PIIMT N. JALAL

International Business

Chapter One: Learning Objectives: the main objectives of this chapter are:

* to introduce students to the basic concepts in international trade and investment,

* to explain the difference between domestic business and international business,

* to determine the main participants in international business,

* to explain the reasons behind the internationalization of firms, and

* to highlight the importance of learning about international business.

1. What is International Business?

International business1 refers to the performance of trade and investment activities by

individual firms2 across national borders3. Firms seek foreign customers and engage in

collaborative relationships4 with foreign business partners. International business and

multinational corporate activities have grown significantly during the past two decades. The

rapid and continuous growth of cross-border economic linkages has contributed to the

importance of the study of international business5.

The growth of international business activity coincides with the broader phenomenon of

globalization of markets. The globalization of markets refers to the ongoing economic

integration and growing interdependency of countries worldwide. While internationalization

of the firm refers to the tendency of companies to systematically increase the international

dimension of their business activities, globalization refers to a macro trend of intense

economic interconnectedness between countries.

2. What are the Key Concepts in International Trade and Investment?

International trade refers to the exchange of products and services across national

borders, typically through exporting and importing and investment. Exporting is the sale of

products6 and/or services (intangibles) to customers located abroad, from a base in the home

country or a third country. Exchange can also take the form of importing, which refers to the

1 We use the expression international business to refer to the cross-border business of individual firms, while economists use international trade to refer to aggregate cross-border flows of products and services between nations. While international business describes an enterprise-level phenomenon, international trade describes the macro-phenomenon of aggregate flows between nations. 2 We mean small firms as well as large multinational companies.3 Governments and international agencies also undertake international business activities. In this course, however, we are mainly concerned with the international business activities of the individual firm.4 Via joint ventures (strategic alliances), licensing, franchising, outsourcing, etc.5 In most countries, international business represents a significant share of gross domestic product (GDP).6 Both finished products and intermediate goods, such as raw materials and components.

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procurement of products or services from foreign suppliers for consumption in the home

country or a third country.

International investment refers to the transfer of assets to another country or the

acquisition of assets in that country. These assets include capital, technology, managerial

talent (know-how), and manufacturing infrastructure.

The two essential types of cross-border investment are International Portfolio

Investment, which refers to the passive ownership of foreign securities such as stocks,

equities7 and bonds for the purpose of generating financial returns. Resources such as

equipment, time, or personnel are not contributed to the overseas venture. Foreign Direct

Investment is an international strategy in which the firm establishes a physical presence

abroad through acquisition of productive assets such as capital, technology, labor, land, plant,

and equipment. The level of control can vary from full control, when a firm owns a foreign

subsidiary entirely, to partial control, as in arrangements such as joint ventures with other

domestic or foreign firms or a foreign government.

3. How Does International Business Differ from Domestic Business?

Firms that engage in international business operate in environments characterized by

unique economic conditions, national culture, and legal and political systems.

* The Four Risks in Internationalization

International firms are constantly exposed to four major categories of risk that must be

managed.

Cross-cultural risk occurs when a cultural misunderstanding puts some human value

at stake. Cross-cultural risk arises from differences in language, lifestyle, mind-sets, customs

and religions. Social norms and attitudes may also affect business practices. In Western

societies, sexuality and sexual topics are often used in marketing communications (such as

advertising, for instance). However, in a comparatively more conservative society social

attitudes may shun the use of sexual topics to advertise products.

Country risk (also known as political risk) refers to the potentially adverse effects on

company operations and profitability caused by developments in the political, legal, and

economic environment in a foreign country. Country risk includes the possibility of foreign

government intervention in firms’ business activities. For example, governments may restrict

access to markets, impose bureaucratic procedures on business transactions, and limit the

amount of income that firms can bring home from foreign operations. Country risk also

7 These are shares which are quoted in the Stock Market/Exchange. The Stock Exchange is a highly organized market for the purchase and sale of second-hand quoted securities; that is those which the Stock Exchange Council has agreed may be sold on the Exchange.

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includes laws and regulations that potentially hinder company operations and performance.

This political risk, as it is known, increases in countries whose governments are unstable and

tends to change frequently.

Currency risk (also known as financial risk) refers to the risk of adverse fluctuations in

exchange rates. Currency risk arises because international transactions are often conducted in

more than one national currency. When currencies fluctuate significantly, the value of the

firm’s earnings can be reduced.

Commercial risk refers to the firm’s potential loss arising from poorly developed or

executed business strategies, tactics or procedures. Managers may make poor choices in such

areas as the selection of business partners, timing of market entry, pricing, etc.

The four types of international business risks are ever-present in international business

and international firms should constantly assess their environments and conduct research to

anticipate potential risks, understand their implications, and take proactive steps to reduce

their effects. One of the objectives of this course is to provide you, the prospective managers,

with a good understanding of these risks as well as managerial skills and strategies to

effectively counter them.

4. Who Participates in International Business?

What types of organizations are active in international business? Among the most

important are focal firms, the companies that directly initiate and implement international

business activity. Two critical focal firms in international business are the multinational

enterprise and the small and medium-sized enterprise.

* Multinational Enterprise (MNE)

A key participant in international business is the multinational enterprise (also known

as the multinational corporation). It is a large company with many resources, headquartered in

one country but has operations in one or more other countries. Its business activities are thus

performed by a network of subsidiaries and affiliates located in multiple countries8. MNEs9

8 A multinational company owns companies in other countries and controls most of the production and marketing systems. Some of its aims are a cheaper labour force and control of the maximum of markets possible to maximize its profits. The companies in other countries are classified into two types; subsidiaries and affiliates. A company is said to be a subsidiary when over 50°/° of its stocks are owned by a MNC. When less than 50°/° of the stocks are controlled by a MNC, the company is called an affiliate. 9 here is a list of those MNEs that grossed more than $100 billion in 2003:Wal-Mart (US)BP (Britain)Exxon Mobil (US)Royal Dutch/Shell Group (Britain/Netherlands)General Motors (US)Ford (US)DaimlerChrysler (Germany) …

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carry out research and development (R&D), procurement, manufacturing, and marketing

activities wherever in the world the firm can reap the most advantages.

* Small and Medium-sized enterprises

Also active in international business are small and medium-sized enterprises (SMEs).

An SME is a company with less than 500 or employees, as defined in Canada and the USA. In

the EU, SMEs are defined as firms with less than 250 employees. In addition to accounting

for smaller market shares of their respective industries, SMEs tend to have limited managerial

and other resources and primarily use exporting to expand internationally. One type of

contemporary international SME is the born global firm, an entrepreneurial firm that initiate

international business very early in its evolution, moving rapidly into foreign markets.

5. Why Do Firms Internationalize?

Companies internationalize for different reasons or motives. Some motives are strategic

in nature, while others are reactive. An example of a strategic, or proactive, motive is to tap

foreign market opportunities or acquire new knowledge. An example of a reactive motive is

the need to serve a key customer that has expanded abroad. Nine specific motivations include:

a. Seek opportunities for growth through market diversification.

b. Earn higher margins and profits.

c. Gain new ideas about products, services, and business methods.

d. Better serve key customers that have relocated abroad. For example, when Nissan opened

its first factory in the UK, many Japanese auto parts suppliers followed, establishing their

own operations there.

e. Be closer to supply sources (raw materials).

f. Gain access to lower-cost or better-value factors of production.

j. Develop economies of scale. Economies of scale reduce the per-unit cost of manufacturing

due to operating at high volume.

h. Confront international competitors more effectively or thwart the growth of competition in

the home market.

i. Invest in a potentially rewarding relationship with a foreign partner. Joint ventures with key

foreign players can lead to the development of new products, profit making, etc.

At the broadest level, companies internationalize to enhance competitive advantage and

to seek growth and profit opportunities.

6. Why Study International Business?

There are many reasons to study international business.

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a. Facilitator of the Global Economy and Interconnectedness.

International business is transforming the world as never before. It has provided new

impetus to worldwide economic interconnectedness.

b. Contributor to National Economic Well-Being.

International business contributes to economic prosperity, helps countries use their

resources more efficiently. Consequently, governments have become more willing to open

their borders to foreign trade and investment.

c. A Competitive Advantage for the Firm.

Going international offers countless opportunities for firms to grow and earn additional

profits. It allows firms to maximize the efficiency of their operations, to access critical

resources that may be unavailable at home, and to reduce the costs of new product

development, after-sales service, and other critical business activities.

d. A Competitive Advantage for You.

From a career standpoint, learning about international business will provide you with a

competitive edge and enhance your ability to thrive in the job market.

DISCUSSION QUESTIONS

1. Why has international business become so important in today’s environment?

2. What are some of the reasons that corporations choose to develop international operations?

3. What factors make international business more complex than domestic business?

4. What are some of the conflicts that may occur between a multinational corporation and the

local government hosting the multinational?

6. How can increases in world trade affect the small businessperson in your hometown?

APPLY YOUR UNDERSTANDING

Zuzu lazrag is the marketing manager of a French firm that makes and sells-high quality red

wine. He believes that there is little difference between his home-country market and foreign

markets and that he can use the same methods for selling in Morocco as he does in his home

country. Write a memo in which you explain to Zuzu the differences between domestic and

international business. Explain the risks that Zuzu’s firm may encounter if it ever decides to

expand its business to Morocco.

Chapter Two: Learning Objectives: In this chapter, students will learn about:

* Why globalization is not new?

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* Market Globalization: An organizing framework.

* Dimensions of market globalization.

* Drivers of market globalization.

1. Why Globalization is not new?

Globalization is not new; it is an old phenomenon but it has accelerated and acquired a

more complex character in recent years

Phases of Globalization

We can distinguish four distinct phases in the evolution of market globalization since

the 1980s.

The first phase began about 1980 and peaked around 1980. International business

became widespread due to the growth of railroads, efficient ocean transport, the rise of large

manufacturing and trading firms, and the invention of the telegraph and the telephone in the

late 1800s.

The second phase began around 1900 and was associated with the rise of electricity and

steel production. This phase reached its height just before 1929 economic depression. Western

Europe was the most industrialized world region, which led to the policy of colonization and,

consequently, to the establishment of some of the earliest subsidiaries of multinational

enterprises (MNEs).

The third phase began after World War II. After that war, leading industrialized

countries, such as Britain and the US, sought to reduce international trade barriers and

establish a new world economic order for the prosperity of all nations in the world. Hence the

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creation of the Bretton Woods Conference in 194710, which led to the GATT organization11,

eventually transformed to the WTO whose aim is to regulate global trade and investment12. 2. Market Globalization: An organizing framework

Market globalization can be modeled in terms of its drivers, dimensions, societal

consequences, and firm-level consequences. As market globalization intensifies, firms are

compelled to respond to challenges and exploit new advantages. Many firms proactively

pursue internationalization as a strategic move. They become more aggressive at identifying

foreign market opportunities, seeking partnerships with foreign firms, and building

organizational capabilities to enhance their competitive advantage.

3. Dimensions of market globalization

Globalization of markets is a multifaceted phenomenon, with six major dimensions:

* Integration and interdependence of national economies.

10 The Bretton Woods Conference was held in 1944 to find ways to avoid the disastrous international economic difficulties of the post-World War I era. It established the International Bank for Reconstruction and Development, commonly called the World Bank (WB). This organization, headquartered in Washington, D.C., is owned by over 125 member countries. Each of them contributes capital to its operations. The largest contributors are the major industrial countries of North America and Europe. The World Bank extends long-term loans to member governments for development projects such as dams, electrification, general infrastructure, agricultural development, and public health. All loans are made either directly to governments or carry the governments guarantee. World Bank loans are made in hard currencies at market interest rates sufficient to cover the cost of funding. Repayment is required in the same currency. In the late 1950s, the fact that many countries could not qualify for World Bank loans was recognized. These were generally poorer countries, unable to generate the means of repayment in hard currencies. The needs of these countries were great, however, and to assist them the World Bank created the International Development Association (IDA) to make long-term development loans on lenient terms. These loans are in the currency of the borrowing country, repayable over fifty years, and are virtually interest-free. The third major component of the World Bank is the International Finance Corporation (IFC). Like those of the IDA, its activities are much more limited than the World Bank’s activities. The IFC’s function is to further the economic growth in developing countries by investing –without government guarantees- in productive private enterprises. The WB also established the International Monetary Fund. Headquartered in Washington D.C., this organization’s purpose is to provide short-term loans to member countries to help them through temporary balance-of-payments difficulties and to assist in the solution of their monetary problems. Also its role in international finance has expanded significantly into other areas. 11 It wasn’t an enforceable global commercial code, though.12 The World Trade Organization (WTO) was established on January 1, 1995, and it is now the umbrella organization that governs the international trading system. It is the successor to the General Agreement on Tariffs and Trade (GATT). The GATT was established in 1947. The purpose of the GATT was to liberalize trade and to negotiate trade concessions among member countries. Although the early years saw a great deal of progress in reducing tariffs, by the 1980s there was a trend toward protectionism by many countries. At the GATT’s eighth round of negotiations in 1986 (called the Uruguay Round because this is where the group met), negotiations dragged on for years before culminating in a number of agreements including reductions on industrial goods and agricultural subsidies, the increased protection of intellectual property rights under the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS), the creation of the General Agreement on Trade in Services (GATS) and the creation of the World Trade Organization to implement the GATT agreement. Today the World Trade Organization is enforcing these agreements. Presently, the Doha Round of the WTO, which began in 2001, has opened the door for further trade negotiations.

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Governments have facilitated this integration by lowering barriers to international trade

and investment, harmonizing their monetary and fiscal policies within regional economic

integration blocs, and developing supranational institutions –the World Bank, International

Monetary Fund, World Trade Organization, and others- that seek further reductions in trade

and investment barriers.

* Rise of regional economic integration blocs.

Examples include the North American Trade Agreement (NAFTA), the Asia Pacific

Economic Cooperation (APEC), and Mercosur in Latin America. In these blocs trade and

investment flows are facilitated through reduced trade and investment barriers. In more

advanced arrangements, like the European Union, countries go beyond adopting free trade

and investment by harmonizing their fiscal and monetary policies and by adopting business

regulations.

*Growth of global investment and financial flows.

The free movement of capital around the world –the globalization of capital- extends

economic activities across the globe and is fostering interconnectedness among world

economies.

*Convergence of consumer lifestyles and preferences.

Shoppers in New York, Tokyo, and Paris demand similar household goods, clothing,

automobiles, and electronics.

*Globalization of production.

Companies strive to drive down prices through economies of scale by relocating their

manufacturing to low labor-cost locations such as China, Mexico, and Eastern Europe.

* Globalization of services. The services sector is undergoing widespread internationalization.

4. Drivers/ Cause of Market Globalization

* Worldwide reduction/easing of barriers to trade and investment.

Falling trade barriers are facilitated by the WTO and by the emergence of regional

economic integration blocs.

*Market liberalization and adoption of free markets.

The collapse of the Soviet Union’s economy in 1989, demolition of the Berlin Wall that

same year, and China’s free-market reforms all signaled the end of the 50-year Cold War and

smoothed the integration of former command economies into the global economy.

*Industrialization, economic development, modernization.

Here, we are referring to the changes that occurred in developing countries around the

world.

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* Integration of world financial markets.

Cross-border transactions are made easier partly as a result of the ease with which funds

can be transferred between buyers and sellers, through a network of international commercial

banks.

* Advances in technology.

Technological advance in information, communication (electronic interconnection), and

transport have triggered the ‘death of distance’-shrinkage of the geographic and cultural

distances that long separated nations. Globalization is gradually shrinking the world into a

manageable marketplace.

APPLY YOUR UNDERSTANDING

Globalization provides numerous advantages to businesses and consumers around the world.

At the same time, some critics believe globalization is harming various aspects of life and

commerce. In what ways is globalization good for firms and consumers? In what ways is

globalization harmful to firms and consumers?

Chapter Three: Learning objectives:

In this chapter, we explain why nations and firms trade and invest internationally. We

explain why such participation allows nations to acquire and sustain competitive advantage in

the global marketplace. We review leading theories of why nations and firms undertake

international activities. We address such questions as:

*What is the underlying economic rationale for international business activities?

*Why does trade take place?

*What are the gains from trade and investment?

The theories discussed in this chapter answer some of these questions. Although no

theory by itself offers all the answers, the different theories do contribute significantly to our

understanding.

1. Why do nations and firms trade?

For centuries, scholars have offered theories to explain economic rationales for

international trade and investment.

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Classical Theories

Mercantilism

To understand the topic of international trade, we must be able to answer the question:

Why do nations trade? One of the earliest and simplest answers to this question was provided

by mercantilism, a theory that was quite popular in the 18th century, when gold was the only

world currency. Mercantilism holds that a government can improve the economic well-being

of the country by encouraging exports and stifling imports. The result is a positive balance of

trade. Because the nation’s power and strength increase as its wealth increases, mercantilism

argued that national prosperity results from a positive balance of trade that leads to wealth

(gold) flowing into the country, achieved by maximizing exports and minimizing or even

impeding imports. Even today, many people believe that running a trade surplus (that is, to

export more goods than they import) is beneficial. Labor unions (which seek to protect home-

country jobs), farmers (who want to keep crop prices high), and certain manufacturers (those

that rely heavily on exports) subscribe to neo-mercantilism which, like mercantilism, seeks to

produce a positive balance of trade but without the reliance on precious metals..

On the other hand, mercantilism tends to harm the interests of nations (those that import

raw materials and parts used in the manufacturing of finished products) as well as the interests

of consumers. Product shortages that result from import restrictions may lead to higher prices

–that is, inflation.

A more useful explanation of why nations trade is provided by trade theories that focus

on specialization of effort. The theories of absolute and comparative advantage are good

examples.

Absolute Advantage Principle

In 1776, in The Wealth of Nations, Adam Smith attacked the mercantilist view by

suggesting that nations benefit most from free trade. By trying to minimize imports, a country

wastes much of its natural resources in the production of goods it is not suited to produce

efficiently. Relative to others, each country is more efficient in the production of some

products and less efficient in the production of others. Smith’s absolute advantage principle

states that a country benefits by producing primarily those products in which it has an

absolute advantage or that it can produce using fewer resources than another country.

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The principle of comparative advantage13 contends that countries should specialize and

export those goods in which they have a relative advantage compared to the others.

Comparative advantage is based on natural advantages and acquired ones.

Competitive advantage typically derives from distinctive organizational assets and /or

competencies of a firm such as specific knowledge, capabilities, skills or superior strategy that

are difficult for competitors to imitate. The collective competitive advantages of many firms

give rise to competitive advantage in the nation as a whole.

Factor Proportions Theory

In the 1920s, Heckscher and Ohlin explained international trade by proposing the factor

proportion theory14. This theory differs somewhat from earlier theories by emphasizing the

importance of each nation’s factors of production. It states that, in addition to differences in

the efficiency of production, differences in the type and quantity of factors of production held

by countries also determines international pattern trends. Thus, each country should export

products that intensively use relatively abundant factors of production and import goods that

intensively use relatively scarce factors of production.

International Product Life Cycle Theory

In 1966, Raymond Vermon explained international trade based on the evolutionary

process that occurs in the development and diffusion of products to markets around the world.

In his International Product Life Cycle theory, he observed that each product and its

manufacturing technologies go through three stages of evolution: introduction, maturity, and

standardization.

In the introduction stage, a new product typically originates in an advanced economy.

During this stage, the new product is produced in the home country, which enjoys a temporary

monopoly.

As the product enters the maturity phase, the product’s inventors mass-produce and

seek to export it to other advance economies. Gradually, however, the product’s

manufacturing becomes more routine and foreign firms begin producing alternative versions,

ending the inventor’s monopoly and, thereby, its competitive advantage.

In the standardization phase, knowledge about how to produce the product is

widespread and manufacturing becomes straightforward. Once standardized, mass production

13 It was David Ricardo, who developed the important concept of comparative advantage in considering a nation’s relative production efficiencies as they apply to international trade. In Ricardo’s view, the exporting country should look at the relative efficiencies of production for both commodities and make only those goods it could produce most efficiently.14 It is sometimes called the endowments theory.

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is the dominant activity and can be accomplished using cheaper inputs and low-cost labor.

Consequently production shifts to low-income countries where competitors enjoy low-cost

advantages and can economically serve export markets worldwide. Eventually, the country

that invented the product becomes a net importer.

All in all, the IPLC illustrates that national advantages are dynamic; that is to say, they

do not last forever.

2. How can Nations Enhance Their Competitive Advantage?

The most advantaged nations today possess national competitive advantage, maximized

when numerous industries collectively possess firm-level competitive advantages and the

nation itself has comparative advantages that benefit those particular industries.

Contemporary theories

Three key modern perspectives that help explain the development of national

competitive advantage are the competitive advantage of nations, Michael Porter’s diamond

model, and national industrial policy.

The Competitive Advantage of Nations

Scholars sought to explain how nations can position themselves for international

business success. An important contribution came from Michael Porter in his 1990 book, The

Competitive Advantage of Nations. According to him, the competitive advantage of nations

depends on the collective competitive advantages of the nation’s firms. Over time, the

relationship is reciprocal.

At both the firm and national levels, competitive advantage and technological advances

grow out of innovation, which results primarily from research and development.

Michael’s Porter’s Diamond Model

As part of his explanation in The Competitive Advantage of Nations, Porter developed

the diamond model, which specifies the four conditions in each nation that give rise to

national competitive advantages.

a. Firm strategy, structure, and rivalry

One of the determinants of national advantage is the context in which the firms are

created, organized, and managed, as well as the nature of domestic rivalry. No one managerial

system is universally appropriate. Germany, for instance, tends to have hierarchical

organizations that emphasize technical or engineering content.

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Another area of importance is domestic rivalry. Researchers have found that vigorous

domestic rivalry and competitive advantage are related. Nations with leading world positions

often have a number of strong, local rivals. For example, in Switzerland, the pharmaceutical

firms Roche and Novartis help the country to maintain its internationally competitive edge.

b. Factor conditions

Factor conditions describe the nation’s position in factors of production, such as labor,

natural resources, capital, technology, and know-how. Consistent with factor proportions

theory, each nation has relative abundance of certain factor endowments, a situation that helps

determine the nature of its national competitive advantage. For example Germany’s

abundance of workers with strong engineering skills has propelled the country to

commanding heights in the global engineering and design industry.

c. Demand conditions

The strength and sophistication of buyer demand facilitates the development of

competitive advantages in particular industries. The presence of highly demanding customers

pressures firms to innovate faster and produce better products.

d. Related and supporting industries

This refers to the presence of clusters of suppliers, competitors, and complementary

firms that excel in particular industries. The resulting business environment is highly

supportive for the founding of particular types of firms. Operating within a mass of related

and supporting industries provides advantages through information and knowledge synergies,

economies of scale and scope, etc.

An industrial cluster refers to a concentration of companies in the same industry in a

given location that interact closely with one another, gaining mutual competitive advantage.

Competitive advantage of nations describes how nations acquire international trade

advantages by developing specific skills, technologies, and industries.

National Industrial Policy Perhaps the greatest contribution of Porter’s work has been

to underscore the notion that national competitive advantage does not derive entirely from the

store of natural resources each country holds. Inherited national factor endowments are

relatively less important than in the past. Rather, as Porter emphasized, countries can

successfully create new advantages and develop new and superior factor conditions they deem

important for their success, by devoting resources to improve national infrastructure15,

education system16, and capital formation17.15 In areas such as IT, communication systems, and transportation.16 Rigorous educational systems at the precollege and university levels that ensure a steady stream of competent workers.17 Via monetary and fiscal policies, such as low-interest loans, that provide a stable supply of capital for company investment needs.

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DISCUSSION QUESTIONS

1. What are the benefits of international trade?

2. Which of the classical theories, do you believe, are relevant today?

3. What factors are most abundant in Morocco?

4. What are the main sources of national competitive advantage? Think about a successful

product in your country (Morocco); what are the sources of competitive advantage that

explain its success?

5. Do you believe that Morocco should adopt a national industrial policy? Why or why not?

ACTIVE LEARNING CASE

Coca-Cola is the largest selling soft drink in the world, but sales vary by nation. For example,

Americans consume almost 30 gallons of Coke annually, in contrast to Europeans who drink

less than half this amount and in some countries, such as France, Italy, and Portugal, the

average is in the range of 10 gallons. In the 1990s, Coke took a number of steps to increase its

European sales.

One of these was to replace local franchisers who had become too complacent with more

active, market-driven sellers. In France, for example, Pernod, a Coca-Cola franchisee, was

forced to sell some of its operations back to Coke which, in turn, appointed a new marketing

manager for the country. In addition, Coke’s price was lowered and advertising was sharply

increased. As a result, per capita consumption in France went up.

In England, Beecham and Grand Metropolitan used to be Coke’s national bottlers but that was

turned over to Cadbury Schweppes, most famous for its Schweppes mixers. The latter

immediately began a series of marketing programs that resulted in sales tripling within three

years.

In Germany the pace has been even faster. Beginning in the early 1990s Coke identified

Germany as one of its primary targets and began building a distribution network there to both

package and sell Coke locally. Meanwhile throughout the entire country the company has

taken even bolder steps including the replacement of an inefficient bottling network and the

institution of a new, well financed marketing campaign. As a result, Germany became Coca-

Cola’s largest and most profitable market in Europe.

But all of this came at a price. For example, some government agencies and companies

expressed concern about Coke’s overriding emphasis on cost control and market growth and

its willingness to push aside those who are unable to meet these goals. As a result, the

European Union’s Competition Department was asked to investigate possible anti-

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competitiveness tactics. Meanwhile, in the UK, the British Monopolies and Mergers

Commission investigated Coke regarding its joint venture with Schweppes; and San

Pellegrino, the mineral water company, filed a complaint with the Commission of the

European Communities, contending that Coca-Cola abused its dominant position by giving

discounts to Italian retailers who promised to stock only Coke.

Yet none of these actions stopped Coca-Cola’s efforts to establish a strong foothold in

Europe. As the European Union eliminated all internal tariffs, it became possible for a chain

store with operations in France, Germany, Italy, and the Netherlands to buy soft drinks from

the lowest-cost supplier on the continent and not have to worry about paying import duties for

shipping them to the retail stores. Low cost and rapid delivery were going to be key strategic

factors for success. Coke believes that its current European strategy puts it in an ideal

competitive position against competitors.

Recent developments shed some doubt on whether the company will be as successful as it is

forecasting. Worldwide market growth has been flat and there has been a move away from

carbonated drinks. In Eastern Europe, it is the market for bottled water that is booming.

Between 1998 and 2004, per capita consumption of bottled water in Eastern Europe doubled.

Although Coca-Cola water division is one of four major players, it is not the market leader

and smaller, local competitors account for a large portion of the market. Other efforts to

develop innovative, non-carbonated products have not proven very successful. The company

knows that its future growth is going to depend heavily on its ability to supplement its current

product line with new offerings such as vitamin-enriched drinks, and perhaps coffee and tea

offerings. Worst of all perhaps, a few years ago the company began centralizing control and

encouraging consolidation among its bottling partners. Coke believed that by making all key

operating decisions in Atlanta, it could drive up profitability. Unfortunately, at the same time

that it was pushing for this centralized type of operation, regional markets began demanding

that the company be more responsive to local needs. In short, Coke was going global while

the market wanted it to go local.

Coke is now trying to turn things around. In particular, the firm is now implementing three

principles that are designed to make it more locally responsive. First, the company is

instituting a strategy of “think local, act local” by putting increased decision making in the

hands of local managers. Second, the firm is focusing itself as a pure marketing company and

pushing its brands on a regional basis and local basis rather than on a worldwide basis. Third,

Coke is now working to become a model citizen by reaching out to local communities and

getting involved in civic and charitable activities. Europe remains an important market for

Coke, which derives about a quarter of its revenues from the region, about the same as the

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Asia-Pacific region. North America, though the dominant market, accounts for just under a

third of Coke’s revenues.

In the past, Coke succeeded as a multinational because of its understanding and appeal to

global commonalities. Today, it is trying to hold its market share by better understanding and

appealing to local differences.

1 Why did Coca-Cola engage in foreign direct investments in Europe?

2 How did Coke improve its factor conditions in Europe?

3 How is local rivalry helping to improve Coke’s competitive advantage?

4 Is the Coca-Cola Company a multinational enterprise? Is it global? Why?

Case Study

Wal-Mart

In 2001, Wal-Mart became the world’s biggest company in terms of sales revenues, a title it

has kept to date; a breathtaking achievement for the company that Sam Walton started in

Arkansas as recently as 1962. Indeed, with revenues of $256 billion for the year ending in

2003, Wal-Mart is now ahead of General Motors and Exxon Mobil. The second largest

retailer, Carrefour, is only about one fourth the size of Wal-Mart.

Wal-Mart’s success can be attributed to a scale strategy based on reduction of costs to steadily

generate its “always low prices” formula and physical growth or market coverage. The United

States offers the perfect landscape for Wal-Mart’s expansion. Large, wealthy suburbs with

vast, inexpensive land allow the firm to set up huge warehouse style retail centers, reducing

overall prices. This is complemented by an entrepreneurial culture in which store managers

have a lot of decision-making power. Wal-Mart pushes its suppliers to provide the best

product they can at the lowest possible price, making its products of better quality than those

of other discount stores.

Presently, Wal-Mart commands an 8 per cent share of the retail sales in its home market and

its growth shows no signs of slowing down any time soon. The firm’s critics accuse it of

exploiting its workers, destroying traditional retail stores, and eroding the manufacturing

industry by importing from countries with low labor costs, among other things. Even those

who sympathize with objectors, however, might not resist saving $100 for an appliance. The

criticism can be argued both ways. Some traditional retail stores suffered as a result of Wal-

Mart’s expansion, but if Wal-Mart sets up shop in a run-down mall, neighboring stores benefit

from the increased traffic. This might include dollar-stores, hair cutting places, and sportswear

outlets, among others. Wal-Mart’s bicycle section falls short of offering all the equipment, not

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to mention the service, of a traditional bicycle store. A mother buying her daughter her first

bicycle might go to Wal-Mart, but a young woman looking for quality, accessories, service,

and a knowledgeable salesperson might instead visit her local bike store. The same can be

said for most product sections within the store. Large competitors have either stopped

competing with Wal-Mart or sought to beat it in its own game. Indeed, Wal-Mart may be

responsible for a more consumer oriented retail service sector in the United States.

One main criticism of Wal-Mart is its dependence on imports from low-cost countries such as

China. In 2003, the firm purchased approximately $15 billion in Chinese products, a fraction

of revenues perhaps, but a sizeable amount just above the total revenues of McDonald’s for

the same year. Here, Wal-Mart had done nothing more than take advantage of the

opportunities, available to all US retailers, that arose from the liberalization of China.

Those things that have helped Wal-Mart grow might be the same things that eventually will

halt its growth.

Low-cost laborers have a higher turnover. The firm hires approximately 600,000 new

employees a year, and if it wants to reduce the costs of searching for personnel and training

them, it might find that increased salaries and benefits are its only alternative. The firm has

been constantly lowering the prices of its products, but this too will come to a stop when it

exploits all available opportunities in low-cost areas and as China begins to see its production

costs increase in the face of development. Finally, the entrepreneurial nature of Wal-Mart’s

decentralized business structure has meant that the organization lacks a coordinated

bureaucracy with the power to impose corporate rules on store managers. For that reason, the

firm is now being plagued with lawsuits, including a class action suit by its female employees

for gender discrimination.

For future long-term growth, Wal-Mart has looked beyond its borders. However, while it has

done extremely well in Canada, Mexico, and the United Kingdom, it has had a rough time in

other markets, including Germany and Japan.

Wal-Mart’s international expansion begun in 1992 when it entered into a joint venture with

Cifra S.A., a successful Mexican retailer, in which it held 50 per cent interest in its partner’s

retail operations. In 1998, Wal-Mart acquired a controlling interest in Cifra and officially

changed the company’s name to Wal-Mart of Mexico in 2000.Wal-Mart entered Canada in

1994 when it acquired 122 Woolco stores. Since then, the firm has established itself

successfully in the markets of its NAFTA partners. One reason for this success is that it can

rely on suppliers for its US stores to deliver products for the Canadian and Mexican market.

In addition, the landscape, culture, and economic situation in Canada are much like in the

United States.

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The group entered Europe in the late 1990s, by purchasing the Wertkauf and Interspar

supermarkets in Germany. Here, Wal-Mart ran into some trouble. Competitors in Europe had

emulated the company’s most successful strategies in cost reduction and supply-chain

management, reducing Wal-Mart’s relative competitive advantage. In Germany, local

competitors offer very low prices, and Wal-Mart is not big enough to achieve the local

economies of scale required to compete on price alone. There was also a different cost

structure. Real estate development, when possible, was more costly and wages were also

higher. The scale effect does not work in Europe. When the company must source 90 per cent

of its goods locally, which bargain or logistics savings can it cash in with so few stores? To

top it all off, Wal-Mart’s American managers had problems adapting to the culture and did

not speak German.

Wal-Mart entered the British market by acquiring ASDA and retained the name. ASDA had

already adopted a focus on low prices and so it had exactly the type of consumer that Wal-

Mart was looking for. Even though it has done relatively well in England, a low-cost strategy

was secondary to developing long-term relationships with suppliers of well-known, quality-

oriented, differentiated brands.

Time, patient investment, and key expertise in each foreign market may help Wal-Mart to

successfully expand its international operations to become a more international player. Until

then, however, the firm remains extremely NAFTA focused.

1 Is Wal-Mart a multinational enterprise? Why?

2 Why is Wal-Mart making foreign direct investments in Europe?

3 Using the Porter model, what are the determinants of Wal-Mart’s competitive advantage?

4 Is Wal-Mart’s competitiveness in Europe dependent on the same determinants listed in

question 3? Why?

Chapter Four: Political and Legal Systems in International Business

Chapter Five: Government Intervention in International Business

Chapter Six: Strategy and Organization in the International Firm

Chapter Seven: Foreign direct investment and collaborative ventures

Chapter Eight: Exporting and Countertrade

Chapter Nine: Licensing, Franchising, and Other Contractual Strategies

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