The post World War If period witnessed an unexpected expansion of national companies into international or multinational companies. The post 1990s period has given greater fillip to international business.

In fact, the term international business was not in existence before two decades. The term international business has emerged from the term international marketing, which in turn, emerged from the term „export marketing‟.

International Trade to International Marketing: Originally, the producers used to export their products to the nearby countries and gradually extended the exports to far-off countries. Gradually, the companies extended the operations beyond trade. For example, India used to export raw cotton, raw jute and iron ore during the early 1900s. The massive industrialization in the country enabled us to export jute products, cotton garments and steel during 1960s.

India, during 1980s could create markets for its products, in addition to mere exporting. The export marketing efforts include creation of demand for Indian products like textiles, electronics, leather products, tea, coffee etc., arranging for appropriate distribution channels, attractive package, product development, pricing etc. This process is true not only with India, but also with almost all developed and developing economies.

International Marketing to International Business: The multinational companies which


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were producing the products in their home countries and marketing them in various foreign countries before 1980‟s started locating their plants and other manufacturing facilities in foreign/host countries. Later, they started producing in one foreign country and marketing in other foreign countries. For example, Uni- Lever established its subsidiary company in India, i.e., Hindustan Lever Limited (HLL). HLL produces its products in India and markets them in Bangladesh, Sri Lanka, and Nepal etc. Thus, the scope of the international trade is expanded into international marketing and international marketing is expanded into international business. NATURE OF INTERNATIONAL BUSINESS

The 1990s and the new millennium clearly indicate rapid internationalization and globalization. The entire globe is passing at a dramatic pace through the transition period. Today, the international trader is in a position to analyze and interpret the global social, technical, economic, political and natural Environmental factors more clearly. Conducting and managing international business operations is a crucial venture due to variations in political, social, cultural and economic factors, from one country to another country. For example, most of the African consumers prefer less costly products due to their poor economic conditions.

Whereas the German consumers prefer high quality and high priced products due to

their higher ability to buy. Therefore, the international businessman should produce and export less costly products to most of the African countries and vice versa to most of the European and North American countries. High priced and high quality Palmolive soaps are marketed in European countries and the economy priced Palmolive soaps are exported and marketed in developing Countries like Ethiopia, Pakistan, Kenya, India, Cambodia etc. International business houses need accurate information to make an appropriate decision.


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Europe was the most opportunistic market for leather goods and particularly for shoes. Bata based on the accurate data could make appropriate decision to enter various European countries. International business houses need not only accurate but timely information. Coca Cola could enter the European market based on the timely information, whereas Pepsi entered later. Another example is the timely entrance of Indian software companies into the US market compared to those of other countries. Indian software companies also made timely decision in the caseof‟ Europe. INTERNATIONAL MARKETING Research

Research is very important when marketing in your own country, but it is even more important in foreign markets. This is because in your own country you can rely on some combination of research results and your own intuition (i.e. your sense of how people think, how they use your products, and how they will respond to certain messages). In foreign markets, you do not have the same kind of personal familiarity with the markets, and therefore need to make up for it with more extensive research.

The results of this research should then be considered in light of what the firm can deliver. - Doing detailed research is costly; a firm would typically only do detailed research on the countries believed to be the most promising.

A. Demand Analysis

The firm needs to analyze and segment its customers. It should clearly identify who are


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the accessible, target customers. It should understand how the country's culture might affect demand for its product. Consider income levels, demographics, education levels, distribution of incomes, urbanization, consumption patterns. Moreover, consider trends in each of these issues. (e.g. How fast are income levels rising? Is the population aging? etc.) - Essentially, you want to spot an emerging demand for your product. It is often easier to break into emerging markets than into saturated markets. - Determine existing demand (based on the data and on expert opinion). - Determine future demand (based on trends). - Determine latent demand (demand for products not currently available in the country). - Determine responsiveness to marketing. - Determine spillover effects to neighboring countries. - Determine what adaptations to the product customers may prefer. - Determine customer bargaining power. (The fewer or larger the customers, the more they will be able to bargain down the selling price)

B. Competitor Analysis

- Identify existing competitors. - Identify potential competitors. - Identify close substitutes to your own product. - Anticipate competitors' responses. Price war? Calls for government intervention

C. How to Collect Data - Ideally, data should be collected by people who know the firm and industry, and who have a


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strong familiarity with the country of study.

- Often such people are not available, so there is a risk that the data is misinterpreted or

misdirected.

- There are many external sources of data: home government, other governments,

international organizations, service organizations, trade associations, databases, other firms.

D. Issues Internal to the Firm

- The firm should consider its own competencies. How will the firm's competencies fare in the

foreign market?

- How transferable are the firm's competencies? If a key function must be done overseas, can

the firm's advantages be transferred to that location?

- What risk is there of giving away competencies if marketing can only be done through a joint

venture or licensing?

- COSTS.

- Can you think of any examples of poor research in foreign markets? Can you think of

any foreign products that failed in our markets (or in your country‟s markets if you are an

international student)? Do you think the foreign company could have avoided its mistakes

through better research?


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Product Design - “Product design” refers to the characteristics of the product. We think of a product in broad terms to include the service and warranty elements. - One of the issues often considered is whether to use a standard product or to adapt the product to the local market. This perhaps unduly simplifies the question of what product the firm should sell in the foreign market, but for the purposes of a general discussion we‟ll focus on this issue. - There are some important reasons why a company might want to sell a standardized product. One is that standardized products typically cost less, because this strategy exploits economies of scale more. A second reason is that the firm's competency may be in that product as is and not in a different product. - Many companies, however, do in fact adapt their products to local markets for a variety of reasons. Often the adaptations are small, are relatively inexpensive and do not cause the firm to deviate from its competencies. There are many reasons why products might need to be modified for the foreign market. Differences in products result from differences across countries. Environmental Differences

- Geography


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- Geography, for example, affects people's mode of transportation. For example, trucks in

mountainous countries need stronger axles.

- Climate

- e.g. does the product need to withstand cold winters?

- Population density

- In densely populated areas products typically need to be more compact.

For example, refrigerators need to be smaller because people‟s kitchens are smaller.

- Population density can affect products indirectly as well. For example, smaller refrigerators

make their owners less likely to buy groceries in bulk.

Thus population density indirectly affects how food product companies package their

products.

Individual Composition - Income- Sellers of luxury goods need to consider how many high income people there are. (Note that GDP per capita is not necessarily a good measure of this. In one country everyone might have about the same income, while another country with the same average income could have a wide range of income levels.) - Age- Age affects demand for products associated with certain stages of the human life cycle. For example, populations with many children may have different needs in automobiles versus elderly populations. Of course, tastes also tend to differ across age groups.


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- Education- Illiterate people may require product designs that allow use without reading. Educated people tend to be better informed on certain issues. - Religion- Some religions place restrictions on people‟s consumption patterns or may influence them. Examples include restrictions on alcohol, beef, pork or certain types of attire. Religions may also discourage materialism. Group Interaction

1. Formal standards (codified by law or regulations). Examples include what side of the road you drive on, safety standards and pollution Standards.

2. Informal standards- The classic example is the QWERTY keyboard, which is slightly

different in some European countries.

3. Symbols- Symbols in one country may be meaningless in another, or may mean something quite different. For example, yellow apparently symbolizes cowardice in Anglo-Saxon cultures, but symbolizes royalty in China.

4. Manners- Behavior that is acceptable in one country might be unacceptable in another

country. For example, in some cultures it might be rude for a pizza-delivery person to knock on the door.

Tastes

- Other differences across countries are hard to classify, and could just be attributed to taste differences.


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Examples include:

- North American preferences for sweeter foods. - Different countries‟ preferences for different beverages.

Cost of Adaptation

There usually are plenty of reasons to adapt a product for a local market, but a firm also needs to consider the costs of doing so. Some types of costs of adaptation are listed below: 1. Research and development costs- In some cases the costs of a new design may be small (such as Cadbury‟s cost of changing its proportions of ingredients), or may be substantial. 2. Market cultivation costs- Some product variations may necessitate a substantially different approach to promotion. 3. Line costs- A new product line may require additional machinery or workers to produce the new product. 4. Switching costs- In some cases, firms use the same production line to produce different types of products. Nevertheless, there are costs associated with frequent retooling within a plant. This process is costly both in terms of money and time. On the other hand, some firms have cut such costs substantially through flexible manufacturing processes. 5. Input costs- If the modified product requires a new input, costs could go up simply because the firm is buying more expensive inputs. (Of course, in some cases, product modifications


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could reduce the production cost, if the modified product uses cheaper inputs.) Other Considerations

1. Trends- Some of the differences (such as education and tastes) can change over time. Others (such as geography and climate) do not.

1. Niche markets- Even though a majority of people may be of one type, a company may

be able to sell an unaltered product to a niche minority. For example, a European chocolate producer may choose to sell an unaltered product in the U.S. (i.e. they don‟t add more sugar) to target the segment of U.S. consumers who prefer less sweet chocolates.

Pricing - For homogenous products, the market sets the price. - For differentiated products, firms choose price to maximize their earnings. When different markets have different elasticities of demand, a firm maximizes profit by practicing price discrimination. Price is determined where MR=MC1 in each market. What is the difference between elastic demand and inelastic demand? What are some reasons that demand might be more elastic in one country than in another? - For example, suppose a firm sells in two markets (1) & (2). The marginal cost of the product is 1 for either market. The demand function in market 1 is Q1=5-P1 (where Q1 is the quantity sold in market 1 and P1 is the price in market 1). So revenue from market 1 would be P1 (5-P1). The marginal revenue is the derivative of this expression, so it is -2P1+5. If we set this


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expression equal to the marginal cost of 1,we get a price of P1=3. Now suppose in market 2 the demand function is Q2=6-2P2.This demand function would yield an optimum price of p2=2.

However, a MNE entering a new market must also consider long-run effects of its pricing decisions today. Pricing can affect future demand (e.g. effect on potential competitors, consumer/distributor awareness, network externalities, habits and addictions, signal of quality). It is possible that a firm might employ predatory pricing to drive out competitors so that afterward the firm can enjoy high profits. In most developed countries, this is illegal. Firms also need to be wary of antidumping rules. Sometimes markets can‟t be segmented so easily. For example, many West European manufacturing companies sell their goods at a lower price in Eastern Europe than in Western Europe. So some Western retail chains are able to buy the goods from wholesalers in Eastern Europe at a lower cost than if they bought the goods directly from the manufacturing company. This is often called the grey market. It is called the grey market because the legality of this is not always clear. Ordinarily, when a manufacturer sells its goods, it gives up its right to have a say on who may or may not buy the product. However, it may have the right to limit warranties and servicing. The legality of this practice will therefore normally depend on what agreements are in place, and on whether the retailer is making true or false representations as to what warranties and servicing the manufacturer will provide. - Do you think price discrimination between countries is ethical? Place (Distribution) - Like a purely domestic firm, a MNE may sell its products directly to consumers or else to a wholesaler or retailer. When goods across international borders additional issues arise, such as exchange rate risk, overseas shipping and customs clearance, and navigating the foreign


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environment. The firm has to decide whether to handle its own distribution or contract part of the distribution function to other firms. Marginal revenue = marginal cost A. Import Agents - Some agents, such as trading houses, will purchase for their own account. They usually require exclusivity if they must invest resources into market development. - Other agents simply handle exports for a fee and do not actually buy the product. B. Advantages of Contracting 1. They have expertise about distribution in the particular market. 2. They can realize economies of scale. 3. Export agents can match currencies and realize lower foreign exchange costs as well as risks. C. Disadvantages of Contracting 1. You have to pay them (or sell your product to them at a discounted price). 2. The manufacturer might lose control over market development and customer service. 3. The manufacturer might disclose some proprietary information. 4. Incentive problem - the foreign distributor might have other agendas than just pushing your product. Factors Influencing Choice


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1. Characteristics of distribution

(a) Retail concentration: whether retailing is dominated by a few large retailers or is spread out among many small retailers. How does retail concentration affect an exporter‟s choice of how to distribute its product?

(b) Channel length: number of intermediaries between producer and consumer (usually the channel length is smaller if there is high retail concentration). How does channel length affect an exporter‟s choice of how to distribute its product?

(c) Channel exclusivity: where it is difficult for new firms to secure shelf space in retail stores. How does channel exclusivity affect an exporter‟s choice of how to distribute its product?

2. Economies of scale and volume - more sales make an investment more feasible 3. Product characteristics - more technical products might best be distributed by the manufacturer, to ensure adequate service and promotion. 4. Characteristics of the other party - Other party may have a conflict of interests. Promotion (Advertising) - The advertising task is the same in most markets - to communicate information and persuade.7 - There are many reasons why advertising might need to be modified for the foreign market. - Consumer Tastes and Preferences - Usually culture related. - Source Effects - Consumers‟ opinion of a producer can matter. e.g. Japanese and German-made goods are often perceived as of high quality. - Consumers in some countries either like or dislike certain countries. Or they simply prefer

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domestic manufacturers. How can a company get around this problem? - Regulation - Another decision to make is whether to use a global brand name, or to develop a new local brand name. - Advantages to a global brand name include: - promotes global recognition - Economies of scale in brand development - Media coverage may cross borders (e.g. in PEI we see Boston ads) - enables standardized advertising - Disadvantages of using a global brand name include: - need to ensure quality remains high in foreign location - Grey market - Local prejudice against foreign brands - Names may not work well in some languages

Chapter 2 INTERNATIONAL BUSINESS MANAGEMENT

The size of the international business should be large in order to have impact on the

foreign Economies. Most of the multinational companies are significantly large in size. In fact, the Capital of some of the MNCs is more than our annual budget and GDPs of the some of the African Countries. Most of the international business houses segment their markets based on the geographic market segmentation. Daewoo segmented its market as North America, Europe, Africa, Indian subcontinent and Pacific markets.

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International Business Opportunities Y2k & Euro India appears to be well positioned to

take advantage of the opportunities by capitalizing on its reputation of being a global centre for development of commercial applications and outsourced software services. But despite these advantages, companies have not been able to cash in on the opportunities even though software firms collectively have the potential, In the Y2K opportunities, a substantial part of the cost involved in initial analysis, finalizing the strategy, testing and implementation. While most of the resources services by companies to address the Y2K business are like “fast chicken,” capable of addressing only the code-correction phase, the real testing requires not pseudo programmers who have entered the field, but genuine software professionals who have considerable experience. The European Union has decided to go for a single currency named Euro. And for this, currency and conversion related changes are to be incorporated within the software. This opportunity is much bigger than the Y2K one, but software developers are not geared well enough to tap the sizeable potential that it holds for them. It is much more a difficult opportunity. The impact of Euro on the application system requires more knowledge. Some software companies are addressing this, particularly by extending their Y2K services to take part in euro projects also.

International markets present more potentials than the domestic markets. This is due to the fact that international markets wide in scope, varied in consumer tastes, preferences and Purchasing abilities, size of the population etc. For example, the IBM‟s sales are more in foreign countries than in USA. Similarly, Coca-Cola‟s sales, Procter and Gamble‟s sales and Satyam Computer‟s sales are more in foreign countries than in their respective home countries. The population for the year 2000 indicates that: USA‟s population would be 300 million, Mexico‟s 126 million, Brazil‟s 205 million, Indonesia‟s 223 million, Pakistan‟s 138 million, Nigeria‟s 154 million and Bangladesh‟s 146 million. The size of the population, sometimes, may not determine the size of the market. This is due to the backwardness of the

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economy and low purchasing power of the people, In fact, the size of Eritrea an African country is roughly equal to that of the United Kingdom in terms of land area and size of the population. But, in terms of per capita income it is one of the poorest countries in the world with estimated per capita income of US $ 150 per annum.

Therefore, the international business houses should consider the consumers‟ willingness to buy and also ability to buy the products In fact, most of the multinational companies, which entered Indian market after 1991, failed in this respect. They viewed that almost the entire Indian population would be the customers. Therefore, they estimated that the demand for consumer durable goods would be increasing in India after globalization. And they entered the Indian market. The heavy inflow of these goods and decline in the size of Indian middle class resulted in a slump in the demand for consumer durable goods. Wider Scope:

Foreign trade refers to the flow of goods across national political borders. Therefore, it

refers to exporting and importing by international marketing companies plus creation of demand, promotion, pricing etc. As stated earlier, international business is much broader in scope. It involves international marketing, international investments, management of foreign exchange, procuring international finance from IMF, IBRD, IFC, IDA etc., management of international human resources, management of cultural diversity, international marketing, management of international production and logistics, international strategic management and the like. Thus, international business is broader in scope and covers all aspects of the system. Inter-country Comparative Study:

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International business studies the business opportunities, threats, consumers‟

preferences, behavior, cultures of the societies, employees, business environmental factors, manufacturing locations, management styles, inputs and human resource management practices in various countries. International business seeks to identify, classify and interpret the similarities and dissimilarities among the systems used to anticipate demand and market products‟. The system presents inter-country comparison and intercontinental comparison/comparative analysis helps the management to evaluate the markets, finances, human resources, consumers etc. of various countries. The comparative study also helps the management to evaluate the market potentials of various countries. The study also indicates the degree of consumer acceptance of the product, product changes and developments in different countries. Managements of international business houses can group the countries with similar features and design the same products, fix similar price and formulate the same marketing strategies. For example, Prentice Hall grouped India, Nepal, Pakistan Bangladesh; Sri Lanka etc. into one category based on the customers‟ ability to pay and designed the same quality product and sell them at the same price in all these countries. Similarly, Dr. Reddy‟s Lab does the same for its products to sell in the African countries. Differences in Government Policies, Regulatory Framework Sovereign governments enact and implement the laws, and formulate and implement policies and regulations. The international business houses should follow these laws, policies and regulations. MNCs operating in India follow our labor laws, business laws and policies and regulations formulated by the Indian Government. For example, international business should enter into joint venture with the domestic company to enter Malaysia. Important among them include: Host Country‟s Monetary System: Countries regulate the price level, flow of money, production levels etc. through their monetary systems. In addition, they regulate foreign exchange rates also through the monetary system. The tools of monetary system include bank rate, cash reserve ratio,

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statutory liquidity ratio etc. Governments also regulate remittance of the profit of international business houses to other countries. International companies should obey these regulations. The Indian Government introduced full convertibility on current account; in fact, many Governments introduced full convertibility on current account as a part of economic liberalization. National Security Policies of the Host Countries: Every country formulates the policies for its national security. Multinational companies should abide by these national security policies. For example, USA is a free economy as far as carrying out the business compared to many Impact of Culture of Switzerland Housewives On Marketing of Dishwashers

In Switzerland, foreign dishwasher manufacturers expected the same rapid sales as they had first obtained in other West European markets; but sales in Switzerland were so slow that research had to be done to find out why (this research should, of course, have been done before not after market entry). The research showed that the Swiss housewife had a different set of values to, for example, her French and English counterparts; she was very conscious of her role as strict and hardworking and her responsibility for the health of her family. To the Swiss housewife dishwashers simply made life easy, and this conflicted with her Calvinistic work ethic. As a result of the research, dishwasher manufacturers had to change their advertising promoting, instead of ease and convenience, hygiene and health. They did this by emphasizing that because dishwashers used temperature higher than hand hot, the process was more hygienic than washing up by hand. Thereafter, they had no automatic dishwashers in Swit7erland. Language:

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Language is an important factor in international business. Even though „English language‟ is a major language in business operations in the world, there are still a large number of „non-English‟ speaking countries. Therefore, international business houses should train their employees in the local language of the host country. Added to this, there would be many languages in use in many, countries like ours. Therefore, the business houses should train their employees in the local languages also. Nationalism and Business Policy:

Nationalism is a dominating factor of the social life of the people of the host countries. In fact, nationalism also affects the business operations of the multinational corporations dramatically and drastically. The US people used the slogan „Be American and Buy American Made‟, when the US automobile industry failed to meet the competition similar incidents are also observed in developing countries. Therefore, international business houses should be cautious of Nationalism and its after effects

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CHAPTER 3

WHY GO INTERNATIONAL?

We have discussed the nature of international business and the precautions that the multinational companies should take while operating in foreign countries. The basic question of “why do the Business firms of a country go to other countywide?” might have been in your minds. Therefore, we answer this question, before proceeding further.

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To achieve Higher Rate of Profits: As we have discussed in various courses/subjects like Principles and Practice of Management, Managerial Economics and Financial Management that the basic objective of the business firms is to earn profits. When the domestic markets do not promise a higher rate of profits, business firms search for foreign markets, which promise for higher rate of profits. For example, Hewlett Packard earned 85.4% of its profits from the foreign markets compared to that of domestic markets in 1994. Apple earned US $ 390 million as net profit from the foreign markets and only US $ 310 millions as net profit from its domestic market in 1994. Expanding the Production Capacities beyond the Demand of the Domestic Country: Some of the domestic companies expanded their production capacities more than the demand for the product in the domestic countries. These companies, in such cases, are forced to sell their excess production in foreign developed countries. Toyota of Japan is an example. The Economies of Developed Countries United States

In the US, the rate of growth of Gross Domestic Product (GDP) rose by 2.6 per cent in the second quarter of 1996 over the corresponding period of 1995 much higher than the first quarter growth rate of 1.7 per cent. The rate of growth of personal consumption rose strongly throughout the first half of 1996 overshadowing the economy‟s performance on the business investment front, which slowed between April and June 1996. Buoyant consumer demand has prompted further speculation about the future course of the inflation curve and short-term interest rates. Recent data present a contradictory picture. While some surveys point to a stronger rate of growth of industrial production in the third quarter of 1996, the growth rate of durable goods orders fell by 0.8 per cent between May and June 1996. Besides, statements by Alan Greenspan, the Chairman of the Federal Reserve, confirm a weaker growth

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prognosis. With growth showing signs of easing, there is a likelihood that interest rates will be on hold. But Consensus Inc. predicts that 10-year treasury bond rates will increase from the 1995 level of 5.6 per cent to 6.7 per cent by November 1996, Canada the Canadian economy‟s growth rate is likely to pick up in 1996. An index of business confidence shows higher real spending on machinery and equipment in the first half of 1996, reflecting a high level of producer confidence. On the consumption side, however, the picture is less promising. Low consumer demand has been strengthened by a high unemployment rate of 9.8 per cent, high household debt levels, and consumer worries over job security. Even so, retail sales are expected to pick up soon. So, the forecast for personal expenditure growth, rather than being downgraded, remains unchanged, but the low spending level has helped in restraining inflation.

Consumer prices rose by only 13 per cent in the first half of‟1996 well within the central bank‟s target range of between 1and 3 per cent allowing the fifth round of interest rate cuts in 1996 independent of US economic conditions. As the data available so far suggest that an upturn on the industrial front is Linder way. Also, the trade surplus is favorable as strong net external demand enhanced by the low Canadian dollar, low domestic demand, and a stronger US growth rate led to a Canadian $4.10 billion trade surplus in May 1996.

Japan In recent months, the prospects of a sustained recovery in Japan have improved although the Economic Planning Agency has warned that the recovery „is still fragile, and that expansionary trends have yet to be confirmed. Recently, there have been increasing signs of an upturn in private consumption, led by improving job opportunities and rising wages. Retail sales rebounded in June 1996, rising by 2 per cent over June 1995, after posting declines in two previous months. Consensus Inc.‟s forecasts for private consumption growth in both 1996 and 1997 have been upgraded to 3.5 and 2.6 per cent respectively. On the supply side, however, the picture is less optimistic, with another fall industrial output

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growth indicating that inventories are still being worked off. Meanwhile, utility costs rose by 1.3 per cent while food prices jumped by 6.8 per cent in July 1996.

However, Consensus Inc. forecasts negligible inflation pressure in 1996 although more significant price rises are expected in 1997, Although the trade surplus narrowed to Y3 trillion in the first, half of 1996, the pace of contraction is slowing due to Japan‟s higher competitiveness following the depreciation of the yen last year Australia Despite stronger than expected economic growth in the first quarter of 1996, the “Reserve Bank of Australia (RBOA) lowered the cash rate by 0.5 per cent to 7 per cent in end July 1996. The governor of the RBOA said that the lower, and declining, rate of growth of wages suggested that economic growth had fallen below its potential levels. Moreover, recent indicators of consumer spending point to a softer private.

Consumption growth rate in the second quarter of 1996 while excess capacity and high inventories suggest that industrial Production growth is likely to remain depressed over the next few months. After a peak of 5.1 per cent in the last quarter of 1995, inflation declined to 3.4 per cent in the first half of 1996. This trend has also been reinforced by the weakening growth of weekly earnings, which averaged 3.7 per cent in the first six months of 1996. However, an upward pressure on wages is building, which will determine the course of both inflation and monetary policy in the short run. In fact, Consensus Inc, expects that the 90day „bank bill rate will fall to 6.8 per cent over the next three months. Severe Competition in the Home Country:

The countries oriented towards market economies since 1960s had severe competition from other business firms in the home countries. The weak companies, which could not meet

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the competition of the strong companies in the domestic country, started entering the markets of the developing countries. Limited Home Market: When the size of the home market is limited either due to the smaller size of the population or due to lower purchasing power of the people or both, the companies internationalize their operations. For example, most of the Japanese automobile and electronic firms entered US, Europe and even African markets due to the smaller size of the home market. ITC entered the European market due to the lower purchasing power of the Indians with regard to high quality cigarettes. Similarly, the mere six million population of Switzerland is the reason for Ciba Geigy to internationalize its operations. In fact, this company was forced to concentrate on global market and establish manufacturing facilities in foreign countries.

Political Stability vs. Political Instability: Political stability does not simply mean that continuation of the same party in power, but it does mean the continuation of the same policies of the Government for a quite longer period. It is viewed that USA is a politically stable country. Similarly, UK, France, Germany, Italy and Japan are also politically stable countries. Most of the African countries and some of the Asian countries like Malaysia, Indonesia, Pakistan and India are politically instable countries. Business firms prefer to enter the politically stable countries and are restrained from locating their business operations in politically instable countries. In fact, business firms shift their operations from politically instable countries into politically stable countries. Availability of Technology and Managerial Competence:

Availability of advanced technology and managerial competence in some countries act as pulling factors for business firms from the home country. The developed countries due to these reasons attract companies from the developing world. In fact, American companies, in recent years, depend on Japanese companies for technology and management expertise.‟

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IBM Gives Fastest Computer to the World International Business Machines Corporation unveiled the fastest computer in the world, which the US government will use to simulate nuclear weapons tests. The supercomputer, able to process more in a second than one person with a calculator could do in 10 million years, was made for the US department of energy‟s Accelerated Strategic Computing Initiative (ASCI.). The system could ease congressional opposition to the United States signing the Comprehensive Test Ban Treaty, banning all actual nuclear weapons testing worldwide. “Without underground testing, we need simulations to make sure the stockpile is safe, reliable and operational,” said David Cooper, a member of the President‟s Council on Computing and chief information officer of Lawrence Livermore Lab in California, where the system will be run. Called ASCI, White super computer will churn the factors involved in a nuclear detonation, including the weapon‟s age and design. This could eventually allow the government to manage its entire stockpile of nuclear weapons without any real nuclear tests, Cooper said. The US Senate last year filed to ratify the test ban treaty, insisting on the nation‟s right to continue testing nuclear weapons underground.

“If you polled the weapons designers right now, they would say that testing is still more effective,” Cooper said. The new supercomputer is a major step toward full simulation but is not yet capable of testing the nuclear weapons stockpile to standards set by experts. A system that could replace actual nuclear tests must have a computing capability of 100 teraflops, or trillions of operations per second, versus the ASCI White computing capacity as tested by IMB of 12.3 teraflops, Cooper said “We‟re still on timescale to do by 2004,” he added. The system contains 8,192 copper microprocessors and is 1,000 times more powerful than its chess playing predecessor „Deep Blue,‟ which defeated World Champion Gary Kasparov in 1997. IBM Is selling the system, which will take up the floor space equivalent to two basketball courts and weighs as much as 17 full-sized elephants to the DOE for $110 million.

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But designing the most powerful computer in the world has other pay-offs of IBM,

including bragging rights that could allow it to take a greater share in the supercomputer market, as well as the use of the advanced technology in its lower-level computer products. “We‟re seeing more and more that deep computing will become a critical element. In how real business is run every day, and that It‟s not just in the territory of the propeller heads,” said Nicholas Donofrio, IBM senior vice-president technology and manufacturing. High Cost of Transportation:

Initially companies enter foreign countries through their marketing operations. At this stage, the companies realize the challenge from the domestic companies. Added to this, the home companies enjoy higher profit margins whereas the foreign firms suffer from lower profit margins. The major factor for this situation is the cost of transportation of the products. Under such conditions, the foreign companies are inclined to increase their profit margin by locating -their manufacturing facilities in foreign countries where there is enough demand either in one country or in a group of neighboring countries. For example, Mobil, which was supplying the petroleum products to Ethiopia, Kenya, Eritrea, Sudan etc. from its refineries in Saudi Arabia, established its refinery facilities in Eritrea in order to reduce the cost of transportation. Similarly, Caterpillar located its manufacturing facilities at different centers in order to reduce the cost of transportation. This company produces high value added parts in limited locations and less valued and non critical components and assembles the final products in a number of foreign countries. Nearness to Raw Materials

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The source of highly qualitative raw materials and bulk raw materials is a major factor for attracting the companies from various foreign countries. Most of the US based and European based companies located their manufacturing facilities in Saudi Arabia, Bahrain, Qatar, Oman, Iran and other Middle East countries due to the availability of petroleum. Theses companies, thus, reduced the cost of transportation. Availability of Quality Human Resources at Less Cost

This is a major factor, in recent times, for software, high technology and telecommunication companies to locate their operations in India. India is a major source for high quality and low cost human resources unlike USA, developed European countries and Japan. Importing human resources from India by these firms is costly rather than locating their operations in India. Hence these companies started their operations in India and other similar countries. To Avoid Tariffs and Import Quotas

It was quite common before globalization that governments imposed tariffs or duty on imports to protect the domestic company. Sometimes Government also fixes import quotas in order to reduce the competition to the domestic companies from the competent foreign companies. These practices are prevalent not only in developing countries but also in advanced countries. For example, Japanese companies are competent competitors to the US companies. USA imposed tariffs and quotas regarding import of automobiles and electronics from Japan. Harley Davidson of USA sought and got five years of tariffs protection from Japanese imports. Similarly, Japan places high tariffs on imports of rice and other agricultural goods from USA to avoid high tariffs and quotas, companies prefer direct investment to go globally. For example, companies like Sony, Honda and Toyota preferred direct investment if]

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various countries by establishing subsidiaries or through joint ventures in various foreign countries including USA and India, Similarly, General Electrical, and Whirlpool also have foreign subsidiaries. Xerox, Canon, Phillips, Unilever, Lucky Gold Star, South

Korean Electronics Company, Pepsi, Coca Cola. Shell, Mobil etc. established manufacturing facilities in various foreign countries in order to avoid tariffs, import duties and quotas. Having discussed the need for international business, we shall discus the basis for international business. Stages of Internationalization The internationalization process generally includes fives stages. Viz domestic company, international company, multinational company, global company and transnational company. Now, we will study stage of internationalization in detail. Stage 1: Domestic Company

Domestic company limits its operations, mission and vision to the national political boundaries. These companies focus its view on the domestic market opportunities, domestic suppliers, domestic financial companies, domestic customers etc. These companies analyze the national environment of the country, formulate the strategies to exploit the opportunities offered by the environment. The domestic companies‟ unconscious motto is that, “if its not happening in the home country, it is not happening”

The domestic company never thinks of growing globally. If it grows, beyond its present

capacity, the company selects the diversification strategy of entering into new domestic markets, new products, technology etc. The domestic company does not select the strategy of expansion/penetrating into the international markets. Stage 2: International Company

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Some of the domestic companies, which grow beyond their production and/or domestic

marketing capacities, think of internationalizing their operations. Those companies who decide to exploit the opportunities outside the domestic country are the stage two companies. These companies remain ethnocentric or domestic country oriented. These companies believe that the practices adopted in domestic business, the people and products of domestic business are superior to those of other countries. The focus of these companies is domestic but extends the wings to the foreign countries.

Markets and extend the same domestic operations into foreign markets. In other

words, these companies extend the domestic product, domestic price, promotion and other business practices to the foreign markets. Normally internationalization process of most of the global companies starts with this stage two process. Most of the companies following this strategy due to limited resources and also to learn from the foreign markets gradually before becoming a global company without much risk. The international company holds the marketing mix constant and extends the operations to new countries. Thus the international company extends the domestic country marketing mix and business model and practices to foreign countries. Stage: 3 Multinational Companies

Sooner or later, the international companies learn that the extension strategy (i.e., extending the domestic product, price and promotion to foreign markets) will not work. The best example is that Toyota exported Toyopet cars produced for Japan in Japan to USA in 1957. Toyopet was not successful in USA. Toyota could not sell these cars in USA as they were overpriced, underpowered and built like tanks. Thus these cars were not suitable for the US markets. The unsold cars were shipped back to Japan.

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Toyota took this failure as a rich learning experience and as a source of invaluable

intelligence but not as failure. Toyota, based on this experience designed new models of cars suitable for the US market. The international companies turn into multinational companies when they start responding to the specific needs of the different country markets regarding product, price and promotion. This statue of multinational company is also referred to as multidomestic. Multidomestic company formulates different strategies for different markets; thus, the orientation shifts from ethnocentric to polycentric. Under polycentric orientation the offices /branches/subsidiaries of a multinational company work like domestic company in each country where they operate with distinct policies and strategies suitable to that country concerned. Thus they operate like a domestic company of the country concerned in each of their markets.

Philips of Netherlands was a multidomestic company of this stage during 1960s. It

used to have autonomous national organizations and formulate the strategies separately for each country. Its strategy did work effectively until the Japanese companies and Matsushita started competing with this company based oil global strategy. Global strategy was based on focusing the company resources to serve tile world market. Philips strategy was to work like a domestic company, and produce a number of models of the product consequently it increased the cost of production and price of the product. But the Matsushita‟s strategy was to give the value, quality, design and low price to the customer. Philips lost its market share as Matsushita offered more value to the customer Consequently Philips changed its strategy and created “industry main groups” in Netherlands which are responsible for formulating a global strategy for producing, marketing and R &D. Stage 4: Global Company

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A global company is the one, which has either global marketing strategy or a global strategy. Global company either produces in home country or in a single country and focuses on marketing these products globally, or produces the products globally and focuses on marketing these products domestically. Harley designs and produces super heavy weight motorcycles in USA and markets in the global market. Similarly, Dr. Reddy‟s Lab designs and produces drugs in India and markets globally. Thus Harley and Dr. Reddy‟s Lab are examples of global marketing focus. Gap procures products in the global countries and markets the products in its retail organization in USA. Thus gap is an example for global sourcing company. Harley Davidson designs and produces in USA and gains competitive advantage as Mercedes in Germany. The Gap understands the US consumer and got competitive advantage. Stage 5:’Fransnational Company

Transnational company produces, markets, invests and operates across the world. It is an integrated global enterprise which links global resources with global markets at profit. There is no pure transnational corporation. However, most of the transnational companies satisfy many of the characteristics of a global corporation. Characteristics of a Transnational Company

The characteristics of a transnational company include: geocentric orientation, scanning or information acquisition, long run visions etc. We discuss these characteristics in detail. (i) Geocentric Orientation:

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A transnational company is geocentric in its orientation. This company thinks globally and acts locally. This company adopts global strategy but allows value addition to the customer of a domestic country. This company allows adaptation to add value to its global offer. Table 1.1 presents stages of internationalization. The assets of a transnational company are distributed throughout the world, independent and specialized. The R & D facilities of a transnational company are spread in many countries, but specialized in each Country based on the local needs and integrated in world R & D project. Similarly, the production facilities are spread but specialized and integrated. In case of Caterpillar, manufacturing and assembly facilities are located in many countries. Components are shipped for assembly and the assembled product is shipped to the place of the customer. Units of the transnational corporation in different countries create and develop the knowledge in all functions and share among them. Thus knowledge and experience is shared jointly. Transnational gains power and competitive advantage by developing and sharing knowledge and experience. of the knowledge among all, Colgate operating companies across globe is an example here. (ii) Scanning or information Acquisition:

Transnational companies collect the data and information worldwide. These companies scan the environmental information regarding economic environment, political environment, social and cultural environment and technological environment. These companies collect and scan the information regardless geographical and national boundaries. (iii) Vision and Aspirations:

The vision and aspiration of transnational companies are global, global markets, global customers and grow ahead of other global/transnational companies

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(iv)Geographic Scope:

The transnational companies scan the global data and information. by doing so, they analyze the global opportunities regarding the availability of resources, customers, markets, technology, research and development etc. Similarly, they also analyze the global challenge and threats like competition from the other global companies, local companies of host countries, political uncertainties and the like. They formulate global strategy. Thus the geographic scope of a transnational company is not limited to certain countries in analyzing opportunities, threats and formulating strategies. (v) Operating Style: Key operations of a transnational are globalize. The transnational companies globalize the functions like R & D, product development, placing key human resources, Procurement of high valued material etc. For example, the R&D activity of Proctor & Gamble, and key human resource.

vi) Adaptation:

Global and transnational companies adapt their products, marketing strategic and

other functional strategies to the environmental factors of the market concerned, For example, Mercedes Benz is a super luxury car in North America, luxury automobile in Germany, standard taxi in Europe. (vii) Extensions: Some products do not require any change when they are marketed in other countries. Their market is just extension. For example, Casio calculators of Japan, Hero pens of China, and BIC‟s line of pens, butane lighters and razors. (viii) Creation through Extension:

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Transnational companies create the global brand through extending the product to the

new market. Rothmans Cigarette extended its product to many European countries and African countries and created it as global and national basis

(ix) Human Resource Management Policy:

The transnational company‟s human resource policy is not restricted by national

political or legal constraints. It selects the best human resources and develops them regardless of nationality, ethnic group etc. But the international company reserves the top and key positions for nationals. (x) Purchasing:

Transnational Company procures world-class material from the best source across the

globe. Which Company is truly multinational?

Four senior executives of the world‟s largest firms with extensive holdings outside the host country speak. Company A:

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“We are a multinational firm. We distribute our products in about 100 countries we

manufacture in over 17 countries and do research and development in three countries. We look at all new investment projects both domestic and overseas using exactly the same criteria”. The execution from company A continues, “of course most of the key posts in our subsidiaries are held by home country nationals. Whenever replacements for these men are sought, it is practice, if not the policy, to look next to you at the head office and pick someone (usually country national) you know and trust”. Company B.

“We are a multinational firm. Only 1 percent of the personnel in our affiliate companies

are non-national. Most of these are US executives in temporary assignments. In major markets, the affiliates managing director is of the local nationality”. He continues, “Of course there are very few non-Americans in the key posts at headquarter. The few we have are so Americanized that we usually do not notice their nationality. Unfortunate you cannot find good foreigners who are willing to live in the United States, were out headquarters is located. American executives are more mobile. In addition, American has the drive and initiates we like. In fact, the European nationals would prefer to report to an American rather than to so other European”. Company C:

“We are a multinational firm. Our product division executives have world w profit

responsibility. As our organizational chart shows, the United States is just one region par with Europe, Latin America, Africa, etc. in each division”. The executives from company C go on to explain, “The

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Worldwide product division cone is rather difficult to implement. The senior executives in charge of these divisions have overseas experience. They have been promoted from domestic posts and tend to view fore consumer needs as really basically the same as ours. Also, product division executives tend focus on the domestic market because the domestic market is larger and generates more revenue than the fragmented foreign markets. The rewards are for global performance, but strategy is focus on domestic. Most of our senior executives simply do not understand what happens overseas and really do not trust foreign executives, even those in key positions”. Company D (non-American):

„We are a multinational firm. We have at least 18 nationalities represented at our

headquarters. Most senor executives speak at least two languages. About 30 percent of our staff at headquarters is foreigners. He continues by explaining “since the voting shareholders must by law come from the home country, the home country‟s interest must be given careful consideration. But we are proud of our nationality; we should not be ashamed of it. In fact, many times we have been reluctant to use home country ideas overseas, to our detriment, especially in our U.S. Subsidiary. Our country produces good executives‟ who tend to stay with us a long time. It is harder to keep executives from the United States.

CHAPTER 4

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INTERNATIONAL BUSINESS APPROACHES

International business approaches are similar to the stages of internationalization or globalization. Douglas Wind and Pelmutter advocated four approaches of international business. They are: 1. Echnocentric Approach

The domestic companies normally formulate their strategies. Their product design and their operations towards the national markets, customers and competitors. But, the excessive production more than the demand for the product, either due to competition or due to changes in customer preferences push the company to export the excessive production to foreign countries. The domestic company continues the exports to the foreign countries and views the foreign markets as an extension to the domestic markets just like a new region. The executives at the head office of the company make the decisions relating to exports and, the marketing personnel of the domestic company monitor the export operations with the help of an export department. The company exports the same product designed for domestic markets to foreign countries under this approach. Thus, maintenance of domestic approach towards international business is called ethnocentric approach. Organization structure of Ethnocentric Company, this approach is suitable to the companies during the early days of internationalization and also to the smaller companies. Managing Director

Manager

R & D manager

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Finance Manager

Production

Manager

Human

Resources

Manager

Marketing

Assistant Manger

North India

Assistant Manager

South India

Assistant Manager

Exports

2. Polycentric Approach

The domestic companies, which are exporting to foreign countries using the ethnocentric approach, find at the latter stage that the foreign markets need an altogether different approach. Then, the company establishes a foreign subsidiary company and decentralists all the operations and delegate‟s decision-making and policy-making authority to its executives. In fact, the company appoints executives and personnel including a chief executive who reports directly to the Managing Director of the company. Company appoints the key personnel from the home country and the people of the host country fill all other vacancies. Organization Structure Of Polycentric Company.

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3. Regiocentric Approach

The company after operating successfully in a foreign country thinks of exporting to the neighboring countries of the host country. At this stage, the foreign subsidiary considers the regions environment (for example, Asian environment like laws, culture, policies etc.) for formulating policies and strategies.

However, it markets more or less the same product designed under polycentric

approach in other countries of the region, but with different market strategies. 4. Geocentric approach

Under this approach, the entire world is just like a single country for the company. They select the employees from the entire globe and operate with a number of subsidiaries. The headquarter coordinates the activities of the subsidiaries. Each subsidiary functions like an independent and autonomous company in formulating policies, strategies, product design, human resource policies, operations etc.

Managing Director

CEO

Foreign Subsidiary(Uganda)Manager

R&D Manager

Finance Manager

Production Manager

Human Resource Manager

Marketing Managing

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Director

CEO

Foreign Subsidiary Manager

R&D Manager

Finance Manager

Production Manager


Marketing Organization Structure of Geocentric Company

Theories of International Business The fundamental question that arises for most of us at this juncture, is why should the business firms of one country should go to the another country, when the industries of that country also produce goods and market them. What is the basis for international business? A number of theories have been developed to explain the basis for international business Comparative Cost Theory It is quite common that some countries have the advantage of producing some goods at a lower cost compared to other countries. This is due to the availability of cheap labour, skilled labour, cheap and qualitative raw materials, advanced technology, competent management practices etc. Availability of these factors enhances productivity and thereby reduces the cost of production per unit. Similarly, other countries have this advantage in producing other goods. For example, Japan has the advantage in producing electronics at low cost whereas India has similar advantage in producing textiles. According to comparative cost theory the countries in the long run will tend to specialize in the business (production and marketing) of those goods in whose business they enjoy comparative low cost advantage and import other goods in which the countries have

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comparative cost disadvantage, if free trade is allowed. This specialization helps for the mutual advantage of the countries participating, in the international business.

David Ricardo illustrated the Comparative Cost Theory in 1817. He used a two country, two commodity model. The conclusions of his model are: Business between two countries is profitable when a country produces one good at a lower cost than other country and that other produces another good at a lower cost than the former country. Business between two countries is also profitable when one country produces more than one product efficiently, but, when it produces one of these products comparatively at greater efficiency than the other product. Both the nations can engage in international business when one country specializes in the production in which it has greater efficiency in production. Assumptions of the Theory: The assumptions of the comparative cost theory include:

Derivates of the Theory: The advantages desired from this theory are:

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Thus, we learn from this theory that, the basis for international business is the comparative advantage of the nations to produce certain products at lower cost than other countries. The Opportunity Cost Theory Another example is that, India produces textile garments by utilizing its human resources worth of Rs I billion and exports to the US in 1999. The opportunity cost of this project is, had

Managing Director

CEO

Foreign Subsidiary(Uganda)Manager

R&D Manager

Finance Manager

Production Manager


Marketing Managing

Director

CEO

Foreign Subsidiary Manager

R&D Manager

Finance Manager

Production Manager


Marketing

India developed software packages by utilizing the same human resources and exported the same to USA in 1999; the worth of the exports would have been Rs 10 billion. Opportunity

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cost approach specifies the cost in terms of the value of the alternatives, which have to be foregone in order to fulfill a specific act. Thus, this theory provides the basis for international business in terms of exporting a particular product rather than other products. The previous example suggests that it would be I India to develop and export software packages rather than textile garments to USA. We slightly modify the previous example. For example, assume that India earned Rs 15 billion by exporting the same software packages to UK in 1999 rather than to USA. This theory suggests that the opportunity cost of India‟s software exports to USA in 1999 is Rs 15 billion. Thus, this theory also provides the basis for international business of exporting a product to a particular country rather to another country.

The Modern Theory of Factor Endowments (Heckscher Ohlin Thesis) Bertil Ohlin and Eli Heckscher explained the basis of international business in terms of factor endowment. This theory explains the reasons for comparative cost differences. They are: Different prevailing endowments of the factors of production and Different factors of production are to be used in different degrees of intensity for producing different goods. According to this theory a country will specialize in the production and export of those goods whose ratio between capital and other factors of production is higher than those in other countries. Assumptions: Heckscher Ohlin theory is built on the following assumptions:

Perfect competition is in existence for both product and factors in both the countries. Factors of production are fixed in each country. Factors of production are of equal quality in both the countries. Factors of production have full employment in both the countries Factors endowments vary from one country to another country. Business between two countries is free from all barriers. There is no cost of transportation; Production in both the countries is

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subject to law of returns Factor intensity varies between goods. Merits: Despite the assumptions, this theory enjoys the following merits: This theory provides more valid basis for the existence of international business compared to the other theories.

the difference in cost of production in two countries in terms of differences in factor endowments.

on to domestic or interregional trade.

Hence, this theory is viewed as the modern theory of international business. This theory is also called General Equilibrium Theory of international business as it deals with the equilibrium between demand for and supply of the products.

prices. Derivatives: The ultimate conclusions we draw from this theory are:

of the globe and in all the regions of each country. However, existence of the cost of transportation and nonexistence of perfect competition are the limitations to this conclusion.

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However,

existence of the cost of transportation and the nonexistence of the perfect competition are the limitations to this conclusion also. Ultimately we can learn from this theory that the tendency of equilibrium of product/service prices and the prices of factors of production is the basis for international business. Adam Smith‟s Theory of Absolute Differences in Cost According to Adam Smith, every country should specialize in Producing those products, which it can produce at less, cost than that of other countries and exchange these products with other products.

These other products are produced absolutely at less cost by other countries.

According to Smith, “whether the advantage which one country has over another be natural or acquired is in this respect of no consequence.” Criticism: According to this theory every country should be able to produce certain products at low cost compared to other countries and should produce certain other products at comparatively high price than other countries. International trade takes place only under such condition. But, in reality most of the developing countries do not have absolute advantage of producing at lowest cost any commodity, yet they participate in international business. The Productivity Theory

It is criticized that the comparative cost theories are not applicable to developing countries. Hence, H.Myint proposed productivity theory and the vent for surplus theory. The productivity theory points toward indirect and direct benefits. This theory emphasizes that the process of specialization involves adapting and reshaping the production structure of a trading country to meet the export demands. Countries increase productivity in order to utilize

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the gains of exports. This theory encourages the developing countries to go for cash crops, increase productivity by enhancing the efficiency of human resources, adapting latest technology etc. Limitations: However, this theory has also certain limitations.

•

unemployed Labour The Vent for Surplus Theory

International trade absorbs the output of unemployed factors. If the countries produce more than the domestic requirements, they have to export the surplus to other countries. Otherwise, a part of the productive labour of the country must cease and the value of its annual Produce diminishes. Thus, in the absence of foreign trade, they would be surplus productive capacity in the country. This surplus productive capacity is taken by another country and in turn gives the benefit under international trade. Appropriateness of this Theory for Developing Countries:

According to this theory, the factors of production of developing countries are fully utilized. The unemployed labour of the developing countries is profitably employed when the vent for surplus is exported. International trade permits for more efficient use of capital and labour. Hence I.S. Mill described this theory as, “serving relic of the Mercantile Theory.”

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Mill’s Theory of Reciprocal Demand

Comparative cost advantage theories. Do not explain the ratios at which commodities are exchanged for one another. J.S. Mill introduced the concept of „reciprocal demand‟ to explain the determinations of the equilibrium terms of trade. Reciprocal demand indicates a country‟s demand for one commodity in terms of the other commodity; it is prepared to give up in exchange. Reciprocal demand determines the terms of trade and relative share of each country. Equilibrium = Quality of a product exported by country A Quality of another product exported by country B Assumptions:

Assumptions of this theory are: Existence of two countries, trade in only two goods, both the goods are produced under the law of constant returns, absence of transportation Costs. Existence of perfect competition and existence of full employment.

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