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THE RISKS AND COST
ASSOCIATED WITHINTERNATIONAL BUSINESS
For the firm which enters foreign markets for thefirst time, a (hypothetical) evolution in its
internationalisation process can be envisaged:
domestic production exportinglicensing foreign direct investment
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Sources of risk in the
internationalisation process
Risk is a problem of perceived uncertainty.
Firms have a good knowledge of their home
country conditions but are less certain about
the operating environment of non-domestic
markets.
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1) Risk associated with generating profits in thehost country.
Economic factors, e.g. decreasing GDP growthrates, increasing inflation rates, reduced localpurchasing power.
Political, e.g. strikes, changes in government,changes in legislation, war.
2) Risk associated with transferring (orrepatriating) earned profits back to homecountry,
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Exchange rate risk, of which there are three types:
i) transaction risk, the risk of not achieving the planned profitmargin on sales due to an adverse movement in exchange rate from
the rate used in the pricing decision.
ii) economic risk, the risk that a sustained, real rise of a currencyagainst the currencies of competitors will adversely affect acompanys cost and therefore sales, margins and market share,
which, in turn, decreases the firms return on capital employed.
iii) translation risk, the risk of loss of net worth of the company whicharises from the legal requirement that all firms annuallyconsolidate, in a single currency, their financial statements (balancesheets and income statements) of all world-wide operations.
Exchange regulations and restrictions limiting or taxing profitrepatriation.
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CHALLENGES ARISING FROM EXPLORING
INTERNATIONAL MARKETS
Cost reduction. This comes from the moreintense competition in world markets. Pressuresfor cost reductions can be particularly intense in
industries producing commodity type productswhere meaningful differentiation on non-pricefactors is difficult and price is the maincompetitive weapon, such as petroleum, steel,
sugar and so on. To certain extent, it is also thecase for calculators, semiconductor chips, andpersonal computers.
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Local responsiveness. Pressures for local responsivenessarise from a number of sources:
Differences in consumer tastes and preferences. Forexample, American like large cars, while in Europe mediumand smaller sized cars are most welcome.
Differences in infrastructure and traditional practices. Forexample, in North America consumer electrical systems are
based on 110 volts, while in European countries 240-voltsystems are standard. Thus domestic electrical applianceshave to be customised for this difference in infrastructure.In the case of traditional practices, for example, in Britainpeople drive on the left side of the road, whereas in
neighbouring Europe, people drive on the right-hand sideof the road, thus creating a demand for right hand drivecars in Britain and left hand cars in Europe.
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Differences in distribution channels. Retailing
industry between countries can be strikingly
different. Host government demands. Economic and
political demands imposed by host country
governments necessitate a degree of localresponsiveness. This includes issues like
protectionism, local content rules and specific
technical standards.
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(3) The global-local dilemma: on the one
hand, firms are competing with each other in
the global marketplace by exploiting own firmspecific advantages in order to cut cost as
much as possible, on the other hand, firms
must respond to the needs of specific singlemarket by customising their products, which
indicates an increase of costs and a weakening
of their competitive advantages. How to deal
with this is central to the international
operation.
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Motivations For Internationalisation
Dunning, 1992). He argued that FDI will only
occur when all 3 conditions are present:
1) A firm must possess Ownership-specific
advantages not possessed by other firms. Ownership-specific advantages include assets
such as certain types of knowledge or skills, for
which however the firm has a proprietary rightof use (e.g. legally-protected rights,
technological know-how, and size and market
power).
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2) There must be Location-specific factors
that make it more profitable for the firm to
exploit its assets in foreign countries (ratherthan in domestic locations). Location-specific
factors refer to the factors which are available
in particular locations and which have to beused in those locations. Location-specific
factors can be related to markets, productions
costs, resources, and other softer issues, e.g.political and cultural.
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3) The firm must Internalise the use of theseownership-specific advantages. In other words, itmust not sell them or lease them to other firms.The greater the market imperfection, the greaterwill be the incentive for a firm to internalisemarket transactions. Example of verticalintegration: many firms control either their ownsources of supply or the destination of theiroutputs. Similarly, in order to protect theirknowledge against predators, many R&D-
intensive firms use this knowledge within theirfirms boundaries.
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c) Seeking technological capability,
management and marketing expertise, andorganisational skills. Examples include
collaborative alliance concluded by Korean
and Indian companies with EU or US firms inhigh technology sectors.
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a)Seeking physical resources:- These include
primary producers and mfg. enterprises, who are
driven to engage in FDI by the motives of costminimization and security of supply sources. The
resources they seek include minerals, raw
materials and agricultural products but especially
those whose production requires the kind of
complementary capabilities and markets that
MNEs are especially well equipped to provide..
These include minerals such as oil, zinc, copper,tin and bauxite and agricultural products such as
rubber, tobacco, sugar, coffee, tea etc.
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b)Seeking Plentiful supplies:- This kind of FDI
is usually undertaken by mfg. And service
MNEs from countries with high real labourcosts, which set up or acquire subsidiaries in
countries with lower labour costs to supply
labour intensive intermediate or final productsfor export. Eg: Mexico, Taiwan, Malaysia.
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c) Seeking technological capability:- These
also include executive search subsidiaries set
up by US firms in the UK; and R&D listeningposts established by UK chemical companies
in Japan. Each of these value-added activities
parallels the investment made. Eg; BelgianMNEs in Africa or Japanese MNE in Australia.
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2) Market Seeking: These are the enterprises
that invest in particular country or region to
supply goods or services to markets in theseor in adjacent countries. Market-seeking
investment may be undertaken to sustain or
protect existing markets or to exploit andpromote new markets. Apart from market size
and the prospects for market growth, there
are five main reasons which might prompt
firms to engage in market seeking
investment:
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a) The first is that their main customers have
set up foreign producing facilities and that to
retain their business they need to follow themoverseas. One example of this kind is that
more than 300 Japanese auto-component
suppliers have set up their own manufacturing
subsidiaries in the US, to supply the leading
Japanese auto assemblers which had
established production bases in the country.
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b) The second reason for market-seeking
investment is that foreign producers need to
adapt their products and marketing behaviourto the needs of the host country; otherwise
they would be in a disadvantageous position
to compete with local producers. Local needs
mean local tastes, local language, business
customs, legal requirements, and marketing
procedures. For example, food,
telecommunications, clothes and cars, all
need to be adapted to meet the local taste.
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c) The third reason is that the production and
transaction costs of manufacturing in the target
country are less than supplying it from a distance.The production of goods that are relatively costly
to transport and can be produced economically in
small quantities is more likely to be located near
the main centres of consumption than are those
that cost relatively little to transport and yield
substantial economies of scale in their
production, for example, washing machines aremore likely to be produced in the target market
than computers.
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d) The fourth reason is that it is increasingly important for afirm to have a physical presence in the leading marketsserved by its competitors. Such strategic market-seekinginvestment might be undertaken for defensive or
aggressive reasons.
Defensive investmentmeans following the investment ofthe competitors of a firm by making its own investment inthe same markets and in similar scale;
Aggressive investmentare those designed to advance theglobal interests of a firm by investing in an expandingmarket. For example, when the market of central and
eastern Europe opened to the international business, Pepsi-Cola made huge investment in Russia before others, andthe aim was to seize the leading role in soft drink market inthis country. This is aggressive investment.
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e) The last reason, the single most importantreason for market-seeking investment, is hostgovernment policy. Traditionally, host
governments usually imposed heavy tariff andnon-tariff barriers on import, and market seekinginvestment was a way of overcoming such tradebarriers. Since the1980s, more and more foreigngovernments have chosen to attract inwardinvestment by offering a variety of investmentincentives ranging from tax concessions tosubsidised labour and capital costs. As a result,foreign investment flourished, and globaleconomic integration has been upgradeddramatically in the past two decades.
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3)Efficiency Seeking: The efficiency seekinginvestment is undertaken to gain benefits fromthe common governance of geographically
dispersed business activities in differentcountries. Such benefits are those of theeconomies of scale and scope and of riskdiversification. That is to say, according to the
different factor endowments, cultures,institutional arrangements, economic systemsand policies, and market structures, MNCsrationalise their investment by concentrating
their production in a limited number of locations,but still serving multiple markets.
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4)Strategic Asset Seeking: Strategic asset seekinginvestment comprises those which engage in acquiring theassets of foreign corporations, to promote their long-termstrategic objectives - especially that of sustaining or
advancing their international competitiveness. The motiveof strategic asset seeking is to:
a) strengthen the present or future competitiveness of theacquiring firm concerned, either by adding to the acquiringfirms existing portfolio of assets, or by weakening that ofits competitors.
b) exploit specific cost or marketing advantages over their
competitors than to add to the acquiring firms existingportfolio of assets, others which they perceive will eithersustain or strengthen their own overall competitiveposition or weaken that of their competitors.
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Other Motives for Engaging in InternationalBusiness/Other motives for MNE activity
1)Escape Investments
Some international investment is made to escaperestrictive legislation or macro-organisational policies
by home governments.
Examples of this kind investment the shifting of itscancer and immune system research of BASF, a Germancompany, from Germany to the US as a way to confront
with the legal and political challenges from the localgreen movement; and the investment by Israeli firmsin EC before 1992 to by-pass the Arab boycott onproducts exported from Israel.
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2) Support Investments
The purpose of these investments is to supportthe activities of the rest of the enterprise ofwhich they are part. Their activities may incurcosts but the rest of the same MNC can benefit
enormously. Eg; Leading clothing wholesaleandroecial outlets in Europe and US such as SeasRoebuck, K. Mart which purchase substantialquantities of clothing and footwear from Asian
suppliers and delegate the sub contractingarrangements to their buying subsidiaries in HongKong, Singapore, Thailand etc.
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International business environment
Firms also need to acquire knowledge of thelocal business environment so that they can
operate effectively there. Countries differ in
respect to:
Cultural environment
Political environment
Economic environment Legal environment
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Cultural Environment
Culture may be defined as that complex wholewhich includes knowledge, belief, morals,
customs & other capabilities acquired by man
as a member of society.
.The collective programming of the mind
which distinguishes the members of one
human group from another.
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Identification and Dynamics of culture
The nation as a point of reference
Cultural formation and dynamics Culture istransmitted in various ways from parent tochild, teacher to pupil, social leader tofollower & one pear to another.
Change in culture may come about throughchoice or imposition.
Language is a factor that greatly affects
cultural stability- when people from differentareas speak the same language culturespreads more easily.
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that helps explain why more cultural similarity
exists among English speaking countries.
Religion is a strong shaper of values and a
cultural stabilizer Christianity, Hinduism,
Buddhism, and Islam have specific beliefs that
affects business.
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Behavioral Practices affecting business
Attitudes and values affects business behavior-whatproducts to sell, how to organize, finance, manage &control operations.
Social Stratification system - Every culture value
some people more highly than others because of apersons class or status within that culture. A
persons ranking is partly determined by his
affiliation.
Ascribed group membership based on Gender,family, age, cast, etc.
Acquired group membership based on religion,
political & professional affiliation.
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Performance orientation- In US eligibility for
jobs & promotion is governed by competence
as the work environment is driven more bycompetition than by cooperation.
In Japan where the work place is characterized
by cooperation than competition, humannessis more important.
Materialism & leisure The Japanese take
less leisure time whereas in the US, incomesallows for more leisure time. In Europe people
are more prone to enjoy leisure time than in
the US.
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Expectation of success & rewardsPeopleusually work harder at any task when the rewardfor success is high compared with that a failure.
Thus employees work attitude is determined bythe work culture and reward system. Needhierarchy is helpful for differentiating the rewardpreferences of employees in different countries.
Power DistanceWhere power distance is highthere is little consultation between superior &subordinates. Dutch managers believe in lowpower distance where as Moroccan managershave high power distance preference.
Individualism Vs collectism - A US scientistinvited to work in Japan was treated as anoutsider until he changed his work behaviour &became group friendly.
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China & Mexico are characterized by collectivistculture.
Uncertainty avoidance - In some countries fewcustomers are prepared to take the risk of tryinga new product this is important for the firms tochoose where to introduce new products.Denmark & UK have low, Belgium & Portugal are
countries with high un certainty avoidance. Trust - Higher Percentage of Norwegian than
Brazilians think that most people are trustworthy.
Future Orientation
Higher in Switzerland,Netherlander & Canada than in Russia, Poland &Italy.
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Obtaining InformationIn US & Northern Europepeople only look at information that has directbearing on the decision making, whereas in
Southern Europe most people believe thatperipheral information is valuable in decisionmaking & Infer meanings from things saidindirectly.
Information Processing - In US, TelephoneDirectories Contain Names in Alphabetical orderby last (Family Name), In Island entries areorganized by 1st (Given Name).
Communication Issues Different words, sounds,gestures, carry different meaning in Differentcountries.
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International Economic Environment
Change in one element of economics Changesenvironment.
Important indicators :
GNI (Gross National Income) total value of all
goods & services produced by a country in ayear.
GDP (Gross Domestic Product) total value of
all goods & services produced within theborders of a country in a year, includingforeign owned companies.
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Human development - access to knowledge,
nutrition, food, healthcare, employment, law
and order, recreation, freedom of expressionetc.
Inflation- aggregate demand> aggregatesupply - prices up more than income rise
Inflation - interest rate, exchange rate, cost of
living, eco stability, political stability.
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Political Environment
Political decisions/ events - can affectprofitability of business.
Imposition of tariffs, local content, export
obligations. Profit repatriation - limits.
Labour rights.
Discrimination in taxes - domestic vs foreign/favored nation.
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Types of political risks :
Shift in public policy - In disfavor of foreign/dominating companies.
To gain greater share of the benefits
May be for the masses - shift from individualism tocollectivism - These are systemic political risks.
Corruption - makes operations costly.
Bureaucracy, customs - assistance, speed money bribe big riskProcedural.
Monitory policies, tax structures, regulations altered
Distributive risk.Ethnic violence, civil disorder, war, military upheavals,and international terrorism
affect one and allCatastrophic.
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Govt. Intervention & Trade Control
What, how much, with which country a countryshould trade ?
Should market forces decide these - Laissez-faire
approach ? Should Government intervene ?
If no restriction, exports will take place from lowto high cost of production countries.
Restrictions exports hampered productionmay happen in restricting countries.
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Legal EnvironmentThe globe may be shrinking, as a place to do business, but
standards of law can still be worlds apart from country tocountry. Consequently national laws greatly impact theglobal business.
Generally Legal systems fall into the following categories.
A Common Law system
is based on tradition & usage,and judge made precedent.
A civil law system- is based on a systematic codification oflaws. More than 70 countries, including Germany, France
& Japan are civil law system countries. Theocratic Law system - Relies on religious & spiritual
principles to define the legal environment. Islamic Law isthe most prevelant theocratic system.
A Mi d L l t E h t f th
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A Mixed Legal system - Emerges when two or more of thepreceding legal systems function in a company. Majority ofcountries with mixed legal system are in Africa & Asia.
Anti-Dumping Laws - The act of exporting a product by aninternational firm at a price lower than the price it normallycharges in its home market is defined as dumping the product.
Cyber Law
Refers to the law that governs the use ofcommunication technology.
Intellectual property rights Refers to certain legal claims orrights in relation to certain inventions, names, written of
recorded media. The laws relating to IPR vary according tojurisdiction, however efforts have been made to bring aboutsome amount of harmony through treaties including WTO &TRIPS.
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International Dispute resolution Arbitration isused to resolve various commercial disputes thatmay arise in the international market place. Most
coats across the world recognize the internationalcommercial arbitration awards.
Product liability International companies mustcustomize product to comply with local standard
of a particular country. Product safety & liabilitycases may involve high punitive damages.
Marketplace Behavior - National laws determinepermissible practices in pricing, distribution,advertising of products and services. Germanyprohibits comparative advertising. In France amanufacturer can not offer a product it does notmanufacture as an inducement to buy one of itsproduct.
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Product Origin national laws shape the flow
of product across borders. Most of the
countries push foreign countries to make agreater share of the product in the local
market.
Legal Jurisdiction
Each country specifieswhich law should apply & where litigation
should occur. Usually a company will push the
court in its home country to claim Jurisdiction.