INSTRUCTOR MANUAL for International Business: The Challenges of Globalization, First Canadian Editio by StudyGuide

INSTRUCTOR MANUAL for International Business: The Challenges of Globalization, First Canadian Edition

Contents Chapter 1

Globalization ................................................................................................2

Chapter 2

Cross-Cultural Business .............................................................................17

Chapter 3

Politics and Law.........................................................................................39

Chapter 4

International Ethics ....................................................................................54

Chapter 5

Economics and Emerging Markets ............................................................61

Chapter 6

International Trade .....................................................................................78

Chapter 7

Foreign Direct Investment .........................................................................97

Chapter 8

Regional Economic Integration ...............................................................111

Chapter 9

International Financial Markets and Foreign Exchange ..........................129

Chapter 10

International Strategy and Organization ..................................................144

Chapter 11

Selecting and Managing Entry Modes .....................................................157

Chapter 12

Developing and Marketing Products .......................................................173

Teaming Up ..................................................................................................................187

Ch 1: Globalization

CHAPTER 1 GLOBALIZATION LEARNING OBJECTIVES: 1. Describe the process of globalization and how it affects markets and production. 2. Identify the two forces causing globalization to increase. 3. Summarize the evidence for each main argument in the globalization debate. 4. Identify the types of companies that participate in international business. 5. Describe the global business environment and identify its four main elements.

CHAPTER OUTLINE: Introduction International Business Involves Us All Technology Makes It Possible Global Talent Makes It Happen Globalization Globalization of Markets Reduces Marketing Costs Creates New Market Opportunities Levels Uneven Income Streams Yet Local Needs Are Important Globalization of Production Access Lower-Cost Workers Access Technical Expertise Access Production Inputs Forces Driving Globalization Falling Barriers to Trade and Investment World Trade Organization Regional Trade Agreements Trade and National Output Technological Innovation E-mail and Videoconferencing Internet and World Wide Web Company Intranets and Extranets Advancements in Transportation Technologies Measuring Globalization Untangling the Globalization Debate Today’s Globalization in Context Introduction to the Debate Globalization’s Impact on Jobs and Wages Against Globalization Eliminates Jobs in Developed Nations Lowers Wages in Developed Nations Exploits Workers in Developing Nations For Globalization Increases Wealth and Efficiency in All Nations Generates Labor Market Flexibility in Developed Nations

Ch 1: Globalization

Advances Economies of Developing Nations Summary of the Jobs and Wages Debate Globalization’s Impact on Labor, the Environment, and Markets Labor Standards Environmental Protection Future Markets Globalization and Income Inequality Inequality within Nations Inequality between Nations Global Inequality Summary of the Income Inequality Debate Globalization and National Sovereignty Globalization: Menace to Democracy? Globalization: Guardian of Democracy? Globalization’s Influence on Cultures Key Players in International Business Multinational Corporations Entrepreneurs and Small Businesses Why International Business Is Special The Global Business Environment The Road Ahead for International Business Bottom Line for Business

A comprehensive set of specially designed PowerPoint slides is available for use with Chapter 1. These slides and the lecture outline below form a completely integrated package that simplifies the teaching of this chapter’s material. Lecture Outline 1.

INTRODUCTION Globalization is reshaping our cultures, our political, legal, and economic systems, and affecting our standards of living. It alters the global pattern of trade and investment by expanding markets and multiplying production possibilities. A. International Business Involves Us All Each of us encounters the result of international business transactions 1. every day whether we realize it or not. 2. International business is any commercial transaction that crosses the borders of two or more nations. 3. Imports are goods and services purchased abroad and brought into a country. Exports are goods and services sold abroad and sent out of a country. B. Technology Makes It Possible Technology is a remarkable facilitator of international business and 1. change. 2. E-business (e-commerce) is the use of computer networks to purchase, sell, or exchange products; service customers; and collaborate with partners.

Ch 1: Globalization C.

Global Talent Makes It Happen 1. Development and production now regularly occur on a global basis for many goods and services. 2. Performing these globally increases firm efficiency and competitiveness.

GLOBALIZATION Globalization is the trend toward greater economic, cultural, political, and technological interdependence among national institutions and economies. It is marked by “denationalization,” which is not “internationalization.” It embraces concepts and theories from economics, political science, sociology, anthropology, and philosophy. A.

Globalization of Markets 1. Convergence in buyer preferences in markets around the world a. Reduces marketing costs by standardizing activities b. Creates market opportunities abroad if home is small or saturated c. Levels uneven income streams for global seasonal products d. Yet companies must not overlook buyers’ needs

Globalization of Production 1. Dispersal of production activities to locations that help a company to minimize costs or maximize quality a. Access lower-cost workers to cut overall production costs b. Access technical expertise c. Access production inputs unavailable or more costly at home

Note: The above material is covered in Chapter One PowerPoint slides from 1 to 10. Think-Pair-Share – Slide 11 3.

FORCES DRIVING GLOBALIZATION Forces increase competition among nations by leveling the global business playing field. A.

Falling Barriers to Trade and Investment 1947 General Agreement on Tariffs and Trade (GATT) was designed to promote free trade by reducing tariffs and nontariff barriers. 1994 GATT revision (1) reduced tariffs and lowered subsidies for agricultural products; (2) defined and protected intellectual property rights; and (3) created the WTO. 1. World Trade Organization a. World Trade Organization (WTO) is the international organization that enforces the rules of international trade. b. WTO goals: (1) to help the free flow of trade, (2) help negotiate the further opening of markets, and (3) settle trade disputes. c. WTO agreements are contracts committing members to fair and open trade policies. WTO dispute settlement system is the spine of the global trading system. 2. Regional Trade Agreements a. Smaller groups of nations also are integrating their economies (e.g., NAFTA, European Union). 3. Trade and National Output a. Effect of the WTO and regional trade pacts is greater global trade and cross-border investing (Map 1.1).

Ch 1: Globalization b. c.

Trade growth has been faster than world output. Gross Domestic Product (GDP) is the value of all goods and services produced by a domestic economy over a one-year period. Gross national product (GNP) adds income from international activities.

Technological Innovation Technology accelerates globalization by making it easier, faster, and less costly to move data, goods, and equipment around the world. 1. E-mail and Videoconferencing a. Speed information flows and ease the tasks of coordination and control, which are complicated by operating across borders. b. Driving growth in videoconferencing are lower-cost bandwidth and equipment, and decreased travel for cost or safety reasons. 2. Internet and World Wide Web a. Helps firms sharpen forecasting, lower inventories, improve communication with suppliers, and communicate quickly and cheaply with distant managers b. Reduces the cost of reaching an international customer base, which is essential for the competitiveness of small firms 3. Company Intranets and Extranets a. Intranets are private networks of company Web sites and other information sources that allow employee access to information from distant locations. b. Extranets are computer networks that give distributors and suppliers access to a company’s database so they can place orders or restock inventories electronically and automatically. 4. Advancements in Transportation Technologies a. Make global shipping more efficient and dependable (e.g., GPS)

Measuring Globalization

The KOF Index of Globalization,measures 24 different variables within three dimensions: economic, social, and political globalization. Its records show changes in globalization by comparing 187 countries over a long-term period (1970–2012). The globalization of a country is measured on a scale from 1 to 100, with higher numbers indicating greater levels of globalization. Some of the factors considered for each of the three main dimensions: 1. Economic globalization: Trade and investment flows, and trade barriers. 2. Social globalization: Flow of ideas and information. 3. Political globalization: Degree of political cooperation between countries. The KOF Index of Globalization 2012 still shows the impact of the 2009 financial and world economic crisis. Nonetheless, overall there has been a progressive upward trend in globalization since the 1970’s (see Figure 1.2 ).2. Figure 1.3 shows the 15 highest-ranking nations in the latest KOF Index of Globalization. It shows each nation’s overall rank and its rank for each of the three dimensions described earlier: (1) economic globalization; (2) social globalization; and (3) political globalization. Europe accounts for 9 of the top 10 spots, while Canada appears as number 15. Belgium, Ireland, The Netherlands, and Austria are the most globalized nations. In the KOF Index 2012, Singapore ranks number 5, but remains number 1 in terms of economic globalization.3.

The least global nations are found in Africa, East Asia, South

Ch 1: Globalization

Asia, Latin America, and the Middle East. Low technological connectivity slows global integration. 4.

UNTANGLING THE GLOBALIZATION DEBATE People can view globalization from vastly different perspectives. A.

Today’s Globalization in Context 1. First age of globalization extended from the mid-1800s to the 1920s. Migration levels reached record highs, domestic workers faced competition from cheaper labor abroad, and trade and capital flowed more freely than ever before. 2. Drivers of that first age of globalization were the steamship, telegraph, railroad, telephone, and airplane. 3. World War I, the Russian Revolution, and the Great Depression abruptly ended that first age of globalization. Globalization backlash led to high tariffs and other barriers. 4. Geographic divide between East and West became an ideological divide between communism and capitalism. International capital flows regained their prior pace but not until the 1990s. 5. Drivers of this second age of globalization are communication satellites, fiber optics, microchips, and the Internet.

Introduction to the Debate 1. The World Bank is an agency created to provide financing for national economic development efforts. 2. The International Monetary Fund (IMF) is an agency created to regulate fixed exchange rates and enforce the rules of the international monetary system.

Globalization’s Impact on Jobs and Wages 1. Against Globalization a. Eliminates jobs in developed nations as good-paying manufacturing jobs go abroad to developing countries. Lowpriced goods are not worth lost jobs. b. Lowers wages in developed nations by causing worker dislocation that gradually lowers wages. New jobs that replace lost manufacturing jobs often pay less. c. Exploits workers in developing nations who work cheaply servicing western consumers. d. Summary: Although globalization eliminates jobs in some economic sectors, it creates jobs in other sectors. 2. For Globalization a. Increases wealth and efficiency in all nations because trade openness raises output. Firms grow more efficient and pass savings on to consumers. b. Generates labor market flexibility in developed nations that allows an economy to rapidly deploy labor where demand is relatively great. c. Advances economies of developing nations by injecting capital that creates higher-paying jobs, which expands the middle class and raises standards of living.

Ch 1: Globalization d.

Summary: Gains to national economies are worth lost livelihoods that individuals may suffer.

Globalization’s Impact on Labor, the Environment, and Markets 1. Labor Standards a. Trade unions claim that firms continually move to nations with low labor standards, which reduces labor’s bargaining power and forces overall labor standards lower. b. But studies of developing nations’ export processing zones instead find evidence that contradicts such claims. 2. Environmental Protection a. Globalization opponents say it creates a “race to the bottom” in environmental conditions and regulations: countries compete in reducing environmental protection laws. b. But evidence shows pollution-intensive U.S. firms tend to invest in countries with stricter environmental standards. Also, closed economies historically are the worst polluters. 3. Future Markets a. Protesters claim international firms pay locals the lowest possible wage and export their goods back to the home country. b. Today, firms want to build local markets in developing nations, not simply exploit workers and foment local animosity.

Globalization and Income Inequality 1. Inequality within Nations a. Globalization critics claim that income disparity in rich nations is increasing as firms move factory jobs to poor nations. b. Evidence is mixed, but poor people in developing nations seem to benefit from an open economy. 2. Inequality between Nations a. Globalization opponents say it is widening the gap in average incomes between rich and poor nations. b. Looking closely at the evidence, we see that open nations are benefiting from trade while closed ones are not. 3. Global Inequality a. Opponents of globalization say it is widening income inequality among all people of the world. b. Studies tend to agree that global inequality has fallen in recent decades, though they disagree on the extent of the decline.

Note: The above material is covered in Chapter One PowerPoint slides from 12 to 29. Slide 30 Think-Pair-Share F. Globalization and National Sovereignty 1. Globalization: Menace to Democracy? a. Supranational institutions with international goals and appointed officials undermine national sovereignty and democracy. b. Elected officials undercut democracy and local and regional authority with “international” agreements on citizens’ behalf. 2. Globalization: Guardian of Democracy?

Ch 1: Globalization a. b.

Globalization has helped spread democracy worldwide (e.g., more democratic nations than ever). Some losses of sovereignty have had positive social impacts, as in human rights, workers’ rights, and discrimination.

Globalization’s Influence on Cultures 1. Critics say globalization homogenizes our world and lets MNCs destroy cultural diversity and wipe out small local businesses. 2. Yet globalization allows nations to: (1) specialize and trade for goods they do not produce, (2) import other peoples’ cultural goods, and (3) still protect deeper moral and cultural norms.

KEY PLAYERS IN INTERNATIONAL BUSINESS Large firms from developed nations once dominated, but firms from Brazil, China, and India now play a bigger role. Technological advancements allow small and midsize companies to better compete.

Multinational Corporations An MNC is a business that has direct investments abroad in multiple countries. They generate significant jobs, investment, and tax revenue for the regions and nations they enter. 1. Profiling the Largest Multinationals a. If Wal-Mart were a country, it would rank just behind Switzerland in terms of economic power (Figure 1.2). b. Some MNCs have more employees than the smallest nations have citizens (e.g., Wal-Mart has more than 2 million employees globally).

Entrepreneurs and Small Businesses 1. They are increasingly active in international business by exporting earlier and growing faster with help from technology. 2. A born global firm is a company that adopts a global perspective and engages in international business from or near its inception. Today they arise from developed and developing nations alike. 3. Some small Internet companies reach customers solely through the Web.

WHY INTERNATIONAL BUSINESS IS SPECIAL What makes international business special is that it occurs within a dynamic, integrated system that weaves together four distinct elements. A.

The Global Business Environment 1. Globalization is transforming our societies and commercial activities. It also increases competition everywhere, forcing companies to be vigilant. 2. Each national business environment consists of unique cultural, political, legal, and economic characteristics. Companies must be attentive to nuances and adapt products and practices as needed. 3. The international business environment influences how business is conducted so firms must closely monitor events. 4. Context of international business management is defined by the characteristics of the national and international business environments.

Ch 1: Globalization

Managers must abide by the prevailing rules in each market in which it operates. B.

The Road Ahead for International Business Part 1 (Chapter 1): The forces of Globalization Part 2 (Chapters 2–5): National Business Environments Parts 3 and 4 (Chapters 6 to 9): International Business Environment Part 5 (Chapters 10 to 12): International Firm Management

BOTTOM LINE FOR BUSINESS A.

Harnessing Globalization’s Benefits 1. The most global nations tend to have the greatest equality, robust environmental protection, inclusive political systems, lowest levels of corruption, healthiest lifestyles, and be where women have achieved the most social, educational, and economic progress. 2. The debate has opened a dialogue on how globalization can be harnessed to make its benefits exceed its costs.

Intensified Competition 1. Continued globalization is taking companies into previously isolated markets and increasing competitive pressures worldwide. 2. As it gets easier and less costly to manage widely dispersed marketing and production activities, new opportunities and threats emerge.

Wages and Jobs 1. Low wages are not all that draws investment by multinationals. A location must offer low-cost, adequately skilled workers in an environment with acceptable levels of social, political, and economic stability. 2. Labor mobility is increasing with globalization—depressing wages in some job categories but developing new job opportunities in others.

The Policy Agenda 1. Rich nations could open their markets, slash agricultural subsidies, and increase development aid. Poor nations could improve their investment climates, and improve social protection for the poor. 2. Rich nations could offer workers their wage insurance, subsidized health insurance if out-of-work, and improve education. Rich nations could help enforce labor standards, help clarify environmental agreements, and research the environmental implications of trade agreements.

Quick Study Questions Quick Study 1 (p. 5) 1.

Q: Define the term international business, and explain how it affects each of us. A: International business is any commercial transaction that crosses the borders of two or more nations. International business involves each of us every day. We consume goods

Ch 1: Globalization

that originate outside our borders or that contain components made abroad. We also consume services, such as a news broadcast or music entertainment, that are sent to us from abroad. 2.

Q: What do we mean by the terms imports and exports? A: Imports are goods and services purchased abroad and brought into a country. Exports are goods and services sold abroad and sent out of a country.

Q: Explain how e-business (e-commerce) is affecting international business. A: E-business (e-commerce) is the use of computer networks to purchase, sell, or exchange products; service customers; and collaborate with partners. E-business is making it easier for companies to make their products abroad, not just import and export finished goods. It also helps companies improve efficiency in international operations and boost competitiveness.

Quick Study 2 (p. 9) 1.

Q: Define globalization. How does denationalization differ from internationalization? A: Globalization is the trend toward greater economic, cultural, political, and technological interdependence among national institutions and economies. It is a trend characterized by denationalization (in which national boundaries are becoming less relevant), and is different from internationalization (which refers to cooperation between national actors).

Q: List each benefit a company might obtain from the globalization of markets. A: Globalization of markets refers to convergence in buyer preferences in markets around the world. Potential benefits for companies include: (1) reduced marketing costs by standardizing activities, (2) market opportunities abroad if home market is small or saturated, and (3) levels an income stream by letting international sales offset domestic sales for a company selling a global seasonal product.

Q: How might a company benefit from the globalization of production? A: Globalization of production refers to the dispersal of production activities to locations that help a company minimize costs or maximize quality of a good or service. Potential benefits for companies include: (1) access lower-cost labor to cut production costs, (2) access technical expertise, and (3) access production inputs unavailable or costly at home.

Quick Study 3 (p. 16) 1.

Q: What two main forces underlie the expansion of globalization? A: The two forces underlying the expansion of globalization are: (1) falling barriers to trade and investment, and (2) technological innovation.

Q: How have global and regional efforts to promote trade and investment advanced globalization? A: Global Efforts: The 1947 GATT lowered trade barriers and made it cheaper and easier to ship goods across borders. In 1988 world merchandise trade was 20 times larger than in 1947; average tariffs dropped from 40 percent to 5 percent. A 1994 GATT revision created the WTO, which has the power to enforce international trade rules. Goals of the WTO are: (1) to help the free flow of trade, (2) help negotiate further opening of markets,

Ch 1: Globalization

and (3) settle trade disputes. WTO agreements are contracts committing members to fair and open trade policies. The WTO dispute settlement system is the spine of the global trading system. Regional Efforts: Smaller groups of nations are banding together in regional trade agreements with similar objectives. Examples are NAFTA and the EU. The combined effect of global and regional efforts: international trade and investment is growing faster than world output. 3.

Q: How does technological innovation propel globalization? A: E-mail and videoconferencing speed information flows and ease the tasks of coordination and control. Firms use the Web to sharpen forecasting, lower inventories, and improve communication with suppliers, and to communicate with distant managers quickly, cheaply, and efficiently. The Web also reduces the cost of reaching international customers—important for the competitiveness of small firms. Company intranets allow employees to access information from distant locations to share best practices. Extranets give distributors and suppliers access to a company’s database so they can place orders or restock inventories electronically and automatically. Transportation advancements are facilitating globalization by making shipping more efficient and dependable.

Q: What factors make some countries more global than others? A: Four factors make a country more global: (1) political engagement, (2) technological connectivity, (3) personal contact, and (4) economic integration. The seven most global countries according to recent data are (beginning with first place): Singapore, Hong Kong, the Netherlands, Switzerland, Ireland, Denmark, and the United States.

Q: What measures does Canada need to take in order to rank higher in the KOF Index of Globalization? A: Canada ranks number 35 in the KOF Index of Globalization, with a score of 76.05 in the economic dimension. One could argue that the efforts the Canadian government has put into diversification of trade over the past five years by negotiating and signing several trade agreements have not yet paid off. On the other hand, Canada ranked number 7 in terms of social globalization, scoring 88.72, and number 10 in political globalization, scoring 94.16.

Quick Study 4 (p. 18) 1.

Q: How does this current period of globalization compare with the first age of globalization? A: Whereas the first age of globalization (mid-1800s to 1920s) encompassed mostly rich nations, this second age reaches into developing and emerging economies. Like today, migration levels were very high, domestic workers faced competition from cheaper labor abroad, and trade and capital flowed freely. Drivers of that first age of globalization were the steamship, telegraph, railroad, telephone, and airplane. Drivers of this second age include communication satellites, fiber optics, microchips, and the Internet.

Q: Explain the original purpose of the World Bank and its mandate today. A: The World Bank is an agency created to provide financing for national economic development efforts. Its initial purpose was to finance European reconstruction following the Second World War. It later shifted its focus to the general financial needs of developing countries. Today it finances many economic development projects in Africa, South America, and Southeast Asia.

Ch 1: Globalization 3.

Q: What are the main purposes of the International Monetary Fund? A: The International Monetary Fund is an agency created to regulate fixed exchange rates and enforce the rules of the international monetary system. Some of the purposes of the IMF include: promoting international monetary cooperation; facilitating expansion and balanced growth of international trade; avoiding competitive exchange devaluation; and making financial resources temporarily available to members.

Quick Study 5 (p. 22) 1.

Q: What are the claims of those who say globalization eliminates jobs, lowers wages, and exploits workers? A: (1) Globalization eliminates manufacturing jobs in developed nations as jobs are sent to nations with lower wages. Also, the new jobs that globalization creates pay less than manufacturing jobs lost. And reduced prices for imported goods are little consolation for workers who have lost their jobs. (2) Globalization lowers wages in developed nations as jobs move abroad and competition increases for the remaining jobs, gradually depressing wages. (3) Globalization exploits workers in developing nations because multinationals operate where labor standards are low by comparison. People in developing nations have few employment options and no power to counter manipulative employment practices.

Q: Identify the arguments of those who say globalization creates jobs and boosts wages. A: (1) Globalization raises overall wealth in developed and developing nations because trade openness raises the output of a nation. It also allows firms to become more efficient and pass savings on to consumers. (2) Globalization generates labor market flexibility that allows an economy to rapidly deploy labor where demand is relatively great, which lets workers leave jobs and find new work fairly quickly. (3) Globalization advances developing nations’ economies by injecting capital that creates higher-paying jobs than would otherwise be available, which expands the middle class and raises standards of living.

Q: Why do critics say globalization adversely affects labor standards, environmental regulations, and future markets? A: The major complaint of those opposed to globalization is that multinational firms contribute to slack labor and environmental protection laws. They say that because multinationals are in constant pursuit of lower costs, they seek out locales with less strict labor and environmental regulation to reduce the cost of operating in those environments. They argue that multinationals thus put downward pressure on labor and environmental standards worldwide.

Q: How do supporters of globalization argue that it does not harm labor standards, environmental regulations, and future markets? A: First, research shows that pollution-intensive U.S. firms tend to invest in countries having stricter environmental standards. In fact, many developing nations liberalized their foreign investment environment while simultaneously enacting stricter environmental legislation. If multinationals were eager to seek out nations with the worst environmental protection laws, they would have avoided that group of nations instead of pouring enormous sums of investment into them over decades. Second, when analyzing a country prior to investing, multinationals today often search for a future market for its goods as well as a production base. In such a scenario, any rational management team would not enter a market with draconian labor and

Ch 1: Globalization

environmental regulations, depressed local wages, and an awful environment, where the locals cannot hope to one day afford to purchase the very items they produce. Quick Study 6 (p. 26) 1.

Q: What does the evidence suggest for each branch of the debate over globalization and income inequality? A: First, regarding the debate over inequality within nations, studies suggest that developing nations can boost incomes of their poorest members of society by integrating them into the global economy. Second, in the debate over inequality between nations, it appears that more nations open to trade and investment grow faster than wealthy nations, whereas sheltered economies are worse off. Thus, countries advance their economies by being open, not closed, to global business. Third, the global inequality debate has generally concluded that global poverty has fallen in recent decades, though there is disagreement on the extent of the drop. Standardized sources and methods are needed.

Q: What are each side’s arguments in the debate over globalization’s impact on national sovereignty? A: Those opposed to globalization claim that supranational institutions, including the WTO, IMF, and UN, consist of appointed, not democratically elected, representatives who impose their will upon citizens of nations. They argue that ceding political authority to such organizations undercuts the legal authority of national, regional, and even local governments, and undercuts democracy itself. Those favoring globalization argue that an amazing consequence of globalization has been the spread of democracy worldwide. People in democracies are better educated, better informed, more assertive, and are challenging elites and the old ways of doing things. Supporters of globalization also argue that national sovereignty must be viewed in the long run, and that consideration must be made of the positive outcomes of international cooperation. UN accords made significant progress in important areas such as women’s rights and racial discrimination.

Q: Summarize the claims of each side in the debate over globalization’s influence on cultures. A: (1) Globalization critics fear it is homogenizing the world and destroying its rich diversity of cultures. In some drab, new world we all will wear the same clothes bought at the same brand-name shops, eat the same foods at the same brand-name restaurants, and watch the same movies made by the same production companies. (2) It is also feared that cultural diversity will be reduced through universal products, as local businesses cannot compete with large MNCs. (1) Globalization supporters counter that it allows each nation to profit from differing circumstances and skills. Trade allows a country to specialize in producing those goods and services in which it is most efficient. It can then trade those products to other nations in exchange for goods and services it desires but does not produce. (2) Focusing only on consumer goods examines only the most superficial aspects of culture. (3) Throughout the past century, the music, art, and literature of developing countries has thrived and gained international attention through globalization.

Quick Study 7 (p. 30) 1.

Q: Why do large multinational corporations dominate international business?

Ch 1: Globalization

A: (1) The economic and political muscle of large firms makes them highly visible in the eyes of the media. Large companies generate significant jobs, investment, and tax revenue for the regions and nations they enter. Likewise, they can leave many hundreds, perhaps thousands of people, out of work when they close or scale back operations. (2) Their dealings typically involve huge sums of money. It is common for the income and deals of large firms, such as M&As, to be valued in the billions. 2.

Q: Explain why small companies and born global firms are increasingly involved in international business. A: Small firms are increasingly international because traditional distribution channels are more accessible and technology makes it easier to communicate and transport products. Born global firms tend to be innovative and knowledge based and often rise to the level of international competition in a very short period of time.

Q: Describe the global business environment and how its main elements interact. A: It is helpful to view international business as occurring within an integrated, global business environment. Four elements comprise the global business environment: (1) Globalization is a potent force transforming our societies and commercial activities. Globalization increases competition and produces significant changes in how a society operates. (2) Separate national business environments, which include elements related to culture and systems of politics, law, and economics, can vary greatly across nations. Companies must be aware of such differences and adapt products and processes as needed. (3) The international business environment, which is where the actions of consumers, workers, companies, financial institutions, and governments from different nations converge. As globalization continues, flows of trade, investment, and capital are becoming more entwined—often causing firms to look simultaneously for production bases and markets. (4) International business management differs from management of a domestic firm in nearly all respects. When a firm ventures into international business, environmental forces present it with many challenges and opportunities. Thus, the context of international business management is defined by the characteristics of each of the other three factors presented here.

Talk It Over 1.

Q: Today, international businesspeople must think globally about production and sales opportunities. Many global managers will eventually find themselves living and working in cultures altogether different from their own. Many entrepreneurs will find themselves booking flights to places they had never heard of. What do you think companies can do now to prepare their managers for these new markets? What can entrepreneurs and small businesses with limited resources do? A: Large companies can keep a watchful eye on such markets by conducting preliminary studies periodically on each potential market it is considering. Companies can conduct such studies in-house or commission them from independent organizations. They can also send key managers that would oversee such new investments to the market to familiarize themselves with the local culture and begin making contacts. However, entrepreneurs and small companies often do not have the money for expensive studies. But they can afford to follow events in potential markets through the international media—especially the international business press. They can also purchase existing surveys of potential markets from international research agencies—usually

Ch 1: Globalization

available for a reasonable fee. They can also seek out the advice and counsel of local retired businesspeople with international experience and contact their local Small Business Administration office (or similar agency outside the United States). The Web is a valuable tool for obtaining a great deal of free information. 2.

Q: In the past, national governments greatly affected the pace of globalization through agreements to lower barriers to international trade and investment. Is the pace of change now outpacing the capability of governments to manage the global economy? Will national governments become more or less important to international business in the future? Explain your answer. A: The first part of the question addresses the fact that the GATT was initially very successful but lost much of its relevance in the mid-1980s with regard to services and erupting trade disputes. Governments then tried to update institutions to suit the changed business environment. In answering, students should identify the Internet as an evolving international business tool which governments are finding difficult to regulate and establish jurisdiction over. Students may also mention the inability of supranational agencies to forecast many recent economic crises worldwide. The second part of this question gets students to consider the power of large multinational and global companies relative to national governments. Students might identify political lobbying that companies undertake to get favorable legislation passed. On the other hand, students might identify the power of governments to control their own national business environment—albeit perhaps with an attached cost.

Q: Information technologies are developing at a faster rate than ever before. How have these technologies influenced globalization? Give specific examples. Do you think globalization will continue until we all live in one “global village”? Why or why not? A: Information and communication technologies are facilitating the process of globalization in many ways. Through e-mail and videoconferencing, companies are better able than ever before to keep in touch with far-flung subsidiaries, suppliers, and customers. Intranets and extranets are facilitating the timely restocking of inventories by suppliers and the ordering of merchandise by buyers. The effect of these technologies has been to remove some of the pain associated with conducting day-to-day operations for international companies—causing them to look more favorably on new international ventures. Students should first question what a “global village” is, and give answers depending upon their definition. Are we talking about an “economic village” or a “true village” that entails cultural homogenization? We are currently witnessing an era of increasing interaction among nations (despite the recent global recession), but it is not certain this will continue. Such times have occurred at other points in history only to result in war and division. Students’ experiences of contact with the people and cultural products (such as movies and music) of other nations (and perhaps living abroad) will affect their answers.

Q: Consider the following statement: “Globalization and the resulting increase in competition harm people, as international companies play one government against another to get the best deal possible. Meanwhile, governments continually ask for greater concessions from their citizens, demanding that they work harder and longer for less pay.” Do you agree? Why or why not?

Ch 1: Globalization

A: This question gets students thinking about the interrelationships among consumers, workers, international companies, and governments. Consumers tend to win from a purchasing standpoint as companies’ cost structures tend to be lower and retail prices should fall along with increasing competition. However, these consumers are also employees in the economy. The power of corporations to get concessions from governments and workers affects wages. On the other hand, if citizens are not satisfied with their government’s stance on trade and investment issues, they can change the government at the ballot box. However, not every nation gives its citizens such powers. This question may cause debate as students take the side of international companies or workers, and delve into the validity of such statements. This question might even be assigned as a debate. Students could be divided into groups, assigned a position, and given until the next class period to develop their arguments.

Practicing International Management Case Ludia Plays Global 1.

Q: Some say globalization is homogenizing the attitudes and spending habits of young consumers worldwide. As one journalist puts it, “It may still be conventional wisdom to ‘think globally and act locally,’ but in the youth market, it is increasingly a case of one size fits all.” Do you agree or disagree? Why or why not? A: “Ludia has clearly benefited from the globalization of markets, enjoying strong growth and selling its games globally, essentially without changes to them”. Interestingly, game shows and movies are often designed for international audiences , so this may help explain why Ludia does not need to modify games for international audiences. Global consumer products

are likely easier to market on a global basis with a global theme. 2.

Q: Do you think Ludia fits the definition of a born global firm? Explain your answer based on the case. A: Globalization has given rise to the born global firm —a company that adopts a global perspective and engages in international business from or near its inception. Born global firms tend to have an innovative culture and knowledge-based organizational capabilities. Many born global firms rise to the status of international competitor in less than three years. Ludia seems to fulfill all of these criteria.

Q: Advances in technology, including the Internet made it possible for Ludia to sell its product worldwide. Can you think of other technological innovations that have helped companies to think globally? A: SKYPE, PayPal, Youtube, ATM’s, iPhones

Q: Advances in technology often spur evolution in the entertainment industry. How might new products and services, such as the iPhone and YouTube, and Ludia’s games affect entertainment in years to come? A: There will be innovations to these technologies and future technologies, as one innovation leads to another. The entertainment industries will no doubt continue along with further miniaturization in medium and mobility in delivery.

Ch 2: Cross-Cultural Business

CHAPTER 2 CROSS-CULTURAL BUSINESS LEARNING OBJECTIVES: 1. Describe culture and explain the significance of both national culture and subcultures. 2. Identify the components of culture and describe their impact on international business. 3. Describe cultural change and explain how companies and culture affect each another. 4. Explain how the physical environment and technology influence culture. 5. Describe the two main frameworks used to classify cultures and explain their practical use. 6. Explain the three different types of staffing policies used by international companies. 7. Describe the recruitment, selection, and cultural training issues facing international companies. 8. Explain how companies compensate managers and workers in international markets. CHAPTER OUTLINE: What Is Culture? Avoiding Ethnocentricity Developing Cultural Literacy National Culture and Subcultures National Culture Subcultures Components of Culture Aesthetics Values and Attitudes Attitudes toward Time Attitudes toward Work Attitudes toward Cultural Change Cultural Diffusion When Companies Change Cultures When Cultures Change Companies Is a Global Culture Emerging? Manners and Customs Manners Customs Folk and Popular Customs The Business of Gift Giving Social Structure Social Group Associations Family Gender Social Status Social Mobility Caste System Class System Religion Christianity Islam Hinduism .

Ch 2: Cross-Cultural Business Buddhism Confucianism Judaism Shinto Personal Communication Spoken and Written Language Implications for Managers Language Blunders Lingua Franca Body Language Education Education Level The “Brain Drain” Phenomenon Physical and Material Environments Physical Environment Topography Climate Material Culture Uneven Material Culture Classifying Cultures Kluckhohn–Strodtbeck Framework Case: Dimensions of Japanese Culture Hofstede Framework International Human Resource Management International Staffing Policy Ethnocentric Staffing Advantages of Ethnocentric Staffing Disadvantages of Ethnocentric Staffing Polycentric Staffing Advantages and Disadvantages of Polycentric Staffing Geocentric Staffing Advantages and Disadvantages of Geocentric Staffing Recruiting and Selecting Human Resources Human Resource Planning Recruiting Human Resources Current Employees Recent College Graduates Local Managerial Talent Non-Managerial Workers Selecting Human Resources Culture Shock Reverse Culture Shock Dealing With Reverse Culture Shock Cultural Training Environmental Briefings and Cultural Orientations Cultural Assimilation and Sensitivity Training Language Training Field Experience Employee Compensation Managerial Employees Bonus and Tax Incentives .

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Cultural and Social Contributors to Cost Bottom Line for Business

A comprehensive set of specially designed PowerPoint slides is available for use with Chapter 2. These slides and the lecture outline below form a completely integrated package that simplifies the teaching of this chapter’s material. Lecture Outline 1.

INTRODUCTION This chapter describes culture in the context of international business, explains how culture affects international business practices and competitiveness, and presents two methods of classifying cultures.

WHAT IS CULTURE? Culture is the set of values, beliefs, rules, and institutions held by a specific group of people. Main components include: aesthetics, values and attitudes, manners and customs, social structure, religion, personal communication, education, and physical and material environments. A. Avoiding Ethnocentricity 1. Ethnocentricity is the belief that one’s own ethnic group or culture is superior to that of others. It causes people to view other cultures in terms of their own and overlook beneficial aspects of other cultures. Ethnocentricity can undermine business projects when employees are 2. insensitive to cultural nuances.

Developing Cultural Literacy Managers working directly in international business should develop 1. cultural literacy—detailed knowledge about a culture that enables a person to function effectively within it. Cultural literacy brings a company closer to customer needs and 2. improves competitiveness.

National Culture and Subcultures National culture generalizes (e.g., British culture: English, Scottish, and Welsh). 1. National Culture Nation-states support and promote the concept of a national a. culture by building museums and monuments to preserve the legacies of important events and people. Nation-states intervene to help preserve their national cultures. b. c. Companies get involved in supporting culture, in part, for the public relations benefit. 2. Subcultures a. A subculture is a group of people who share a unique way of life within a larger, dominant culture. It can differ from the dominant culture in language, race, lifestyle, values, attitudes, and so on.

Ch 2: Cross-Cultural Business b. c. d.

Companies must be mindful of subcultures when formulating business strategies (e.g., China has 50 ethnic groups). Decisions regarding product design, packaging, and advertising must consider distinct cultures. Subcultures also can extend beyond national borders.

Note: The above material is covered in Chapter Two PowerPoint slides from 1 to 6. Think-Pair-Share – Slides 8 to 14 COMPONENTS OF CULTURE Culture includes what people consider beautiful and tasteful, their underlying beliefs, their traditional habits, and how they relate to one another and their surroundings.

Aesthetics 1. Aesthetics is what a culture considers to be in “good taste” in the arts, the imagery evoked by certain expressions, and the symbolism of colours. 2. Affective appropriate colours for advertising, product packaging, and even work uniforms can enhance success (e.g., Green in Islam). 3. Blunders can result from selecting inappropriate colours and symbols for advertising, product packaging, and architecture (e.g., Nike “Air”). Music is deeply cultural and must be considered in promotions. 4. Also an important consideration in marketing over the Internet. 5.

Values and Attitudes 1. Values are ideas, beliefs, and customs to which people are emotionally attached. Affect work ethic and desire for material possessions. Some cultures value leisure; others hard work. 2. Attitudes are positive or negative evaluations, feelings, and tendencies that individuals harbor toward objects or concepts. Learned from role models and formed within a cultural context. More flexible than values. 3. Attitudes toward Time Latin American and Mediterranean cultures are casual about a. time; people in Japan and the United States arrive promptly for meetings and keep tight schedules. b. Americans strive toward workplace efficiency and may leave work early if their work is done because they value individual results. Japanese look busy even when business is slow to demonstrate dedication—an attitude grounded in cohesion, loyalty, and harmony. 4. Attitudes toward Work Some cultures have a strong work ethic, others stress a balanced a. pace in work and leisure (e.g., “Work to live, or live to work”). b. Many European nations are trying to foster an entrepreneurial spirit to achieve the job growth realized in the United States. 5. Attitudes toward Cultural Change A cultural trait is anything that represents a culture’s way of life including gestures, material objects, traditions, and concepts.

Ch 2: Cross-Cultural Business a.

c. d.

Cultural diffusion is the process whereby cultural traits spread from one culture to another. Globalization and technology are increasing the pace of cultural diffusion and change. Cultural imperialism is the replacement of one culture’s traditions, folk heroes, and artifacts with substitutes from another. Culture can force companies to adjust business policies and practices, such as using situational management. Rapid cultural diffusion and increased human interaction across borders cause cultures to converge. Convergence is taking place in some market segments for some products.

Manners and Customs It is important to understand manners and customs to avoid mistakes abroad. Indepth knowledge improves the abilities of managers. 1. Manners are appropriate ways of behaving, speaking, and dressing in a culture (e.g., conducting business during meals in Canada). 2. Customs are habits or ways of behaving in specific circumstances that are passed down through generations in a culture. Customs define appropriate habits or behaviors in specific situations. a. Folk customs are behaviors, dating back generations, practiced within a homogeneous group of people (e.g., turbans). b. A popular custom is behavior practiced by a heterogeneous group or by several groups (e.g., blue jeans, “burgers ‘n’ fries”). c. Although giving token gifts to business and government associates is customary, the proper type of gift varies. d. Cultures differ in their legal and ethical rules regarding bribery. In 2013, Canada significantly strengthened its Corruption of Foreign Public Officials Act (CFPOA). Canadian companies and individuals who are involved in the bribery of foreign public officials will be subject to Canadian law regardless of where the acts constituting the offence took place, and even if there is no connection with Canada other than their nationality. The exception allowing “facilitation payments” (small payments made to an official for the purpose of securing the performance of routine administrative acts that are part of the official’s duties or functions) will be eliminated at a future date to be determined by Cabinet order.

Social Structure Social structure embodies a culture’s fundamental organization, including groups and institutions, social positions and relationships, and resource distribution. 1. Social Group Associations A social group is a collection of two or more people who identify and interact with one another. Contribute to identity and self-image. a. Family i. Nuclear family consists of immediate relatives, including parents, brothers, and sisters. Prevails in Australia, Canada, United States, and in Europe.

Ch 2: Cross-Cultural Business ii.

Extended family includes grandparents, aunts and uncles, cousins, and relatives through marriage. More important in Asia, Middle East, North Africa, and Latin America.

Gender i. Gender refers to socially learned traits associated with, and expected of, men or women. Sociologists regard gender as a category—people who share some status. ii. Countries vary regarding gender equality at work. Social Status a. Social stratification is the process of ranking people into social layers according to family heritage, income, and occupation. b. Top layer: royalty, government officials, and business leaders. Middle layer: scientists, medical doctors, and others with a university education. Bottom layer: manual and clerical workers with vocational training or secondary-school educations. c. Rankings can and do change over time. Social Mobility a. Social mobility is the ease with which individuals can move up or down a culture’s “social ladder.” b. Caste system: people are born into a social ranking, with no opportunity for social mobility. c. Class system: personal ability and actions decide status and mobility. Highly class-conscious cultures can offer less mobility but experience more class conflict.

Religion Human values often derive from religious beliefs. Different religions take different views of work, savings, and material goods. Beliefs influence competitiveness, economic development, and business strategies. 1. Christianity a. Founded in Palestine 2,000 years ago among Jews who believed that Jesus of Nazareth was the messiah. With 2 billion followers, it is the world’s single largest religion. b. More than 300 denominations but most are Roman Catholic, Protestant, or Eastern Orthodox. c. Roman Catholics are to refrain from placing materialism above God and people. Protestants believe that salvation comes from faith in God and that hard work gives glory to God. d. Christian organizations sometimes get involved in social causes that affect business policy (e.g., Ryanair, Hyundai). 2. Islam a. Founded by Muhammad in 600 A.D. in Mecca, Saudi Arabia— the holy city of Islam. World’s second largest religion with 1.3 billion adherents. Word Islam means “submission to Allah” and Muslim means “one who submits to Allah.” b. Religion strongly affects the goods and services acceptable to Muslim consumers (e.g., alcohol, pork, interest in money). 3. Hinduism a. Founded 4,000 years ago in present-day India, where more than 90 percent of its nearly 900 million adherents live.

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Some say it is a way of life rather than a religion. Caste system is integral to the Hindu faith. Believe in reincarnation—rebirth of the human soul at the time of death. Do not eat or willfully harm living creatures as they may be reincarnated human souls. c. Cows considered sacred animals so eating beef is not allowed (e.g., McDonald’s replaces beef with lamb). Buddhism a. Founded 2,600 years ago in India by a Hindu prince named Siddhartha Gautama. About 380 million followers, mostly in Asia: China, Tibet, Korea, Japan, Vietnam, and Thailand. b. Promotes a life centered on spiritual rather than worldly matters. Buddhists seek nirvana (escape from reincarnation) through charity, modesty, compassion for others, restraint from violence, and general self-control. Confucianism a. Founded 2,500 years ago by exiled politician and philosopher Confucius. China is home to most of the 225 million followers. b. Confucian thought ingrained in the cultures of Japan, South Korea, and nations with large numbers of ethnic Chinese, including Singapore. c. South Korean business practice reflects Confucian thought in its rigid organizational structure and reverence for authority (e.g., Korean-style management in overseas subsidiaries). d. For centuries, people despised merchants because earning money violated Confucian beliefs. Many Chinese moved to Indonesia, Malaysia, Singapore, and Thailand to do business. Judaism a. Founded more than 3,000 years ago and 18 million followers. Was first religion to believe in one God. Orthodox (“fully observant”) Jews make up 12 percent of Israel and constitute an increasingly important economic segment. b. Important observances are Rosh Hashanah (the Jewish New Year), Yom Kippur (the Day of Atonement), Passover (the Exodus from Egypt), and Hanukkah (a victory over the Syrians). c. Employers must be aware of Jewish holidays. Because Sabbath lasts from sundown on Friday to sundown on Saturday, work schedules might need adjustment. d. Marketers must take into account foods banned among observant Jews (e.g., pork and shellfish prohibited, meat stored and served separately from milk) and “kosher” foods. Shinto a. Means “way of the gods” and arose as the native religion of the Japanese. Teaches sincere and ethical behavior, loyalty and respect toward others, and enjoyment of life. Shinto claims about 4 million strict adherents in Japan. b. Shinto beliefs are reflected in the workplace through lifetime employment (although this is waning today) and the traditional trust extended between firms and customers.

Ch 2: Cross-Cultural Business c.

Japanese competitiveness in world markets has benefited from loyal workforces, low employee turnover, and good labour– management cooperation.

Personal Communication Every culture has a communication system to convey thoughts, feelings, knowledge, and information through speech, writing, and actions. A culture’s spoken and body language can help explain people’s thoughts and behaviors. 1. Spoken and Written Language a. Linguistically different segments of a population are often culturally, socially, and politically distinct. b. Companies have made language blunders in their international business dealings. c. A lingua franca is a third or “link” language that is understood by two parties who speak different languages. d. Some languages are dying out, whereas some languages are growing, including Mandarin, Spanish, and English. 2. Body Language a. Communicated through unspoken cues, including hand gestures, facial expressions, physical greetings, eye contact, and the manipulation of personal space. b. Communicates information and feelings and differs among cultures. Most is subtle and takes time to interpret. c. Proximity is an element of body language; standing too close may invade personal space and appear aggressive.

Note: The above material is covered in Chapter Two PowerPoint slides from 14 to 30. Think-Pair-Share – Slide 31 is the second group discussion of this chapter.

Education Education passes on traditions, customs, and values. Cultures educate young people through schooling, parenting, religious teachings, and group memberships. Families and other groups provide informal instruction about customs and how to socialize with others. 1. Education Level a. Excellent basic education attracts high-wage industries that invest in training and increase productivity. Skilled, welleducated workforce attracts high-paying jobs; a poorly educated one attracts low-paying jobs. b. Newly industrialized economies in Asia owe much of their economic development to solid education systems. The “Brain Drain” Phenomenon 2. a. Brain drain: departure of highly educated people from one profession, geographic region, or nation to another. b. Reverse brain drain: professionals return to their homelands.

Physical and Material Environments These heavily influence a culture’s development and pace of change. 1. Physical Environment

Ch 2: Cross-Cultural Business

Topography: all physical features that characterize the surface of a geographic region. Cultures isolated by impassable mountains or large bodies of water are less exposed to the cultural traits of others and change slowly. Topography impacts product needs. b. Topography impacts personal communication (e.g., mountains and the Gobi Desert consume two thirds of China). c. Climate affects where people settle and directs systems of distribution (e.g., Australian desert, jungles, coastal areas). d. Climate plays a large role in lifestyle, clothing, and work habits, such as organizing production schedules for idled machines. Material Culture Includes all technology a culture uses to manufacture goods and provide services, and can measure a culture’s technological advancement. a. A firm enters a market under one of two conditions: (1) demand for its products has developed, or (2) the market is capable of supporting its production operations. b. Changes in material culture can change other aspects of culture. c. Many nations display uneven levels of material culture across geography, markets, and industries.

CLASSIFYING CULTURES People in different cultures respond differently in similar business situations. Two ways to classify cultures based on characteristics such as values, attitudes, and social structure.

Kluckhohn–Strodtbeck Framework The Kluckhohn–Strodtbeck Framework compares cultures along six dimensions, asking the following questions: 1. Do people believe that their environment controls them, that they control the environment, or that they are part of nature? 2. Do people focus on past events, on the present, or on the future implications of their actions? 3. Are people easily controlled and not to be trusted, or can they be trusted to act freely and responsibly? 4. Do people desire accomplishments in life, carefree lives, or spiritual and contemplative lives? 5. Do people believe that individuals or groups are responsible for each person’s welfare? 6. Do people prefer to conduct most activities in private or in public? a. Dimensions of Japanese Culture: i. Japanese believe in a delicate balance between people and environment that must be maintained. ii. Japanese culture emphasizes the future. iii. Japanese culture treats people as quite trustworthy. iv. Japanese are accomplishment oriented for employers and work units. v. Japanese culture emphasizes individual responsibility to the group and group responsibility to the individual. vi. The culture of Japan tends to be public.

Hofstede Framework

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The Hofstede Framework grew from a study of more than 110,000 people working in IBM subsidiaries by Dutch psychologist Geert Hofstede. He developed five dimensions for examining cultures. 1. Individualism versus Collectivism: Identifies the extent to which a culture emphasizes the individual versus the group. a. Individualist cultures value hard work, entrepreneurial risktaking, and freedom to focus on personal goals. b. Collectivist cultures feel a strong association to groups, including family and work units. The goal is to maintain group harmony and work toward collective rather than personal goals. 2. Power Distance: Identifies the degree to which a culture accepts social inequality among its people. a. Large power distance is characterized by inequality between superiors and subordinates. Organizations are hierarchical, with power derived from prestige, force, and inheritance. b. Small power distance means equality, with prestige and rewards equally shared between superiors and subordinates. Power derives from hard work and is considered more legitimate. c. Refer to Figure 2.2. Tight grouping of nations within the five clusters (plus Costa Rica): African, Asian, Central and South American, and Middle Eastern nations in Quadrant 1 (cultures with large power distance and lower individualism). Quadrants 2 and 3 include Australia and the nations of North America and Western Europe (cultures high in individualism and smaller power distance scores). 3. Uncertainty Avoidance: Identifies the extent to which a culture avoids uncertainty and ambiguity. a. Cultures with large uncertainty avoidance value security, place faith in strong systems of rules and procedures, have lower employee turnover, formal rules for employee behavior, and more difficulty implementing change. b. Low uncertainty avoidance cultures are more open to change and new ideas. c. Refer to Figure 2.3. Quadrant 4 contains nations characterized by small uncertainty avoidance and small power distance, including Australia, Canada, Jamaica, the United States, and many Western European nations. Quadrant 2 contains many Asian, Central American, South American, and Middle Eastern nations—nations having large power distance and large uncertainty avoidance indexes. 4. Achievement versus Nurturing: Identifies the extent to which a culture emphasizes personal achievement and materialism, versus relationships and quality of life. a. Cultures scoring high are characterized by assertiveness and the accumulation of wealth, and entrepreneurial drive. b. Cultures scoring low have relaxed lifestyles, with more of a concern for others than material gain. 5. Long-Term Orientation: Indicates a society’s time perspective and an attitude of overcoming obstacles with time. It attempts to capture the differences between Eastern and Western cultures. .

Ch 2: Cross-Cultural Business a.

Cultures scoring high (strong long-term orientation) value respect for tradition, thrift, perseverance, and a sense of personal shame. Cultures scoring low are characterized by individual stability and reputation, fulfilling social obligations, and reciprocation of greetings and gifts.

International Human Resource Management Human resource management (HRM) is the process of staffing a company and ensuring that employees are as productive as possible. It requires managers to be effective in recruiting, selecting, training, developing, evaluating, and compensating employees and in forming good relationships with them. A.

International Staffing Policy There are three main approaches to the staffing of international business operations— ethnocentric, polycentric, and geocentric.

Ethnocentric Staffing In ethnocentric staffing, individuals from the home country manage operations abroad. This policy tends to appeal to companies that want to maintain tight control over decision making in branch offices abroad. 1. Advantages Of Ethnocentric Staffing Firms pursue this policy for several reasons. First, locally qualified people are not always available. Second, companies use ethnocentric staffing to recreate local operations in the image of home country operations. Finally, some companies feel that managers sent from the home country will look out for the company’s interests more earnestly than will host-country natives 2. Disadvantages Of Ethnocentric Staffing Despite its advantages, ethnocentric staffing has its negative aspects. First, relocating managers from the home country is expensive. Second, an ethnocentric policy can create barriers for the host-country office. The presence of home-country managers in the host country might encourage a “foreign” image of the business. Polycentric Staffing In polycentric staffing, individuals from the host country manage operations abroad. 1. Advantages and Disadvantages of Polycentric Staffing Polycentric staffing places managerial responsibility in the hands of people intimately familiar with the local business environment. Geocentric Staffing In geocentric staffing, the best-qualified individuals, regardless of nationality, manage operations abroad. 1. Advantages and Disadvantages Of Geocentric Staffing Geocentric staffing helps a company develop global managers who can adjust easily to any business environment— particularly to cultural differences.

Recruiting and Selecting Human Resources A. Human Resource Planning

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Recruiting and selecting managers and workers requires human resource planning —the process of forecasting a company’s human resource needs and its supply. B. Recruiting Human Resources The process of identifying and attracting a qualified pool of applicants for vacant positions is called recruitment. Companies can recruit internally from among their current employees or look to external source i. Current Employees ii. Recent College Graduates iii. Local Managerial Talent iv. Non-Managerial Workers C. Selecting Human Resources The process of screening and hiring the best-qualified applicants with the greatest performance potential is called selection. D. Culture Shock Travelling to and living in unfamiliar cultures, therefore, is an extremely important factor when recruiting for international posts. Set down in the midst of new cultures, many expatriates experience. culture shock is a psychological process affecting people living abroad that is characterized by homesickness, irritability, confusion, aggravation, and depression. E. Reverse Culture Shock Ironically, expatriates who successfully adapt to new cultures often undergo an experience called reverse culture shock —the psychological process of readapting to one’s home culture. i. Dealing With Reverse Culture Shock Home-culture reorientation programs and career-counseling sessions for returning managers and their families can be highly effective. F. Cultural Training Ideally, everyone involved in business should be culturally literate and prepared to go anywhere in the world at a moment’s notice. Realistically, many employees and many companies do not need or cannot afford to be entirely literate in another culture i. Cultural Assimilation And Sensitivity Training Cultural assimilation teaches the culture’s values, attitudes, manners, and customs. ii. Language Training the need for more thorough cultural preparedness brings us to intensive language training. iii. Field Experience Field experience means visiting the culture, walking the streets of its cities and villages, and becoming absorbed by it for a short time. Employee Compensation A. Managerial Employees Most companies add a certain amount to an expatriate manager’s pay to cover greater cost-of-living expenses i. Bonus and Tax Incentives This bonus can be in the form of a one-time payment or an add-on to regular pay—generally 15 to 20 percent ii. Cultural and Social Contributors to Cost. Some nations offer more paid holidays than others. Many offer free medical care to everyone living and working there

Bottom Line for Business .

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In this chapter we discussed many of the cultural differences among nations that affect international business. We saw how problems can erupt from cultural misunderstandings and learned how companies can improve their performance with cultural literacy. Localizing business policies and practices can promote success. Understanding a people’s values, beliefs, rules, and institutions makes managers more effective at their jobs. Quick Study Questions Quick Study 1 (p. 49) 1.

Q: Define culture. How does ethnocentricity distort one’s view of other cultures? A: Culture is the set of values, beliefs, rules, and institutions held by a specific group of people. Ethnocentricity is the belief that one’s own ethnic group or culture is superior to that of others. Ethnocentricity distorts people’s views of other cultures because it views other cultures in terms of their own culture. Thus, it causes one to overlook important human and environmental differences among cultures.

Q: What is cultural literacy? Why should businesspeople understand other cultures? A: Cultural literacy is detailed knowledge about a culture that enables people to live and work within it. Globalization is one force creating the need for cultural literacy because it is knitting business activities in various countries more closely together than ever before. Cultural literacy improves the ability of managers to manage employees, market products, and conduct negotiations in other countries. It also helps managers modify products and management techniques to better suit local markets.

Q: How do nation-states and subcultures influence a nation’s cultural image? A: First, we are conditioned to think in terms of national culture. Nation-states promote the concept of national culture by building museums and monuments to preserve the legacies of important events and people in their histories. This reaffirms the importance of national culture to citizens and organizations. Nation-states also intervene in business to help preserve their national cultures. Second, a subculture is a group of people who share a unique way of life within a larger, dominant culture. Although we often overlook important subcultures in forming our impressions of other national cultures, they are extremely important to conducting business abroad.

Quick Study 2 (p. 53) 1.

Q: What is meant by a culture’s aesthetics? Give several examples. A: Aesthetics are what a culture considers to be “good taste” in the arts, the imagery evoked by certain expressions, and the symbolism of certain colours. An example of aesthetics with respect to good taste in music is playing polka music in central European nations including the Czech Republic, Poland, and Slovakia. An example with respect to the arts in the Czech Republic is the production of fine glassware through the art of glass blowing. An example of good taste with respect to dance is the ritualistic dancing of the native Australian Aborigines.

Q: How can businesses incorporate aesthetics into their Web sites? A: Incorporating aesthetics into Web sites can reap tremendous benefits. When going global on the Internet, the more a firm adapts to local cultural traditions, the better. Some .

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specific tips are to (see Entrepreneur’s Toolkit box) choose colours carefully, select numbers with care, watch the clock, avoid slang, wave the flag cautiously, do the math (check local currency), and get feedback. 3.

Q: Compare and contrast values and attitudes. How do cultures differ in their attitudes toward time, work, and cultural change? A: Values are ideas, beliefs, and customs to which people are emotionally attached. People hold as values only those ideas, beliefs, and customs extremely important to them. Attitudes are positive or negative evaluations, feelings, and tendencies that individuals harbor toward objects or concepts. People harbor attitudes toward things that are important and unimportant to them. Certain cultures are more relaxed in their attitudes toward time whereas others are more rigid. For example, Latin American and Mediterranean cultures tend to be relaxed toward the use of time whereas Northern Europe and the United States tend to keep far tighter schedules. Some cultures see work strictly as a means to an end whereas others see work as an end in itself. Attitudes toward work also then influence people’s attitudes toward time. For example, in France where people tend to take a relaxed attitude toward work, attitudes toward time are quite flexible. The opposite is true in Japan. Some cultures readily accept the cultural traits of other nations, whereas others are more wary. Yet globalization and technological advancements are increasing the pace of cultural change.

Q: Describe the process of cultural diffusion. Why should international businesses be sensitive to charges of cultural imperialism? A: A cultural trait is anything that represents a culture’s way of life, including gestures, material objects, traditions, and concepts. The process whereby cultural traits spread from one culture to another is called cultural diffusion. This process is natural, yet gradual. Cultures not open to the cultural traits of other nations typically fear that those traits will harm their own values. Cultural imperialism is the replacement of one culture’s traditions, folk heroes, and artifacts with substitutes from another. Companies must be sensitive to charges of cultural imperialism because they can result in laws designed to protect the local culture. Such laws can render a market opportunity infeasible.

Quick Study 3 (p. 57) 1.

Q: How do manners and customs differ? Give examples of each. A: Manners are appropriate ways of behaving, speaking, and dressing in a culture. Customs are habits or ways of behaving in specific circumstances that are passed down through generations in a culture. They differ from each other in that manners apply generally in a culture whereas customs apply to specific situations. An example of good manners is behaving in a modest manner and dressing conservatively in Japan. An example of a custom is the practice of arranging marriages on the behalf of children in India—just as it was a widespread custom across Europe several or more generations ago. Another custom is the playing of cricket in Britain and its former colonies including India and Australia.

Q: List several manners that managers should keep in mind when doing business abroad. A: Several tips include (See Global Manager’s Briefcase box): don’t rush familiarity, adapt to personal space, respect religious values, give and receive business cards respectfully, use comedy sparingly, and maintain good posture. .

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Q: Define folk and popular customs. How can a folk custom become a popular custom? A: A folk custom is behavior often dating back several generations that is practiced within a homogeneous group of people. A popular custom is behavior shared by a heterogeneous group or by several groups. Folk customs can become popular customs through the process of cultural diffusion.

Q: Define social structure. How do social rank and social mobility affect business? A: Social structure is a culture’s fundamental organization, including its groups and institutions, its system of social positions and their relationships, and the process by which its resources are distributed. Social status (or rank) refers to the social layers or classes into which people are classified. Social rank affects business in that the type of occupation a person has often determines or heavily influences their social standing. Social mobility is the ease with which individuals can move up or down a culture’s social ladder. Social mobility is severely restrained in a caste system but quite free in most class systems. Social mobility can influence business activities in caste cultures because certain occupations can be off-limits for certain groups of people. Also, someone from a lower caste generally cannot supervise a member from a higher caste because personal conflict will likely occur. Systems that do not allow a great deal of social mobility tend to be characterized by greater labour–management conflict because workers often consider them unfair. Also, people can be hesitant to work hard in systems that do not reward hard-working individuals with social mobility. On the other hand, increased productivity and economic development often characterize systems that reward hard work with social mobility.

Quick Study 4 (p. 62) 1.

Q: What are the main beliefs of each of the seven religions presented above? A: The Roman Catholic faith asks its followers to refrain from placing material possessions above God and others. Protestants believe that salvation comes from faith in God and that hard work gives glory to God—a tenet known widely as the “Protestant work ethic.” Religion strongly affects the kinds of goods and services acceptable to Muslim consumers. Islam, for example, prohibits the consumption of alcohol and pork. Popular alcohol substitutes are soda pop, coffee, and tea. Substitutes for pork include lamb, beef, and poultry (all of which must be slaughtered in a prescribed way so as to meet halal requirements). Hindus believe in reincarnation—the rebirth of the human soul at the time of death. For many Hindus the highest goal of life is moksha—escaping from the cycle of reincarnation and entering a state of eternal happiness called nirvana. Strict Hindus do not eat or willfully harm any living creature because it may be a reincarnated human soul. Buddhists also seek nirvana (escape from reincarnation) through charity, modesty, compassion for others, restraint from violence, and general self-control. Confucian thought is based partly upon rigid organizational structure and unswerving reverence for authority. Judaism is the oldest religion to believe in one God and foods that are banned among strict Jews include pork and shellfish (such as lobster and crab). Meat is stored and served separately from milk. Other meats must be slaughtered according to a practice called shehitah. Meals prepared according to Jewish dietary traditions are called kosher. Shinto teaches sincere and ethical behavior, loyalty and respect toward others, and enjoyment of life. .

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Q: In what ways does religion affect international business activities? A: Knowing the principles of each religion wherever a firm operates can help reduce cultural conflict. Different religions take different views of work, savings, and material goods. Understanding why they do so may help us to understand why companies from certain cultures are more competitive in the global marketplace. It also may help us understand why some countries develop more slowly than others. Knowing how religion affects business practices is especially important in countries with religious governments.

Q: Identify the dominant religion in each of the following countries: (a) Brazil, (b) China, (c) India, (d) Ireland, (e) Mexico, (f) Russia, and (g) Thailand. A: (a) Christianity—Roman Catholic; (b) Chinese—Buddhist, Taoist, and Confucian; (c) Hinduism; (d) Christianity—Roman Catholic; (e) Christianity—Roman Catholic; (f) Christianity—Eastern Orthodox; and (g) Buddhism—Southern Buddhist.

Quick Study 5 (p. 66) 1.

Q: Define communication. Why is knowledge of a culture’s spoken language important for international business? A: Communication is a system of conveying thoughts, feelings, knowledge, and information through speech, writing, and actions. Gaining knowledge of a culture’s spoken language is important for international managers because this knowledge provides insight into why people think and act the way they do.

Q: Describe the threat faced by endangered languages. What is being done to help them survive? A: There are about 6,000 languages in the world, of which about 90 percent have fewer than 100,000 speakers. By the end of this century, more than half of the world’s languages may be lost, and perhaps fewer than 1,000 will survive. To help combat this trend, linguists are creating videotapes, audiotapes, and written records of endangered tongues before they disappear. Communities are also taking action. In New Zealand, Maori communities set up nursery schools called “language nests,” that are staffed by elders and lessons are conducted entirely in Maori.

Q: What is a lingua franca? Describe its implications for conducting international business. A: A lingua franca is a link language that is understood by two parties who speak different native languages. English is the lingua franca of global business, higher education, diplomacy, science, popular music, entertainment, and international travel. More than 70 nations give a special status to English (including India, Nigeria, and Singapore) and roughly one quarter of the world’s population is fluent or competent in it.

Q: Why is body language important for international business? Give several examples of how it differs across cultures. A: Body language is important because it reflects cultural communication styles through unspoken movements. It communicates through hand gestures, facial expressions, physical greetings, eye contact, and the manipulation of personal space. Like spoken language, it communicates both information and feelings and differs greatly from one culture to another. Italians, for example, animate conversations with lively hand gestures and other body motions. Japanese and Koreans, although more reserved, communicate .

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just as much information through their own body languages; a look of the eye can carry as much or more meaning as two flailing arms. Quick Study 6 (p. 69) 1.

Q: Why is the education level of a country’s people important to international companies? A: Multinational firms often rely on education statistics to determine whether a culture represents a good market for their products or a good location for production or assembly facilities. Such statistics also help companies determine how to promote products to potential customers after the decision is made to enter a market. Finally, a highly educated workforce typically attracts high-paying jobs in many high-tech industries.

Q: What is meant by the terms brain drain and reverse brain drain? A: Brain drain is the departure of highly educated people from one profession, geographic region, or nation to another. Reverse brain drain occurs when a profession, region, or nation lures back these highly educated professionals.

Q: How are a people’s culture and physical environment related? A: Two aspects of the physical environment (topography and climate) influence a people’s culture. Topography is all the physical features that characterize the surface of a geographic region. Topography such as treacherous mountain ranges, large bodies of water, and deserts can increase cultural dissimilarity and hinder cultural diffusion. Climate can influence a people’s work patterns, such as when people in hot climates take breaks of one or two hours in the middle of the day to rest and then return to work in the cooler hours of late afternoon. People in cultures with hot and humid tropical climates wear little clothing to stay as cool as possible. People in cultures with hot and dry sunny climates often wear long, loose-fitting clothing to protect them from intense sunshine and blowing sand. Climate also affects the types of vegetation and animals living in a specific region and therefore influences a people’s diet.

Q: What is the significance of material culture for international business? A: All the technology employed in a culture to manufacture goods and provide services is called material culture. Changes in material culture often cause changes in other aspects of a people’s culture. An increasingly sophisticated material culture dictates rising incomes and a greater emphasis on material goods and, even, the development of a consumer culture. Material culture is often uneven across a culture and can result in different regions developing at far different paces.

Quick Study 7 (p. 72) 1.

Q: What six dimensions comprise the Kluckhohn–Strodtbeck framework for classifying cultures? A: This framework captures the essence of a culture by answering six questions: • Do people believe that their environment controls them, that they control the environment, or that they are part of nature? • Do people focus on past events, on the present, or on the future implications of their actions? • Are people easily controlled and not to be trusted, or can they be trusted to act freely and responsibly? .

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Do people desire accomplishments in life, carefree lives, or spiritual and contemplative lives? Do people believe that individuals or groups are responsible for each person’s welfare? Do people prefer to conduct most activities in private or in public?

Q: What are the five dimensions of the Hofstede framework for classifying cultures? A: The Hofstede framework applies the following five dimensions to analyze cultures: • Individualism versus collectivism: Identifies whether a culture holds individuals or the group responsible for each member’s welfare. • Power distance: Describes the degree of inequality between a culture’s people in different occupations. • Uncertainty avoidance: Identifies a culture’s willingness to accept uncertainty about the future. • Achievement versus nurturing (quantity versus quality of life): Cultures focused on quantity of life emphasize accomplishments such as power, wealth, and status. Cultures that stress quality of life generally have more relaxed lifestyles and people are more concerned with cultivating relationships and the general welfare of others. • Long-term orientation: Indicates a society’s time perspective and an attitude of overcoming obstacles with time. It attempts to capture the differences between Eastern and Western cultures.

Q: Briefly explain how each framework can be used to analyze a culture. A: Both the Kluckhohn–Strodtbeck and Hofstede frameworks can be employed to analyze a culture by assessing each dimension on an individual basis. After determining how the selected culture scores along each cultural dimension, a more comprehensive determination of the compatibility with the foreign culture with your own cultural values can be analyzed. It is important to understand the specific cultural differences between two cultures, such as the difference in individualism between the United States and Japan, prior to establishing a relationship with a foreign firm or establishing a policy for a joint venture agreement.

Quick Study 8 (p. 75) 1.

Q: List several ways in which human resource management differs in the international versus domestic environment. A: International HRM differs considerably from HRM in a domestic setting because of differences in national business environments. There are concerns over the employment of expatriates — citizens of one country who are living and working in another. Companies must deal with many issues when they have expatriate employees on job assignments that could last several years. Some of these issues are related to the inconvenience and stress of living in an unfamiliar culture. 2. Q: What are the three different types of international staffing policies that companies can implement? A: There are three main approaches to the staffing of international business operations— ethnocentric, polycentric, and geocentric. Q. Identify the advantages and disadvantages of each type of international staffing policy. A: Advantages of Ethnocentric Staffing .

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First, locally qualified people are not always available. Second, companies use ethnocentric staffing to recreate local operations in the image of home country operations. Finally, some companies feel that managers sent from the home country will look out for the company’s interests more earnestly than will host-country natives. Disadvantages of Ethnocentric Staffing First, relocating managers from the home country is expensive. Second, an ethnocentric policy can create barriers for the host-country office. Advantages and Disadvantages of Polycentric Staffing Managers with deep cultural understanding of the local market can be an enormous advantage. They are familiar with local business practices and can read the subtle cues of both verbal and nonverbal language. Another important advantage of polycentric staffing is elimination of the high cost of relocating expatriate managers and families. This benefit can be extremely helpful for small and medium-sized businesses that cannot afford the expenses associated with expatriate employees. The major drawback of polycentric staffing is the potential for losing control of the hostcountry operation. Advantages and Disadvantages of Geocentric Staffing Geocentric staffing helps a company develop global managers who can adjust easily to any business environment—particularly to cultural differences. This advantage is especially useful for global companies trying to break down nationalistic barriers, whether between managers in a single office or between different offices. One hope of companies using this policy is that a global perspective among its managers will help them seize opportunities that may otherwise be overlooked. The downside of geocentric staffing is the expense. Understandably, top managers who are capable both of fitting into different cultures and being effective at their jobs are highly prized among international companies. The combination of high demand for their skills and their short supply inflates their salaries. Moreover, there is the expense of relocating managers and their families—sometimes every year or two. Quick Study 9 (p. 80) 1.

Q: Identify the types of training and development used for international managers. A: Environmental Briefings and Cultural Orientations, Cultural Assimilation and Sensitivity Training, Language Training, Field Experience

Q: Describe each type of cultural training used to prepare managers for international assignments. A: Environmental Briefings and Cultural Orientations, Environmental Briefings include information on local housing, health care, transportation, schools, and climate. Cultural orientations offer insight into social, political, legal, and economic institutions. Their purpose is to add depth and substance to environmental briefings. Cultural Assimilation and Sensitivity Training, Cultural assimilation teaches the culture’s values, attitudes, manners, and customs. Sensitivity training teaches people to be considerate and understanding of other people’s feelings and emotions. Language Training .

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This level of training entails more than memorizing phrases for ordering dinner or asking directions. It gets a trainee “into the mind” of local people. The trainee learns more about why local people behave as they do. This is perhaps the most critical part of cultural training for long-term assignments. Field Experience Field experience means visiting the culture, walking the streets of its cities and villages, and becoming absorbed by it for a short time

Q: What variables are involved in decisions regarding employee compensation for managers? A: cost of living , which includes factors such as the cost of groceries, dining out, clothing, housing, schooling, health care, transportation, and utilities. Bonus and Tax Incentives base pay accounts for nearly all employee compensation in some countries. In others, bonuses and fringe benefits account for more than half of a person’s compensation. Cultural and Social Contributors To Cost Some nations offer more paid holidays than others. Many offer free medical care to everyone living and working there. Granted, the quality of locally available medical care is not always good. Many companies, therefore, have plans to take seriously ill expatriates and family members home or to nearby countries where medical care is equal to that available in the home country. Companies that hire managers in the local market might encounter additional costs engendered by social attitudes. For instance, in some countries employers are expected to provide free or subsidized housing. In others the government obliges employers to provide paid maternity leaves of up to one and a half years. Government-mandated maternity leaves vary significantly across European countries. Although not all such costs need to be absorbed by companies, they do tend to raise a country’s cost of doing business.

Talk It Over 1.

Q: Two students are discussing the various reasons why they are not studying international business. “International business doesn’t affect me,” declares the first student. “I’m going to stay here, not work in some foreign country.” “Yeah, me neither,” agrees the second. “Besides, some cultures are real strange. The sooner other countries start doing business our way, the better.” What counterarguments can you present to these students’ perceptions? A: First, students should present a counterargument to the statement that international business does not affect them if they do not work in another country. Today, international business reaches deep into nearly every domestic economy. It affects the foods we consume, the movies we watch, the cars we drive, the computers we use, the clothing we wear, and so on. Chapter 1 explains how every national business environment is affected by events occurring in other nations. Second, students should recognize the emphasis on the words “foreign” and “strange.” This betrays an ethnocentric bias in which anyone or anything from other countries is considered “foreign” and different ways of thinking or acting is considered “strange.”

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Q: In this exercise, two groups of four students each will debate the benefits and drawbacks of individualist versus collectivist cultures. After the first student from each side has spoken, the second student questions the opponent’s arguments, looking for holes and inconsistencies. A third student attempts to reply to these counterarguments. Then, a fourth student summarizes each side’s arguments. Finally, the class votes on which team presented the more compelling case. A: First, students should question the origins of these terms. Students’ statements may be biased depending on their cultural origins or those of their parents. The culture of Greece is very different from many of those found in Northern and Western Europe, such as Germany. They differ in their attitudes toward the use of time and the pace of work. This is at least somewhat affected by the fact that Greece is extremely warm for nearly onehalf of the year. German culture places an emphasis on punctuality and hard work whereas Greek culture places greater emphasis on enjoying as much free time as possible. These differences reflect different underlying values in the two cultures. German culture tends to emphasize quantity of life accomplishments whereas Greek culture focuses on quality of life measures. German culture is also more open to risk-taking (small uncertainty avoidance) than Greece and is characterized by greater individualism that tends to promote entrepreneurial drive. Throughout the debate, students should give specific examples to support their general statements. An instructor may want to point out inaccuracies in students’ statements prior to voting, and note that any statements do not imply the superiority of one culture over another.

Q: 3. Many Japanese companies use ethnocentric staffing policies in international operations. Why do you think Japanese companies prefer to have Japanese in top management positions? Would you recommend a change in this policy? A: Some clues to the answer might be found by looking at the Kluckhohn–Strodtbeck and Hofstede Frameworks and considering the risk a Japanese might think is inherent with having a “foreigner” in charge of an international operation. They may feel that a “foreigner” simply would not share Japanese values as they pertain to the work environment. As far as policy changes go, this is often an outgrowth of the changing dynamics of the international business environment. Attracting the best talent may require revisions to long standing policies and traditions.

Practicing International Management Case Culture Makes or Breaks the Deal 1.

Q: What could OMNI have done differently when setting up in Canada to accelerate their market entry? A: A review of the Kluckhohn–Strodtbeck and Hofstede Frameworks will be helpful when considering a solution to this problem. According to Hofstede, Arab countries are lower in individualism and have a greater power distance than Canadians. The difference is great enough that it would have been advisable to have developed a more Geocentric or at least Polycentric International Staffing Policy.

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2. Q: What are some of the cultural challenges OMNI faced when entering the Canadian market? A: Some challenges described in the case include the pace and rhythm of the Canadian work day and the importance ascribed to contractual agreements. 3.

Q: What cross-cultural factors may have influenced OMNI’s market entry into Canada? A: The positive factors in the case include “OMNI’s CEO and CFO both had children attending school in Canada; they had developed relationships with friends in Canada; and they had experienced a culture of openness and innovation.” Some challenging factors include “OMNI set up a partnership with a manufacturing company in the Toronto area that had similar Arab cultural roots and a sales office in Calgary, with an Egyptian manager who had moved to Canada to represent OMNI in the market.”

Q: If you were to do a Hofstede analysis, what would you define as the main cultural differences between the United Arab Emirates and Canada? A: Canada has much higher individualism, and lower power distance. This can have a big impact on how individuals are treated as employees and as managers.

Ch 3: Politics and Law

CHAPTER 3 POLITICS AND LAW LEARNING OBJECTIVES: 1. Describe each main type of political system. 2. Identify the origins of political risk and how managers can reduce its effects. 3. Describe each main type of legal system and the important global legal issues. 4. Explain how international relations affect international business activities. CHAPTER OUTLINE: Introduction Political Systems Politics and Culture Political Participation Political Ideologies Totalitarianism Theocratic Totalitarianism Secular Totalitarianism Doing Business in Totalitarian Countries Democracy Representative Democracy Doing Business in Democracies Political Systems in Times of Change Political Risk Types of Political Risk Conflict and Violence Terrorism and Kidnapping Property Seizure Policy Changes Local Content Requirements Managing Political Risk Adaptation Information Gathering Political Influence Legal Systems Common Law Civil Law Theocratic Law Standardization Intellectual Property Industrial Property Copyrights Product Safety and Liability Taxation Antitrust Regulations Business and International Relations The United Nations Bottom Line for Business .

Ch 3: Politics and Law

A comprehensive set of specially designed PowerPoint slides is available for use with Chapter 3. These slides and the lecture outline below form a completely integrated package that simplifies the teaching of this chapter’s material. Lecture Outline 1.

INTRODUCTION This chapter considers the basic differences between political and legal systems around the world. Disputes grounded in political and legal matters affect business activities, but companies can manage the associated risks.

POLITICAL SYSTEMS A political system includes the structures, processes, and activities by which a nation governs itself.

Politics and Culture 1. A nation’s political system derives from its history and culture. 2. Factors such as population, age and race composition, and per capita income influence a country’s political system.

Political Participation 1. Participation occurs when people voice opinions, vote, and show general approval or disapproval of the system. Wide participation occurs when people who are capable of influencing 2. the political system make an effort to do so. Narrow participation occurs when few people participate.

Political Ideologies Totalitarianism is the belief that every aspect of people’s lives must be controlled in order for a political system to be effective. Anarchism is the belief that only individuals and private groups should control a nation’s political activities. Pluralism is the belief that private and public groups belong in politics. 1. Totalitarianism Individuals govern without the support of the people, tightly control people’s lives, and do not tolerate opposing viewpoints. Totalitarian governments share three features: imposed authority, lack of constitutional guarantees, and restricted participation. Theocratic totalitarianism: political system under the control of a. totalitarian religious leaders. b. Secular totalitarianism: political system in which leaders rely on military and bureaucratic power. i. Communism: obtain social and economic equality only by establishing an all-powerful Communist Party and by granting the government ownership and control over all types of economic activity.

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ii.

Socialism: obtain social and economic equality through government ownership and regulation of the means of production. iii. Tribal totalitarianism: one ethnic group imposes its will on others with whom it shares a national identity. iv. Right-wing totalitarianism: government endorses private ownership of property and a market-based economy but grants few (if any) political freedoms. Leaders strive for economic growth but oppose left-wing totalitarianism, or communism. c. Doing Business in Totalitarian Countries: Companies need not be concerned with political opposition outside the government. It can be risky because the law is vague or nonexistent, and people in powerful government positions can interpret laws at will. Democracy Democracy: Political system in which government leaders are elected directly by the wide participation of the people or their representatives. a. In representative democracies, citizens elect individuals from their groups to represent their political views. b. Representative democracies strive to provide: freedom of expression; periodic elections; full civil and property rights; minority rights; and nonpolitical bureaucracies. c. Doing Business in Democracies: Democracies tend to maintain stable business environments through laws protecting individual property rights. Participative democracy, property rights, and free markets encourage (not guarantee) economic growth. d. Capitalism: belief that ownership of the means of production belongs in the hands of individuals and private businesses.

Political Systems in Times of Change People around the world are demanding greater participation in politics and many nations are abandoning totalitarianism. Globalization is playing a role.

POLITICAL RISK Political risk is the likelihood that a government or society will undergo political changes that negatively affect local business activity. It can threaten an exporter’s market, manufacturing facilities, and the ability to repatriate profits. A.

Types of Political Risk Macro risk threatens all companies regardless of industry and affects all companies equally in a country, both domestic and international. Micro risk threatens companies within a particular industry or even smaller groups. Five events can cause political risk: 1. Conflict and Violence a. Local conflict discourages investment. Violence hinders manufacturing, obtaining materials and equipment, and recruiting talented personnel. b. It can arise from: (1) resentment toward the government; (2) territorial disputes; and (3) ethnic, racial, and religious disputes.

Ch 3: Politics and Law 2.

Terrorism and Kidnapping a. Used to make political statements. Groups dissatisfied with current political or social situations try to force change through fear and destruction. b. Kidnapping and hostage-taking can fund terrorism. Property Seizure a. Confiscation is the forced transfer of assets from a company to the government without compensation. There is no framework for legal appeal, and compensation is far below market value. b. Expropriation is the forced transfer of assets from a company to the government with compensation. c. Nationalization involves government takeover of an entire industry and is more common than confiscation and expropriation. It is used to: (1) protect an industry for ideological reasons, (2) save local jobs in an ailing industry, (3) control industry profits, and (4) invest in industries that private companies cannot afford. Policy Changes a. Result from newly empowered political parties, pressure from special interests, and civil or social unrest. b. One policy tool restricts ownership to domestic companies or limits ownership by nondomestic firms to a minority stake. c. Other policies relate to investments made across borders. Local Content Requirements a. Specify an amount of a product to be supplied locally. Can foster local business activity and create jobs. b. Force companies to use local raw materials, procure parts from local suppliers, or employ local workers. May force a firm to take on poorly trained or excess workers, and local raw materials could increase costs or reduce quality.

Managing Political Risk Companies manage political risks that threaten operations and future earnings. 1. Adaptation: Incorporate risk into business strategies, often with the help of local officials. a. Partnerships can be used to leverage expansion plans through informal arrangements or joint ventures, strategic alliances, and cross-holdings of company stock. b. Localization entails modifying operations, the product mix, or other elements to suit local tastes and culture. c. Development assistance allows an international business to assist the host country in developing distribution and communications networks and improving the quality of life for locals. d. Insurance can be used to protect companies against losses and can provide project financing. 2. Information gathering: Predict and manage political risk. Sources include employees with information and political risk agencies. a. Current Employees with Relevant Information: people who worked in the country and have valuable contacts and knowledge.

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Agencies Specializing in Political-Risk Services: such as banks, political consultants, news publications, and risk-assessment services. Political Influence: Deal with local lawmakers and politicians directly or through lobbyists. a. Lobbying: policy of hiring people to represent a company’s views on political matters. b. Foreign Corrupt Practices Act forbids U.S. companies from bribing government officials or political candidates in other countries (unless a person’s life is in danger). A bribe constitutes “anything of value” and cannot be given to any “foreign government official” empowered to make a “discretionary decision” that may be to the payer’s benefit.

Think-Pair-Share – Slide 20 4.

LEGAL SYSTEMS Set of laws and regulations, including the process by which laws are enacted and enforced and the ways in which courts hold parties accountable for their actions. It is influenced by cultural variables, including class barriers, religious beliefs, emphasis on individualism or conformity, and the political system. Totalitarian governments favor public ownership and enact laws limiting entrepreneurial behavior. Democracies encourage entrepreneurial activity and protect businesses with property-rights laws. A.

Types of Legal Systems 1. Common Law • Tradition: Country’s legal history • Precedent: Past cases that have come before the courts • Usage: How laws are applied in specific situations a. Originated in England in the eleventh century and adopted in its territories worldwide. b. Business contracts tend to be lengthy because they consider many contingencies and possible interpretations in case of dispute. Common law systems are flexible, taking into account particular situations and circumstances. c. Practiced in Australia, Britain, Canada, Ireland, New Zealand, the United States, and some nations in Asia and Africa. 2. Civil Law a. Based on a detailed set of written rules and statutes that constitute a legal code. Can be traced to Rome in the fifth century B.C. and is the oldest and most common legal tradition. b. Can be less adversarial than common law because it is not interpreted according to tradition, precedent, and usage. Because laws are codified and concise, parties are concerned with the explicit wording of the code; obligations, responsibilities, and privileges follow the relevant code. c. Practiced in Cuba, Puerto Rico, Quebec, Central and South America, most of Western Europe, and parts of Asia and Africa.

Ch 3: Politics and Law 3.

Theocratic Law a. Legal tradition based on religious teachings (e.g., Islamic, Hindu, and Jewish law). b. Islamic law is the most widely practiced theocratic legal system today. It was initially a code governing moral and ethical behavior and was later extended to commercial transactions. It restricts investments and sets guidelines for business conduct. c. Firms operating in countries with theocratic legal systems must be sensitive to local values and beliefs. Must evaluate business activities, including hiring practices and investment policies, to ensure compliance with the law, local values, and beliefs. Standardization a. Standardization is uniformity in interpreting and applying laws across countries, not to the standardizing of entire legal systems. b. Treaties and agreements already exist in intellectual property rights, antitrust (antimonopoly) regulation, taxation, contract arbitration, and general matters of trade. c. Organizations that promote standardization: the UN, OECD, and International Institute for the Unification of Private Law. Intellectual Property a. Results from intellectual talent and abilities such as graphic designs, novels, computer software, machine-tool designs, and secret formulas. b. Property rights are the legal rights to resources and any income they generate. Intellectual property can be traded, sold, and licensed in return for fees or royalty payments. i. Industrial property is often a firm’s most valuable asset. Laws protecting industrial property reward inventive and creative activity. • Patent is a right granted to the inventor of a product or process that excludes others from making, using, or selling the invention. The WTO grants patents for 20 years. • Trademarks are words or symbols that distinguish a product and its manufacturer. Trademark protection lasts indefinitely, provided the word or symbol continues to be distinctive (e.g., Xerox). ii. Copyrights give creators of original works the freedom to publish or dispose of them as they choose. • Holder can (1) reproduce the copyrighted work, (2) derive new works from it, (3) sell or distribute it, (4) perform it, and (5) display it publicly. • Protected under the Berne Convention and the 1954 Universal Copyright Convention. Product Safety and Liability a. Product liability holds manufacturers, sellers, and others, including individual company officers, responsible for damage, injury, or death caused by defective products.

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Developed nations have the toughest product liability laws. Lessdeveloped and emerging countries have weaker laws. Taxation a. Tax revenues needed to pay government salaries, build military capacity, and shift earnings from people with high incomes to the poor. b. Consumption taxes: indirect taxes that help pay for consequences of using a particular product and to make imports more expensive. c. Value added tax (VAT): levied on each party that adds value to a product throughout its production and distribution. Antitrust Regulations a. Antitrust (antimonopoly) laws are designed to prevent companies from fixing prices, sharing markets, and gaining unfair monopoly advantages. Such laws help ensure a wide variety of products at fair prices. b. The United States and European Union have strict antitrust regulation and are strict enforcers. In Japan, the Fair Trade Commission enforces antitrust laws, but it is often ineffective. c. In strict antitrust countries, companies see a disadvantage against competitors whose home countries condone market sharing, whereby competitors agree to serve only designated market segments.

Think-Pair-Share – Slide 30

BUSINESS AND INTERNATIONAL RELATIONS Favorable political relationships foster stable business environments and increase international cooperation. Stable environments require a strong legal system to resolve disputes quickly and fairly. Multilateral agreements are treaties concluded among several nations, each of which agrees to abide by treaty terms even if tensions develop.

The United Nations 1. Formed after the Second World War to provide leadership in fostering peace and stability around the world. The UN and its many agencies provide food and medical supplies, educational supplies and training, and financial resources to poor member nations. Receives funding from member contributions based on gross national 2. product (GNP). Entire world is involved with the UN in some manner. 3. UN system consists of six main organs: (1) General Assembly; (2) Security Council; (3) Economic and Social Council; (4) Trusteeship Council; (5) International Court of Justice; and (6) the Secretariat. 4. Within the UN Economic and Social Council is the United Nations Conference on Trade and Development (UNCTAD). The organization has a broad mandate in international trade and economic development.

Ch 3: Politics and Law 7.

BOTTOM LINE FOR BUSINESS Differences in political and legal systems present both opportunities and risks for international companies. Understanding differences in culture, politics, and law is the first step for any company that hopes to manage the risks of doing business in unfamiliar environments. Managers of international companies also need to understand how global legal issues, including intellectual property, product safety, and antitrust laws, affect operations and strategy.

Quick Study Questions Quick Study 1 (p. 92) 1.

Q: What is a political system? Explain the relation between political systems and culture. A: A political system includes the structures, processes, and activities by which a nation governs itself. A people’s political system derives from their history and culture. Factors such as current population, age and race composition, and per capita income influence a country’s political system.

Q: Identify the three main features of totalitarianism. A: Totalitarianism is a political system in which individuals govern without the support of the people, tightly control people’s lives, and do not tolerate opposing viewpoints. Imposed authority means that an individual or group forms the political system without the explicit or implicit approval of the people. A lack of constitutional guarantees means that a totalitarian system denies its citizens the constitutional guarantees of democracies. Restricted participation means that political representation is limited either to parties that are sympathetic to the government or to those that pose no credible threat.

Q: Briefly explain each form of totalitarianism. A: Theocratic totalitarianism is a political system that is under the control of totalitarian religious leaders. Historically, theocratic totalitarianism has badly damaged the economies of those nations implementing it. Secular totalitarianism is a political system in which leaders rely on military and bureaucratic power. Communist totalitarianism is when a government has sweeping political and economic powers. In this type of system, private business is virtually or totally nonexistent. These types of political systems often do not allow inward investment or do so selectively. They make investing in a country less appealing because governments can act as they wish and can destroy the profitability of an operation. Tribal totalitarianism is where one tribe (ethnic group) imposes its will on others with whom it shares a national identity. Nations with this type of political system typically discourage investment because they are often characterized by a great deal of civil unrest, ethic conflict, or even war. Right-wing totalitarianism is where the government endorses private ownership of property and a market-based economy but grants few (if any) political freedoms. Countries with this type of political system are typically very attractive to international companies as a location for investment. The government wants financial returns to pay for better education, infrastructure, and so on for their people but creates stability through suppression of free political expression. .

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Q: How might a totalitarian government affect business activities? A: Doing business in a totalitarian country can be a risky proposition. Many facets of business law pertain to contractual disputes. In a country such as the United States, laws regarding the resolution of such disputes are quite specific. In totalitarian nations, the law can be either vague or nonexistent, and people in powerful government positions can interpret laws largely as they please. For instance, in China it may not matter so much what the law states as it does how individual bureaucrats interpret the law. The sometimes arbitrary nature of totalitarian governments makes it hard for companies to know how laws will be interpreted and applied to their particular business dealings.

Quick Study 2 (p. 94) 1.

Q: What is democracy? Explain the difference between democracy and totalitarianism. A: Democracy is a political system in which government leaders are elected directly by the wide participation of the people or by their representatives. In a democracy, the views and opinions of the people are incorporated into the national decision-making process. Democracies, in general, represent more stable business environments than do totalitarian systems because laws protecting individual property rights are enforced. Democracies also tend to have a greater portion of the country’s factors of production under private ownership. Totalitarian systems tend to have a greater portion of the factors of production under government ownership.

Q: What five freedoms does a representative democracy strive to provide its people? A: (1) Freedom of expression, (2) periodic elections, (3) full civil and property rights, (4) minority rights, and (5) nonpolitical bureaucracies.

Q: How might a democratic government affect business activities in a nation? A: Democracies maintain stable business environments primarily through laws that protect individual property rights. In theory, commerce prospers when the private sector includes independently owned firms that exist to make profits. Bear in mind that although participative democracy, property rights, and free markets tend to encourage economic growth, they do not always do so. India, for example, is the world’s largest democracy; but it experienced slow economic growth for decades. Meanwhile, some countries achieved rapid economic growth under nondemocratic political systems. Asia’s four tigers—Hong Kong, Singapore, South Korea, and Taiwan—built strong market economies absent of truly democratic practices.

Q: Does Venezuela have a democratic or totalitarian political system? A: Although some people view Venezuela as a communist country, in reality it is neither democratic nor communist. Venezuela holds periodic elections—the last federal election was held in April 2013—one of the characteristics of a democracy. Venezuelans also have the freedom to organize political parties. with the death of Hugo Chavez in March 2013, the Venezuelan political system is once more in a state of flux and may undergo further changes in the near future, depending on the decisions of its newly elected president.

Quick Study 3 (p. 102) 1.

Q: What are the five main types of political risk? How might each affect international business activities? .

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A: Conflict and violence can arise from people’s resentment toward their government or over territorial disputes between countries. Violent disturbances impair a company’s ability to manufacture and distribute products, obtain materials and equipment, and recruit talented personnel. Terrorism aims to create fear and force change through the sudden and unpredictable destruction of life or property. Kidnapping and the taking of hostages may be used to fund a terrorist group’s activities. Each of these increases risks for international companies because expatriate executives are prime targets because their companies can afford large ransoms. Property seizure also increases the risks for international firms and can cause them to avoid investing in nations implementing such tactics. Policy changes can result from civil or social unrest or might represent the views of newly empowered political parties. They can cause managers to regard a nation’s business environment as one of a “field of moving goal posts.” Local content requirements are regulations that require international manufacturers to use a certain amount of local resources. They foster local business activity and ease regional or national unemployment, but can also force companies to invest elsewhere if they are too confining. 2.

Q: Identify several steps managers can take to stay safe while on an international assignment. A: Managers should be cautious traveling to their destination and moving about the country. Specifically, a) take nonstop flights, b) vary routines, c) keep a low profile, d) guard personal data, e) use good judgment, and f) know local S.O.S. procedures.

Q: Distinguish between confiscation, expropriation, and nationalization. A: Each of these is a form of property seizure. Confiscation is the forced transfer of assets from a company to the government without compensation. Expropriation is the forced transfer of company assets with compensation. Nationalization is government takeover of an entire industry.

Q: What three methods can businesses use to manage political risk? A: (1) Adaptation involves incorporating risk into business strategies—often with the help of local officials. Companies can incorporate risk by establishing partnerships, localizing operations, offering development assistance, and obtaining insurance. (2) Information gathering involves monitoring and even trying to predict political events that could threaten local operations and future earnings. (3) Political influence involves proposing changes that positively affect their local activities, often through lobbying.

Quick Study 4 (p. 104) 1.

Q: What is meant by the term legal system? A: A legal system is a country’s laws and regulations, including the processes by which its laws are enacted and enforced, and the ways in which its courts hold parties accountable for their actions. A legal system is influenced by many cultural variables, including class barriers, religious beliefs, and whether individualism or group conformity is emphasized. Many laws, rules, and regulations are used to safeguard cultural values and beliefs.

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Q: Explain the role of nationalism in politics. A: Nationalism can play a significant role in the political process of a country. Nationalism is essentially the devotion of a people to their nation’s interests and advancement, it typically involves intense national loyalty and cultural pride, and it is often associated with drives toward national independence. A country’s legal system is influenced by its political system that reflects nationalistic attitudes. Totalitarian governments tend to favor public ownership of economic resources and enact laws limiting entrepreneurial behavior. In contrast, democracies tend to encourage entrepreneurial activity and to protect small businesses with strong property-rights laws. The rights and responsibilities of parties to business transactions also differ from one nation to another. For all these reasons, business strategies must be flexible enough to adapt to different legal systems. In India, for instance, because most business laws originated when the country was struggling for “self-sufficiency,” the legal system tended to protect local businesses from international competition.

Q: Identify the main features of each type of legal system (common, civil, and theocratic). A: Most legal systems fall into one of three categories. A common law system is one in which the justice system decides cases by interpreting the law on the basis of tradition, precedent, and usage. A civil law system is based on a detailed set of written rules and statutes that constitute a legal code. A theocratic law system is one that is based on religious teachings. Three prominent theocratic legal systems are Islamic law, Hindu law, and Jewish law.

Quick Study 5 (p. 108) 1.

Q: What are intellectual property rights? What is the significance of such rights? A: Intellectual property rights are legal rights to resources that result from intellectual abilities and any income these resources generate. Like other types of property, intellectual property can be traded, sold, and licensed in return for fees or royalty payments. Intellectual property laws are designed to compensate people whose property rights are violated.

Q: Explain the term industrial property. What are its two types? A: Industrial property includes patents and trademarks. A patent is a right granted to the inventor of a product or process that excludes others from making, using, or selling the invention. Trademarks are words or symbols distinguishing a product and its manufacturer.

Q: What is a copyright? Explain its importance to international business. A: Copyrights give creators of original works the right to publish or dispose of them as they choose. Copyrights give creators of original works the freedom to publish or dispose of them as they choose. The copyright holder can (1) reproduce the copyrighted work, (2) derive new works from it, (3) sell or distribute it, (4) perform it, and (5) display it publicly.

Q: Identify the ramifications of antitrust (antimonopoly) laws and product liability laws. A: Antitrust (antimonopoly) laws are designed to prevent companies from fixing prices, sharing markets, and gaining unfair monopoly advantages. Antitrust efforts increase competition and thereby keep products fairly priced and ensure a variety of products in any one category. .

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Product liability laws hold manufacturers, sellers, and others responsible for damage, injury, or death caused by defective products. They differ greatly from one nation to another. The United States has the toughest product liability laws in the world, with Europe a close second. Awarded damages tend to be several times larger in the United States than in other developed nations. Developing and emerging countries have the weakest laws. Enforcement of such laws also varies from nation to nation, with highly developed countries being the strictest enforcers. Quick Study 6 (p. 110)

Q: Why are international relations among countries important to international business? A: Favorable political relationships foster stable business environments and increase international cooperation. A stable environment requires a strong legal system to resolve disputes quickly and fairly. Multilateral agreements are treaties concluded among several nations, each of which agrees to abide by treaty terms even if tensions develop. All of these are helped by the presence of good relations among countries.

Q: Many people question the existence of the United Nations (UN). Do you think the existence of the UN is useful for business? A: An important body within the UN Economic and Social Council is the United Nations Conference on Trade and Development (UNCTAD) ( www.unctad.org ). The organization has a broad mandate in the areas of international trade and economic development. It hosts conferences on pressing development issues including entrepreneurship, AIDS, poverty, and national debt. Certain conferences are designed to develop the business management skills of individuals in developing nations. Another important organization related to international business is the International Trade Centre (ITC) ( www.intracen.org ). The ITC’s goal is “to assist developing and transition countries to achieve sustainable development through exports.” This objective is achieved through partnerships that provide sustainable and inclusive development solutions to the private sector, trade support institutions, and policy makers.

Talk It Over 1.

Q: The Internet and the greater access to information it can provide are forcing politicians to change their methods of governing. How might the Internet change totalitarian political systems, such as North Korea? What might the Web’s future expansion mean for nations with theocratic systems, such as Iran? How might technology change the way that democracies function? A: Control of information and state-run media that bias news reports in their favor help totalitarian leaders remain in power. The Internet is making it more difficult for leaders to maintain absolute control. Theocratic states sometimes also rely on closed media that is controlled by the government. At the very least, they censor much incoming programming to weed out what the government considers immoral. The Internet is also making it more difficult for theocracies to restrict access to information that is not created by or permitted by the government. The Internet may also radically alter the way that democracies function. For instance, with the necessary infrastructure, online voting for the masses could soon become a reality. Many U.S. states are exploring online voting for state elections but are .

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cautious out of concerns over fraud. Because online voting may make it easier for many citizens to vote, it could spark greater use of referendums. This could make many representative democracies closer resemble pure democracies—in which all citizens are involved in most decisions. 2.

Q: Under a totalitarian political system, the Indonesian economy grew strongly for 30 years. Meanwhile, the economy of the largest functioning democracy, India, performed poorly for decades until recently. Relying on what you learned in this chapter, do you think the Indonesian economy grew despite or because of a totalitarian regime? What might explain India’s relatively poor performance under a democratic political system? A: It is quite probable that the types of political systems in place in Indonesia and India have played large roles in the pace of economic development in these two countries. In the case of Indonesia, President Suharto’s long reign in power (which ended in 1998) created a right-wing totalitarian state that was very pro-business. Suharto’s family grew incredibly wealthy in the process, but it can also be argued that Indonesia’s general population would not have fared nearly as well over these recent decades if it were not for the stability that the Suharto regime provided. After a year of pro-democracy demonstrations, Indonesia held its first free election in 44 years in 1999. If the country moves away from the “Golkar” party, it will be interesting to see if true democracy will come to Indonesia and what it will mean for business and the economy. India is clearly a democracy and should therefore create a stable business environment. In the past, numerous political parties and resulting coalition governments made it difficult for India to create consistent policies on domestic economic and business issues. One administration took an anti-free market stance and the subsequent one took a pro-business stance. This made India a risky proposition for multinationals because the ground rules were continuously in flux. But today India is more pro-business than at any time in its history. Still, some politicians encourage antiforeigner sentiment and demonstrations because they help to unify the electorate.

Q: Consider the following statement: “Democratic political systems, as opposed to totalitarian ones, provide international companies with more stable environments in which to do business.” Do you agree? Why or why not? Support your argument with specific country examples. A: This question forces students to examine the relation between the type of political system and economic performance from a theoretical perspective. They will often look for country examples that support the statement. Indonesia had stellar growth under totalitarianism whereas India had slow growth under democracy. Analyzing India in detail allows students to see an example of how political change can disrupt the investment plans of multinational companies—even in democracies. India in Detail: India is an independent republic made up of 25 states and 7 territories. A president serves as India’s head of state but a prime minister actually heads the government. India’s constitution went into effect in 1950. Like the American Bill of Rights, it names and guarantees the basic equal rights of every citizen. The Indian Constitution gives every person who is 21 years of age or older the right to vote. It prohibits unequal treatment on the basis of race, religion, caste (social class), sex, or place of birth. The document also contains goals for the federal and state governments including decent working conditions, fair wages, and old-age assistance. India has a parliament-cabinet form of democratic national government. Parliament meets at New Delhi, the capital of India. It consists of the Lok Sabha (House of the People) and the Rajya Sabha (Council of States). The prime minister is usually the leader of the political party that has the most seats in Parliament. The president appoints .

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the prime minister to office. The prime minister chooses a cabinet and heads the government with the support of Parliament. If Parliament withdraws its support, the president either dismisses the prime minister or dissolves the Lok Sabha and calls a new election. Parliament and all the state legislatures elect the president to a five-year term. Representatives of states and territories make up Parliament, the numbers of which increase or decrease along with changes in the population of the state or territory. The voters elect most of the 545 members of the Lok Sabha. They serve five-year terms unless the Lok Sabha is dissolved. Most of the 244 members in the Rajya Sabha are elected by state legislatures. They serve six-year terms and every two years, one-third of them stand for reelection. The president appoints a few members of each body. The Congress Party, or one of the branches that developed from it, has ruled India almost continuously since 1947. In the early days, the Congress Party had a majority in Parliament but today must frequently form coalitions with other parties. Parliament has great power over the states. It can change the state boundaries, and even break up old states to make new ones. Parliament can prevent the Supreme Court from interfering in certain types of legislation. In an emergency, Parliament can also take over the powers of the state legislatures. It taxes the largest sources of money, such as personal and business income. The states can tax only the poorer sources, such as real estate. As a result, the states rely heavily on Parliament for financial assistance. The Indian states have a governor, a chief minister, and a legislature composed of one or two houses. The federal government rules the seven territories through appointed officials. The president of India appoints the state governors who name chief ministers, who are the leaders of the majority party in their state legislature. The people elect almost all of the legislators but the governor appoints some legislators. A Supreme Court heads India’s court system. Each state in India has a High Court and a number of lower courts. It is common today for India to be governed by a coalition government because of the very large number of political parties. India’s political scene is almost always in a state of turmoil so that managers must closely monitor events.

Practicing International Management Case Pirates of Globalization Q: What actions can companies and governments take to ensure that products cannot be easily pirated? Be specific. A: The first and most obvious response is to have an effective intelligence operation that has a close working relationship with local authorities worldwide. This gives a company a reputation of intolerance regarding counterfeiting and makes pirates aware that if they counterfeit the firm’s products, they will be raided and prosecuted. Second, the tags on products can be emblazoned with special holograms that are extremely difficult, if not impossible, to duplicate. Buyers could then be made aware of how the hologram should appear. Third, companies can tighten security at their production sites so that employees cannot steal merchandise and sell it on their own—this is a significant problem in emerging markets, especially China. Fourth, companies should destroy any defective products coming off the assembly line rather than throwing them in the trash. This prevents pirates from fixing minor flaws or defects and selling them on the black market. Of course, there are many additional possibilities.

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Q: Do you think that the international business community is being too lax about the abuse of intellectual property rights? Are international companies simply afraid to speak out for fear of jeopardizing access to attractive markets? A: This question gets students to consider the ramifications of cracking down on counterfeiters in lucrative markets. A policy of zero tolerance in some developing and emerging markets may invite the wrath of politicians and government bureaucrats. Officials might see multinationals with deep pockets as extremely greedy and determined to go after every petty pirate in a market. This can create a damaging backlash by local law enforcement.

Q: Increased digital communication may pose a threat to intellectual property because technology allows people to create perfect clones of original works. How do you think the Internet is affecting intellectual property laws? A: The spectacular growth of e-business conducted over the Internet will force a reevaluation of intellectual property laws. Holders of intellectual property will likely want existing laws revised to protect them from hackers that break into company networks and others who monitor e-mails and other Internet traffic in an effort to steal valuable data and information.

Q: Research Canada Goose’s current counterfeiting situation. What actions has the company taken to reduce this problem? A: Encourage students to access the Canada Goose Counterfeit web page http://www.canadagoose.com/counterfeit/ If you were hired as a consultant for Canada Goose, what other recommendations would you give, based on what you learned in this chapter? Political relations between a company’s home country and those with which it does business strongly affect its international activities. In general, favourable political relations lead to increased opportunity and stable business environments. It may be advisable for Canada Goose to develop and maintain relationships with government officials in areas where they are experiencing large numbers of manufactures knocking off their products.

Ch 4: International Ethics

CHAPTER 4 INTERNATIONAL ETHICS LEARNING OBJECTIVES 1. Explain ethics, ethical behaviour, ethical dilemmas, and codes of ethics. 2. Understand the different philosophies of ethics and how international business managers apply them to their decision making processes. 3. Explain corporate social responsibility, understand the concept of sustainability and sustainable practices, and provide examples of international businesses that apply these concepts. 4. Understand the principles of responsible investment CHAPTER OUTLINE: Introduction Ethics, Ethical Behaviour, and Ethical Dilemmas Ethical Dilemmas Codes of Ethics Philosophies of Ethics Corporate Social Responsibility and CSR Issues Bribery and Corruption Labour Conditions and Human Rights Fair Trade Practices Sustainability Carbon Footprint The Principles of Responsible Investment Bottom Line for Business

A comprehensive set of specially designed PowerPoint slides is available for use with Chapter 4. These slides and the lecture outline below form a completely integrated package that simplifies the teaching of this chapter’s material. Lecture Outline

INTRODUCTION Understanding ethics is key to success in international business because what is considered right and wrong varies, depending upon the country’s cultural, political, and legal systems. This chapter also examines corporate social responsibility and sustainable practices in international business.

ETHICS, ETHICAL BEHAVIOUR, AND ETHICAL DILEMMAS Ethics is the moral obligation to separate right from wrong. Ethics can also be defined as the set of moral principles or values that defines right or wrong for a person or group. Ethics seeks to resolve questions dealing with human morality. Acts can be legal or illegal. While illegal acts should not be difficult to resolve through law enforcement, legal acts can sometimes present ethical challenges, meaning that an act can be legal but unethical. a. Ethical Dilemmas .

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An ethical dilemma occurs when moral imperatives are in conflict. A moral or ethical dilemma may be understood as “the process of moral judgment on appropriateness or inappropriateness of some action, activity, or decision of an institution and/or individual, with appreciation of basic moral standards and information about the facts concerning the actions which are the subject of discussion. ” There is no clear formula or model to resolve an ethical dilemma, but the following are some guidelines and questions to ask before making a decision. ● Is the proposed action legal? ● Is the decision a fair and balanced one? Consider this question not only in terms of the individual involved but also for all other stakeholders, both in the short and the long term. ● Does the situation justify the action? ● How will this decision make me feel about myself? ● How would I feel if my decision were to be published in the newspaper? Or if my family found out about it? Codes of Ethics Set of guidelines established by an organization to help their employees or members behave in accordance with the organization’s values and ethical standards.

PHILOSOPHIES OF ETHICS There are four commonly cited philosophies of business ethics: the Friedman view, the cultural relativist view, the righteous moralist view, and the utilitarian view. The Friedman view —named for its main supporter, the late economist Milton Friedman— says that a company’s sole responsibility is to maximize profits for its owners (or shareholders) while operating within the law. The cultural relativist view says that a company should adopt local ethics wherever it operates because all belief systems are determined within a cultural context. Cultural relativism sees truth, itself, as relative and argues that right and wrong are determined within a specific situation. The expression “When in Rome, do as the Romans do” captures the essence of cultural relativism The righteous moralist view says that a company should maintain its home-country ethics wherever it operates because the home-country’s view of ethics and responsibility is superior to others’ views The utilitarian view says that a company should behave in a way that maximizes “good” outcomes and minimizes “bad” outcomes wherever it operates. The utilitarian manager asks the question, “What outcome should I aim for?” and answers, “That which produces the best outcome for all affected parties.” In other words, utilitarian thinkers say the right behaviour is that which produces the greatest good for the greatest number. Think-Pair-Share – slide 7

CORPORATE SOCIAL RESPONSIBILITY AND CSR ISSUES Practice of companies going beyond legal obligations to actively balance commitments to investors, customers, other companies, and communities. a. Bribery and Corruption Similar to other cultural and political elements, the prevalence of corruption varies from nation to nation. In certain countries, bribes are routinely paid to distributors and retailers to push a firm’s products through distribution channels. Bribes can mean the difference between obtaining an important contract and being completely shut out of a market. But corruption is detrimental to society and business. Among other things, corruption can .

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send resources toward inefficient uses, hurt economic development, distort public policy, and damage national integrity. Labour Conditions and Human Rights To fulfill their responsibilities to society, companies are monitoring the actions of their own employees and the employees of companies with whom they conduct business. Pressure from human rights activists drove conscientious apparel companies to introduce codes of conduct and monitoring mechanisms for their international suppliers. Fair Trade Practices A trading partnership, based on dialogue, transparency, and respect, that seeks greater equity in international trade and contributes to sustainable development by offering better trading conditions to, and securing the rights of, marginalized producers and workers. Sustainability Development that meets the needs of the present without compromising the economy or the social and natural environments for future generations. i. Carbon Footprint The environmental impact of greenhouse gases (measured in units of carbon dioxide) that results from human activity.

The Principles of Responsible Investment The Principles of Responsible Investment (PRI) , a set of socially responsible investment principles created in 2006, is another instrument to encourage companies to behave ethically. The main objectives of the PRI are to protect the world’s assets by applying social responsibility to investments and to assist investors to achieve better long-term investments and create sustainable markets.

Bottom Line for Business This completes our chapter coverage of international ethics. We have seen that ethical behaviour varies among cultures, that there are different philosophies of ethics companies can adopt to implement their business objectives, and that ethical issues are becoming increasingly important for any company wanting to operate or invest internationally. Think-Pair-Share – slide 20

Quick Study Questions Quick Study 1 (p. 122) 1.

Q: Define ethics and ethical behaviour? A: ethics Moral obligation to separate right from wrong. ethical behavior Personal behaviour in accordance with guidelines for good conduct or morality.

Q: What are the benefits of having a code of ethics in place for companies operating in foreign markets? A: Companies and professional organizations in Canada and around the world have been adopting codes of ethics for many years. A code of ethics is a set of guidelines established by an organization to help their employees or members behave in accordance with the organization’s values and ethical standards. Increasingly, multinational corporations are following this practice

Ch 4: International Ethics

and publishing codes of ethics. A corporate code of ethics defines the expected ethical behaviour for all members of the corporation. 3.

Q: Can a company guarantee that its employees or its stakeholders will act ethically by having a code of ethics in place? Why or why not? A: A code of ethics is no guarantee that a corporation or its employees and stakeholders will behave ethically. However, it does provide guidelines for acceptable ethical conduct and may discourage unethical behaviour, especially if there is evidence that disciplinary measures will be enforced.

Quick Study 2 (p. 124) 1.

Q: What are the four commonly cited philosophies of business ethics? A: There are four commonly cited philosophies of business ethics: the Friedman view, the cultural relativist view, the righteous moralist view, and the utilitarian view. The Friedman view —named for its main supporter, the late economist Milton Friedman— says that a company’s sole responsibility is to maximize profits for its owners (or shareholders) while operating within the law. The cultural relativist view says that a company should adopt local ethics wherever it operates because all belief systems are determined within a cultural context. Cultural relativism sees truth, itself, as relative and argues that right and wrong are determined within a specific situation. The expression “When in Rome, do as the Romans do” captures the essence of cultural relativism The righteous moralist view says that a company should maintain its home-country ethics wherever it operates because the home-country’s view of ethics and responsibility is superior to others’ views The utilitarian view says that a company should behave in a way that maximizes “good” outcomes and minimizes “bad” outcomes wherever it operates. The utilitarian manager asks the question, “What outcome should I aim for?” and answers, “That which produces the best outcome for all affected parties.” In other words, utilitarian thinkers say the right behaviour is that which produces the greatest good for the greatest number.

Q: You are the manager of an oil and gas company that is considering drilling in a wildlife preserve abroad. You decide to go ahead with the project because the economic benefits of job creation outweigh the costs of environmental degradation. Which philosophy are you using to justify your decision? A: The Friedman view —named for its main supporter, the late economist Milton Friedman— says that a company’s sole responsibility is to maximize profits for its owners (or shareholders) while operating within the law. Possibly The utilitarian view says that a company should behave in a way that maximizes “good” outcomes and minimizes “bad” outcomes wherever it operates. The utilitarian manager asks the question, “What outcome should I aim for?” and answers, “That which produces the best outcome for all affected parties.” In other words, utilitarian thinkers say the right behaviour is that which produces the greatest good for the greatest number.

Q: Your manager or supervisor tells you to “do whatever it takes to meet the goals as long as it’s legal.” What ethical approach do you think he or she favours? A: The Friedman view —named for its main supporter, the late economist Milton Friedman— says that a company’s sole responsibility is to maximize profits for its owners (or shareholders) while operating within the law

Ch 4: International Ethics

Quick Study 3 (p. 133) 1.

Q: What is corporate social responsibility? A: Practice of companies going beyond legal obligations to actively balance investors, customers, other companies, and communities

commitments to

Q: What is the Corruption Perception Index? A: Map 4.1 shows how countries rate on their perceived levels of corruption. The higher a country’s score on the Corruption Perceptions Index (CPI), the less corrupt it is perceived to be by international managers. What stands out immediately on this map is that the least developed nations tend to be perceived as being most corrupt (such as Haiti, much of Africa, North Korea, Venezuela, Russia, and areas in the Middle East). This reflects the hesitancy on the part of international companies about investing in corrupt economies. Among the countries perceived as having the least corruption are Denmark, Finland, New Zealand, Sweden, Singapore, Switzerland, Australia, Norway, Canada and The Netherlands. All these countries are considered developed nations or advanced economies.

Q: What is sustainability ? Name three companies applying sustainable practices. A: Development that meets the needs of the present without compromising the economy or the social and natural environments for future generations. Three companies Loblaw’s, Four Seasons, Mariott

Quick Study 4 (p. 135) 1.

Q: What is the main objective of the Principles of Responsible Investment (PRI)? A: The Principles of Responsible Investment (PRI) , a set of socially responsible investment principles created in 2006, is another instrument to encourage companies to behave ethically. The main objectives of the PRI are to protect the world’s assets by applying social responsibility to investments and to assist investors to achieve better long-term investments and create sustainable markets. Q: What are the benefits for the signatories? A: First, implementing the principles should ultimately result in increased returns and lower risk. Why? Because by applying the principles, investors will have a more complete understanding of a range of material issues. A second benefit is “being part of a global network, with opportunities to pool resources and influence to engage with companies on ESG issues, lowering costs for signatories to undertake stewardship activities.” Finally, signatories may improve their reputation or public image, as they will be seen as socially responsible companies.

Q: What are the sanctions for not complying with the PRI? A: Signatories commit to completing the annual reporting framework. The process is mandatory, because it helps signatories and the PRI Initiative to evaluate progress in implementing the six principles. However, there are no legal or regulatory sanctions associated with the principles. Compliance is voluntary and aspirational. But a company that does not comply may be publicly delisted from the PRI Initiative, which could affect the company’s reputation. In other words, noncompliance can have reputational risks.

Ch 4: International Ethics

Talk It Over 1.

Q:Two owners of small businesses are discussing the various reasons why they don’t apply corporate social responsibility to their business practices. “It’s too expensive to implement;” “The costs outweigh the benefits;” “It’s not required by law.” What counterarguments can you present to these business owners’ perceptions? A: Conscientious business leaders realize that the future of their companies rests on healthy workforces and environments worldwide. International law says that only nations can be held liable for human rights abuses. But activist groups can file a lawsuit against a business for an alleged human rights violation. In the United States, this can be done under the Alien Tort Claims Act by alleging a company’s complicity in the abuse. In 2013, Canada’s Joe Fresh (the clothing brand owned by Loblaw) got caught in the spotlight over a human rights issue when the building housing its Bangladesh manufacturing operation collapsed. The incident is considered the deadliest for Bangladesh’s clothing industry. Joe Fresh vowed to help improve working conditions in Bangladesh and promised to work with its vendors to improve the health and safety standards by making sure its products are produced in a socially responsible manner

Q: Consider the following statement: “Developed countries provide international business with more secure environments in which to operate.” Do you agree? Why or why not? Support your argument with specific country examples. Hint: This topic relates to corruption and the Corruption Perception Index (CPI). A: The higher a country’s score on the Corruption Perceptions Index (CPI), the less corrupt it is perceived to be by international managers. What stands out immediately on this map is that the least developed nations tend to be perceived as being most corrupt (such as Haiti, much of Africa, North Korea, Venezuela, Russia, and areas in the Middle East). This reflects the hesitancy on the part of international companies about investing in corrupt economies. Among the countries perceived as having the least corruption are Denmark, Finland, New Zealand, Sweden, Singapore, Switzerland, Australia, Norway, Canada and The Netherlands. All these countries are considered developed nations or advanced economies.

Q:“A company’s sole responsibility is to maximize profits for its owners while operating within the law.” Do you agree with this statement? Why or why not? Hold a debate in class on the benefits and drawbacks of applying this philosophy. Opposing arguments should focus on CSR and sustainability. A: Class Debate

Practicing International Management Case Digging Deep for CSR 1.

Q: Which ethical philosophy is TVIRD using in the Philippines? A: The utilitarian view says that a company should behave in a way that maximizes “good” outcomes and minimizes “bad” outcomes wherever it operates. The utilitarian manager asks the question, “What outcome should I aim for?” and answers, “That which produces the best outcome for all affected parties.” In other words, utilitarian thinkers say the right behaviour is that which produces the greatest good for the greatest number.

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Q: Name a few of TVIRD’s corporate social responsibility initiatives. A: TVIRD pointed out that the chemicals in the Siocon River came from an illegal mining operation that had preceded TVIRD’s arrival on the scene. Nevertheless, the company took measures to clean up the river. TVIRD also established a sustainability program for Canatuan, encompassing such areas as livelihood, health and sanitation, education, environmental management and protection, and human resource development. One of TVIRD’s sustainable livelihood initiatives in Canatuan is its Farmer-Instructor-Technician (FIT) program. Under the FIT program, the formerly semi-nomadic Subanons are encouraged to change their traditional way of farming to an irrigated multi-cropping method using rice terrace techniques. As part of its health and sanitation program, TVIRD set up a medical clinic with a full-time doctor, nurse, and midwife in Canatuan, bringing medical care to communities that previously had had no access to medical services. TVIRD also participated with the Philippine government in a regional campaign to eradicate lymphatic filariasis (a mosquito-borne disease common in the area) and carried out medical missions to remote communities. Although mining affects the environment in both the short and the long term, TVIRD’s environmental management and protection program aims “to minimize its impact footprint, to implement appropriate and best practice measures to control the impacts, and to promote restoration and rehabilitation that best support the needs of the community and the natural environment.” Measures include tailings management, water quality monitoring, protection of land and water habitats to preserve the region’s biodiversity, and reforestation. Since 2004, TVIRD has planted almost 380 000 seedlings as part of its rehabilitation program.

Q: Do you think TVIRD is applying the concept of sustainability in its operations? A: Based upon the information provided in the case, TVIRD would appear to be applying the concept of sustainability in its operations

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CHAPTER 5 ECONOMICS AND EMERGING MARKETS LEARNING OBJECTIVES: 1. Describe what is meant by a centrally planned economy and explain why its use is declining. 2. Identify the main characteristics of a mixed economy and explain the emphasis on privatization. 3. Explain how a market economy functions and identify its distinguishing features. 4. Describe the different ways to measure a nation’s level of development. 5. Discuss the process of economic transition and identify the obstacles for business.

CHAPTER OUTLINE: Introduction Economic Systems Centrally Planned Economy Origins of the Centrally Planned Economy Decline of Central Planning Failure to Create Economic Value Failure to Provide Incentives Failure to Achieve Rapid Growth Failure to Satisfy Consumer Needs Emerging Market Focus: China Early Years Patience and Guanxi Challenges Ahead Mixed Economy Origins of the Mixed Economy Decline of Mixed Economies Move toward Privatization Emerging Market Focus: India Challenges Ahead for India Emerging Market Focus: Brazil Challenges Ahead for Brazil Market Economy Origins of the Market Economy Laissez-Faire Economics Features of a Market Economy Government’s Role in a Market Economy Enforcing Antitrust Laws Preserving Property Rights Providing a Stable Fiscal and Monetary Environment Preserving Political Stability Economic Freedom Development of Nations UN World Risk Index National Production Uncounted Transactions

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Question of Growth Problem of Averages Pitfalls of Comparison Purchasing Power Parity Big Mac Index Human Development Classifying Countries Developed Countries Newly Industrialized Countries Developing Countries Economic Transition Obstacles to Transition Lack of Managerial Expertise Shortage of Capital Cultural Differences Environmental Degradation Emerging Market Focus: Russia Rough Transition Challenges Ahead for Russia Bottom Line for Business

A comprehensive set of specially designed PowerPoint slides is available for use with Chapter 5. These slides and the lecture outline below form a completely integrated package that simplifies the teaching of this chapter’s material. Lecture Outline 1.

INTRODUCTION This chapter introduces different economic systems and their effect on international business. It explains each type of economic system, economic development, how nations are classified, and how countries implement market-based economic reforms.

ECONOMIC SYSTEMS Economic system: structure and processes a country uses to allocate its resources and conduct its commercial activities. No economy reflects a completely individual or group orientation but displays a blend of individual and group values. A.

Centrally Planned Economy Land, factories, and other economic resources are owned by the government, which plans nearly all economic activity. Ultimate goal is to achieve political, social, and economic objectives through complete control of production and distribution of resources. 1. Origins of the Centrally Planned Economy a. Group welfare is more important than individual well-being, and thus strives to achieve economic and social equality. b. Karl Marx in the 1800s argued the economy must be overthrown and replaced with an equitable “communist” system.

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By the 1970s, central planning was found in Eastern Europe, Asia, Africa, and Latin America. Decline of Central Planning a. In the late 1980s, nations dismantled central planning in favor of market-based economics for several reasons. b. Failure to Create Economic Value: Central planners failed to produce quality products efficiently. c. Failure to Provide Incentives: Government ownership limited incentives to maximize benefits from resources, which lowered economic growth and living standards. d. Failure to Achieve Rapid Growth: Leaders realized their nations were falling quickly behind other nations. e. Failure to Satisfy Consumer Needs: Consumers’ basic needs were not being met. Emerging Market Focus: China China’s theme is “Socialism with Chinese characteristics,” and the nation has undergone great economic reform over the past two decades. a. Early Years i. 1949: Communes planned all agricultural and industrial production and schedules. Rural families owned their homes and land and produced particular crops. ii. 1979: Government reforms allowed families to grow crops they chose and sell produce at market prices. iii. 1984: Township and village enterprises (TVEs) obtained materials, labour, and capital on open market and used a private distribution system. TVEs laid the groundwork for a market economy. iv. Mid-1980s: Foreign companies were allowed to form joint ventures with Chinese partners. b. Challenges Ahead i. Political and social problems loom. Skirmishes between secular and Muslim Chinese, and democracy restricted. ii. Unemployment, slow economic progress in rural areas, and misery of migrant workers. iii. China’s one country, two systems policy must preserve order, as Taiwan is watching closely.

Mixed Economy Land, factories, and other economic resources are more equally split between private and government ownership. Government controls economic sectors important to national security and long-term stability. Generous welfare system supports unemployed and provides health care. 1. Origins of the Mixed Economy a. Successful economy must be efficient and innovative, but also protect society. Goals are low unemployment, low poverty, steady economic growth, and an equitable distribution of wealth. b. Mixed economies are modernizing to be more competitive. 2. Decline of Mixed Economies Mixed economies are converting to market-based systems. Government ownership means less efficiency, innovation, responsibility, and accountability; higher costs; slower growth; and higher taxes and prices.

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Move toward Privatization i. Selling government-owned economic resources to private companies and individuals. ii. Increases efficiency, cuts subsidies to state-owned firms, curtails appointment of managers for political reasons.

Emerging Market Focus: India India began its transition to a mixed economy in 1947, adopting a democratic government after it gained independence from Britain. a. Early Years i. At first, the country operated a centrally planned type of economy with state-owned companies even though Prime Minister Rajiv Ghandi introduced small reforms during the 1980s, India’s economy stagnated, and low annual growth rates prevailed from 1947 to 1990 ii. In 1991, Prime Minister Narasimha Rao initiated a trade liberalization process by abolishing the Licence Raj system, which ended several monopolies. An ambitious economic reform program was implemented to reduce the fiscal deficit, privatize the public sector, and increase infrastructure investment. At the same time, trade reforms and foreign direct investment regulations changed to open the economy to foreign investors. iii. Today India is one of the fastest developing economies in the world and has achieved annual growth rates above 6 percent since 2003. In 2009 and 2010—while most of the world was undergoing a severe economic crisis—India’s annual growth rate was 8.4 percent b. Challenges Ahead i. India does not yet have a well-functioning legal and regulatory framework, despite progress made in this regard. ii. Huge efforts have been made to privatize the country, but there are still many state-owned enterprises. iii. Subsidies remain high, creating a large budget deficit. The government continues to control prices on a number of products; the average tariffs to import products are at 8 percent; and complex nontariff barriers are still in place. Intellectual and property rights are not well protected, and high levels of corruption persist. iv. The labour market is underdeveloped, and a substantive informal sector remains. v. In summary, India has many challenges to overcome, challenges that hinder international trade and investment, and stand in the way of India becoming a developed nation with a full market economy.

Emerging Market Focus: Brazil Brazil began its transition to a democracy in 1985, after 21 years (1964– 1985) under an authoritarian military regime. a) Early Years

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Although provincial and federal elections were held between 1985 and 1989, many of the elected politicians in power at that time still belonged to the old military regime. ii. In 1989, Fernando Collor de Mello was elected president of Brazil in Brazil’s first democratic presidential election since the military dictatorship. During his term of office, Collor de Mello battled a huge national debt and hyperinflation, which at times reached rates of 25 percent per month. However, he managed to privatize fifteen companies. Accused of corruption, Collor de Mello resigned in 1992 and was later prosecuted and convicted. iii. From 1995 to 2003 under President Fernando Cardoso, Brazil went through a major economic transformation that saw a reduction of trade barriers and an increase in international cooperation. Cardoso’s successor, iv. Lula da Silva, was elected in 2003 and served until 2011. During Lula’s presidential term, Brazilian foreign trade increased dramatically, changing deficits to surpluses; v. Dilma Rousseff, Brazil’s first female president, was elected in 2011. Her government is currently focused on reducing inflation, tightening Brazil’s monetary policy, maintaining and extending social programs to raise the standard of living, and improving Brazil’s infrastructure. b) Challenges Ahead for Brazil a. Brazil has not yet established a full market economy and needs to overcome several issues before it can be considered a free economy. b. High inflation and unemployment, both at 6 percent, continue to plague the country. c. It has an overly bureaucratic regulatory system: d. Despite its challenges, Brazil’s economy is one of the fastest growing in the world and is forecast to become one of the five largest economies in the coming decades. C.

Market Economy Most land, factories, and other economic resources are privately owned, either by individuals or businesses. Price mechanism determines: • Supply: Quantity of a good or service that producers are willing to provide at a specific selling price. • Demand: Quantity of a good or service that buyers are willing to purchase at a specific selling price. 1. Origins of the Market Economy Individual concerns are above group concerns. The group benefits when individuals receive incentives and rewards to act in certain ways. a. Laissez-Faire Economics: French for “allow them to do [without interference].” Individualism fosters democracy as well as a market economy. 2. Features of a Market Economy a. Free choice: individuals have purchase options. c. Free enterprise: companies can decide what to produce and which markets to compete in. d. Price flexibility: prices rise or fall reflecting supply and demand.

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Think – Pair – Share, Slide 20 3.

Government’s Role in a Market Economy Little direct involvement, but plays four important roles: a. Enforce Antitrust Laws i. Goal of antitrust (antimonopoly) laws is to encourage the development of industries with as many competing businesses as the market will sustain. ii. Prevent trade-restraining monopolies and combinations that exploit consumers and constrain commerce. b. Preserve Property Rights i. Encourage individuals and firms to take risks such as technology investments, new product invention. ii. Legally safeguard claims to assets and future incomes they generate. c. Provide a Stable Fiscal and Monetary Environment i. Influence inflation and unemployment rates through effective fiscal and monetary policies. ii. Stability improves company forecasts and reduces risks associated with future investments. d. Preserve Political Stability i. Market economy depends on a stable government. ii. Helps companies avoid worrying about political risk. Economic Freedom a. Connection between political freedom and economic growth is very uncertain. b. Yet greater economic freedom tends to coincide with higher living standards.

DEVELOPMENT OF NATIONS Economic development is a measure for gauging the economic well-being of one nation’s people as compared with that of another nation’s people. It reflects economic output (agricultural and industrial); infrastructure (power and transportation facilities); physical health and level of education; and cultural, political, legal, and economic differences. A.

National Production Can classify countries by gross national product per capita, but there are problems using GNP and GDP as indicators of development. 1. Uncounted Transactions a. Volunteer work, household work, illegal or underground deals, and unreported cash transactions. b. Shadow economy can be so large and prosperous that official statistics are meaningless. c. Barter is an alternative for buyers who lack hard currency to pay for imports (e.g., Pepsi-Cola in USSR). 2. Question of Growth a. GNP and GDP are a snapshot of one year’s economic output, and do not indicate whether an economy is growing. 3. Problem of Averages

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a. 4.

Per capita figures are averages. Urban areas can be more developed than rural areas and have higher per capita income. Pitfalls of Comparison a. To compare gross product per capita, each currency must be translated into a single currency. b. Official exchange rates do not show what the local currency can buy in its home country.

Purchasing Power Parity 1. Purchasing power is the value of goods and services that can be purchased with one unit of a country’s currency. Purchasing power parity is the relative ability of two countries’ currencies to buy the same “basket” of goods in those two countries. 2. If we convert Canadian dollars to US dollars at official exchange rates, we estimate Canada’s GDP per capita at $50 345. This is higher than the official GDP per capita of the United States ($48 112). But adjusting Canada’s GDP per capita for PPP gives us a revised figure of just $39 660, which is lower than the US GDP figure of $48 820. The opposite phenomenon occurs in Mexico. Because the cost of living there is lower than in Canada, Mexico’s GDP per capita rises from $10 047 to $15 390 when PPP is considered (see Table 5.1 ). a) Big Mac Index An informal way of measuring the PPP is the Big Mac Index. It was introduced by The Economist in 1986 and is published every year. The Economist Big Mac Index is based on the theory of purchasing power parity (PPP). In this index, the “basket” is a McDonald’s Big Mac. By comparing actual exchange rates with PPPs, the index indicates whether a currency is under or overvalued. For example, the cheapest burger in the chart is in India, at $1.62, compared with an average Canadian price of $4.73 or an American price of $4.20. This implies that the rupee (India’s currency) is undervalued by about 60 percent. On the same basis, the Euro is overvalued by around 10 % and the Brazilian Real is overvalued by about 40%

Human Development 1. Human development index (HDI) measures extent to which a people’s needs are satisfied and the degree to which these needs are addressed equally across a nation’s entire population. Three dimensions: a long and healthy life, an education, and a decent standard of living. 2. Often disparity between wealth and HDI. 3. HDI demonstrates that high national income alone does not guarantee human progress.

Classifying Countries Classifications normally based on indicators such as GNP per capita, portion of the economy devoted to agriculture, amount of exports in the form of industrial goods, and overall economic structure. 1. Developed Countries a. Highly industrialized, highly efficient, and whose people enjoy a high quality of life. People receive the finest health care and benefit from the best educational systems in the world.

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Examples are Australia, Canada, Japan, New Zealand, the United States, all western European nations, and Greece. Newly Industrialized Countries (NICs) a. Recently increased the portion of national production and exports derived from industrial operations. b. Mainly in Asia and Latin America: Hong Kong, South Korea, Singapore, Taiwan, Brazil, China, India, Malaysia, Mexico, South Africa, and Thailand. c. Combining NICs with those having potential to become a NIC forms a category called emerging markets. Developing Countries a. Poor infrastructure and extremely low personal income. b. Rely on one or a few sectors of production—agriculture, mineral mining, or oil drilling. They often lack resources and skills. c. Mainly in Africa, the Middle East, and the poorest nations in Eastern Europe and Asia. d. Often characterized by technological dualism—use of the latest technologies in some sectors of the economy coupled with the use of outdated technologies in other sectors.

ECONOMIC TRANSITION Changing a nation’s fundamental economic organization and creating new free-market institutions. Typically involves several reforms: • Stabilize the economy, reduce budget deficits, and expand credit availability. • Allow prices to reflect supply and demand. • Legalize private business, sell state-owned firms, and support property rights. • Reduce barriers to trade and investment and allow currency convertibility. A.

Obstacles to Transition 1. Lack of Managerial Expertise a. Central planners had little need for management skills including production, distribution, pricing, and marketing strategies; investigating consumer wants and needs and conducting research; competitively pricing products; or advertising. b. Yet the gap in education and experience between managers from the former communist nations and others has narrowed. 2. Shortage of Capital a. Transition is expensive, requiring spending to: • Develop a telecommunications and infrastructure system, including highways, bridges, rail networks, and subways. • Set up financial institutions, including stock markets and a banking system. • Educate people in the ways of market economics. 3. Cultural Differences a. Transition causes cultural change and replaces dependence on the government with greater emphasis on individuals. b. Often are cuts in welfare, unemployment benefits, and guaranteed government jobs.

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Environmental Degradation a. Economic and social policies of former communist governments in Central and Eastern Europe were disastrous for the natural environment. b. Environmental destruction is evident in increased levels of sickness and disease, which cause lower productivity in the workplace.

Emerging Market Focus: Russia Russia’s experience with communism began in 1917. For 75 years, government controlled all aspects of production and distribution, including prices of labour, capital, and products. 1. Rough Transition a. In the 1980s Russia entered a new era of freedom of thought, freedom of expression, and economic restructuring. b. Except for criminals and the wealthy, people have difficulty maintaining their standard of living and buying necessities. c. Some Russians survive because they were factory managers under the old system and retained their jobs. Others have turned to the black market or organized crime. 2. Challenges Ahead for Russia a. Managers must improve skills in every facet of management practice, including financial control, research and development, employee hiring and training, marketing, and pricing. b. Political instability, especially nationalism. c. Nuclear weapons sales for cash can be lucrative, despite the clear threat to global security and Russia itself. d. Unstable investment climate causes uneasiness in Russia (e.g., arrest of Mikhail Khodorkovsky, then head of oil giant Yukos, for fraud, embezzlement, and tax evasion).

Think - Pair - Share, Slide 42 5.

BOTTOM LINE FOR BUSINESS Ongoing market reforms in formerly centrally planned and mixed economies have a profound effect on international business. Freer markets are spurring major shifts in manufacturing activity. Lured by low wages and growing markets, international companies are forging ties in newly industrialized countries and exploring opportunities in developing nations. Global capital markets make it easier to set up factories abroad, and some newly industrialized countries produce world-class competitors of their own.

Quick Study Questions Quick Study 1 (p. ???) 1.

Q: Define economic system. What is the relation between culture and economics? A: An economic system consists of the structure and processes that a country uses to allocate its resources and conduct its commercial activities. A nation’s economy tends to

Ch 5: Economics and Emerging Markets

express individual or group values as reflected in its history and culture. However, no economy is focused entirely on the group at the expense of individuals or vice versa. 2.

Q: What is a centrally planned economy? Describe the link between central planning and communism. A: A centrally planned economy is one in which a nation’s government owns most of the land, factories, and other economic resources and plans nearly all economic activity. Karl Marx popularized the idea of central economic planning in the nineteenth century while promoting his belief in communism. Marx argued that market economies cannot be reformed—governments must be overthrown and economies replaced with more equitable “communist” systems.

Q: Identify several factors that contributed to the decline of centrally planned economies. A: Factors included: (1) failure to create economic value, (2) failure to provide incentives, (3) failure to achieve rapid growth, and (4) failure to satisfy customer needs.

Q: Describe China’s experience with central planning, and the challenges it faces. A: China always reserved a place for private initiative even in the early days of its implementation of communism in 1949. Families in rural areas owned their own land. Each family’s crop production in excess of that dictated by central planners could be consumed by the family or sold on the open market. In 1979, the Chinese government strengthened work incentives in agriculture by allowing families to grow whatever crops they wanted and to sell the produce at market prices. The government also legalized township and village enterprises (TVEs) in 1984. Challenges ahead for China include: (1) Political and social problems loom, such as skirmishes between secular and Muslim Chinese, and restrictions on democracy. (2) Unemployment, slow economic progress in rural areas, and misery of migrant workers. (3) China’s one country, two systems policy must preserve order if Taiwan is ever going to freely accept reunification with the mainland.

Quick Study 2 (p. ???) 1.

Q: What is a mixed economy? Explain the origin of mixed economies. A: A mixed economy is one in which land, factories, and other economic resources are more equally split between private and government ownership. Support for mixed economies grew out of the belief that an economic system must protect society from the excesses of unchecked individualism and organizational greed.

Q: Explain the changes occurring in mixed economies and the role of privatization. A: The basic rationale underlying mixed economies is that a successful economic system must be not only efficient but also must protect society from excesses. Many mixed economies are beginning to mirror market-based systems. This is due in part to the need to be more competitive. By selling off government-owned businesses, nations are both embracing market-based economies and becoming more competitive from a tax and price perspective.

Q: Define what is meant by market economy and identify its three required features. A: A market economy is an economic system in which the majority of a country’s land, factories, and other economic resources are privately owned. To function smoothly, a market economy requires: (1) Free choice that gives individuals access to alternative purchasing options. (2) Free enterprise that gives companies the ability to decide which

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goods and services to produce and the markets in which to compete. (3) Price flexibility that allows most prices to rise and fall to reflect the forces of supply and demand. 4.

Q: Explain government’s role in a market economy. How are economic freedom and living standards related? A: In a market economy, the government has relatively little direct involvement in business activities. Even so, it usually plays an important role in four areas: enforcing antitrust laws, preserving property rights, providing a stable fiscal and monetary environment, and preserving political stability. The more economic freedom a country has, the higher its per capita income is, but economic freedom does not guarantee a high per capita income. Q: Do you consider Canada a mixed economy or a market economy? A: according to the 2013 Index of Economic Freedom, Canada is the sixth freest economy in the world, with an overall score of 79.4. Canada performs well in freedom from corruption, financial freedom, and regulation transparency. Canada has sound public finance management and a strong, stable democratic political system. The index refers to Canada as “one of the world’s leading free market economies.” However, Canada still has federal and provincial nontariff barriers, restrictions on agricultural products imports, import licensing in certain industries, and restrictions on foreign direct investment in sectors such as the media, telecommunications, fishing, mining, and aviation.

Quick Study 3 (p. ???) 1.

Q: What is meant by the term economic development? Explain the relation between productivity and living standards. A: Economic development is a measure for gauging the economic well-being of one nation’s people, as compared to that of another nation’s people. Three categories of nations regarding their levels of economic development are developed (e.g., Germany, Japan, and the United States), newly industrialized (e.g., India, Mexico, and Taiwan), and developing (e.g., Chad, Nicaragua, and Laos). Productivity can increase standards of living by bringing more wealth into a nation. Some experts argue that information technology (IT) can assist in the improvement of firm, and ultimately national, productivity and result in greater income at all levels. The Productivity Paradox refers to the lag between IT spending and productivity gains, which arise only after firms reorganize themselves around new technologies.

Q: Describe two measures of economic development and list their advantages and disadvantages. A: National production provides a good estimate of a nation’s overall wealth. It provides marketers with a broad indicator of whether a nation’s people are wealthy enough to purchase their products. It also gives managers an overall indicator of whether a nation has the level of development to support production facilities. But there are problems with national production as an indicator of economic development. First, estimates for the wealth generated in the official economy can be almost meaningless for countries with large, shadow economies or those that extensively employ barter. Second, national production figures alone do not tell whether an economy is growing, static, or shrinking. Third, national averages ignore differences between different regions within a nation. Fourth, simply converting national production figures at official exchange rates does not provide any indication of the quantity of goods that

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money can actually buy in an economy. Finally, this indicator takes into account only the financial well-being of a people. Purchasing power parity remedies the fourth disadvantage of national production figures. This modified national production indicator relays the quantity of goods that a person can buy in their own country using their own currency. The problem with this indicator of development is that it ignores other aspects of a people’s total well-being. 3.

Q: Explain the concept of purchasing power parity. What are its implications for a nation’s relative income per capita? A: (1) Purchasing power parity is the relative ability of two countries’ currencies to buy the same “basket” of goods in those two countries. It shows what a currency can actually buy in real terms. This basket of goods represents daily-use items such as apples, rice, and soap. (2) Purchasing power is the value of goods and services that can be purchased with one unit of a country’s currency. Purchasing power parity is the relative ability of two countries’ currencies to buy the same “basket” of goods in those two countries. If we convert Canadian dollars to US dollars at official exchange rates, we estimate Canada’s GDP per capita at $50 345. This is higher than the official GDP per capita of the United States ($48 112). But adjusting Canada’s GDP per capita for PPP gives us a revised figure of just $39 660, which is lower than the US GDP figure of $48 820. The opposite phenomenon occurs in Mexico. Because the cost of living there is lower than in Canada, Mexico’s GDP per capita rises from $10 047 to $15 390 when PPP is considered (see Table 5.1 ).

Q. Explain the concept of the Big Mac Index. What are the implications for a Canadian business trying to export its products? A: Big Mac Index An informal way of measuring the PPP is the Big Mac Index. It was introduced by The Economist in 1986 and is published every year. The Economist Big Mac Index is based on the theory of purchasing power parity (PPP). In this index, the “basket” is a McDonald’s Big Mac. By comparing actual exchange rates with PPPs, the index indicates whether a currency is under or overvalued. For example, the cheapest burger in the chart is in India, at $1.62, compared with an average Canadian price of $4.73 or an American price of $4.20. This implies that the rupee (India’s currency) is undervalued by about 60 percent. On the same basis, the Euro is overvalued by around 10 % and the Brazilian Real is overvalued by about 40% What are the implications for a Canadian business trying to export its products? Currency fluctuations can impact all facets of business from pricing to receivables to asset acquisition and disposal to profit and loss calculations

Quick Study 4 (p. ???) 1.

Q: Explain the value of the Human Development Index (HDI) in measuring a nation’s level of development. A: The United Nations Human Development Index (HDI) evaluates the extent to which a government equitably provides its people with a long and healthy life, an education, and a decent standard of living. This indicator goes beyond estimating only financial wealth and directly assesses human aspects of development.

Q: How are communicable diseases devastating human and economic development in some poor nations? A: A number of diseases create a serious challenge for poor nations and hamper the global economy. HIV/AIDS, tuberculosis, and malaria are rampant in some regions of the

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world. AIDS has killed more than 22 million people worldwide, tuberculosis kills 2 million people annually, and malaria kills between 1 and 3 million per year. 3.

Q: Identify the main characteristics of: (a) developed countries, (b) newly industrialized countries, (c) emerging markets, and (d) developing countries. A: (a) Developed countries are highly industrialized, highly efficient, and whose people enjoy a high quality of life. People in developed countries receive the finest health care and benefit from the best educational systems. Developed nations support aid programs to help poorer nations improve their economies and their standards of living. (b) Newly industrialized countries have recently increased the portion of national production and exports derived from industrial operations. In the past two decades, these countries have received an increasing share of total worldwide direct investment. (c) Emerging markets is the term for the group of countries formed by combining newly industrialized countries and countries that have the potential to become newly industrialized. They have developed some (but not all) of the operations and export capabilities associated with NICs. (d) Developing countries have poor infrastructures and low personal incomes. They may show potential for becoming newly industrialized countries, but typically lack the resources and skills to do so. They often rely for much of their wealth on production from one or a few sectors of the economy such as agriculture, mining, or oil.

Quick Study 5 (p. ???) 1.

Q: What are several reform measures that are involved in economic transition? A: Several reform measures include: (1) stabilize the economy, reduce budget deficits, and expand credit availability; (2) allow prices to reflect supply and demand; (3) legalize private business, sell state-owned companies, and support property rights; and (4) reduce barriers to trade and investment and allow currency convertibility.

Q: Describe some of the remaining obstacles to businesses in transitional economies. A: (1) A lack of managerial expertise caused by the fact that central planners formerly decided nearly every aspect of the nation’s commercial activities hampers progress today. There was little need for managers to learn management skills including how to develop production, distribution, pricing, and marketing strategies. (2) A shortage of capital presents special problems because of the high cost of economic transition. Governments of nations in transition can often only afford a portion of the required investment. These nations lack capital because of the disastrous financial management during the years of central planning. (3) Economic transition can be especially slow when a nation’s people find reform difficult for cultural reasons. In addition, importing modern management practices without tailoring them to the local culture can have serious consequences. (4) Environmental degradation caused by the headlong rush among transition economies to catch up to developed countries is leaving serious environmental damage in its wake. The direct effects of environmental destruction are evident in increased levels of sickness and disease, including asthma, blood deficiencies, and cancer—which obviously negatively impact national productivity.

Q: Explain Russia’s experience with economic transition. A: Russia’s experiment with communism lasted nearly 75 years beginning in 1917—a longer period than for any other centrally planned economy. Communism became so ingrained in Russian culture in part because it endured for so many generations. Also, Russia’s political and economic systems fell apart at the same time. The nation is now struggling to rebuild itself with new institutions. The political system is rife with

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corruption and contract killings of major political figures. The economy is in turmoil because of the government’s empty coffers—this being a direct result of its inability to collect taxes because of the very little business actually being done in the “official” economy. Inflation is one force that has hampered more rapid progress. Personal incomes and business profits are eaten away by rising prices and costs. Talk It Over 1.

Q: The Internet has penetrated many aspects of business and culture in developed countries, but it is barely available in many poor countries. Do you think this technology will widen the economic development gap between rich and poor countries? Why or why not? Is there a way for developing countries to use such technologies as tools for economic development? A: The dissemination of the Internet throughout developed nations could very well widen the economic development gap between themselves and developing nations. One reason is that the Internet is creating economic efficiencies in developed nations (particularly the United States). For example, companies can provide product information to potential buyers on the Internet any time of day or night that it is desired. The cost of having customer representatives attend to the basic needs of customers is therefore reduced. Then when potential buyers contact the company they can simply order the product they desire or request any last-minute information they may want. Potential buyers can even purchase certain products such as books, music, and prescription drugs over the Internet directly—eliminating the need for buyers to travel to a store and perhaps even eliminating the need for a “store” to have a physical retail presence. These costs are passed on to buyers in the form of lower prices. Money saved by conducting business over the Internet can be used for other purchases or invested in new private ventures or government projects. Developing nations not taking advantage of such efficiencies could potentially fall further behind developed nations.

Q: Imagine that you are the director of a major international lending institution supported by funds from member countries. What one area in newly industrialized and developing economies would be your priority for receiving development aid? Do you suspect that any member country will be politically opposed to aid in this area? Why or why not? A: An international lending institution could provide newly industrialized and developing countries two types of aid. It could provide aid in the areas of health, education, and the general welfare of the recipient nation’s people. These investments could include schools, hospitals, prenatal care, pregnancy prevention, and so on. Aid could also be designed to improve a nation’s infrastructure such as in granting or guaranteeing loans to build roads, bridges, ports, and telecommunications networks, for example. It is unlikely that member nations would object to the education and health care investments. However, nations could certainly object to infrastructure improvements if a member had disagreements with the political leadership in a recipient nation. The donor nation might hope that withholding economic aid to a nation might cause changes in the recipient nation’s political leadership or ideals.

Q: Two students are discussing the pros and cons of different measures of economic development. “GDP per capita,” declares the first, “is the only true measure of how developed a country’s economy is.” The second student counters: “I disagree. The only

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true measure of a country’s economic development is its people’s quality of life, regardless of its GDP.” Why is each of these students’ statements incorrect? A: Response to Student #1. Gross national product (GNP) per capita is a good estimate of a nation’s overall wealth. It provides marketers with a broad indicator of whether a nation’s people are wealthy enough to purchase their products. It also gives managers an overall indicator of whether a nation has the level of development to support production facilities. However, there are problems with national production as an indicator of economic development. First, estimates for the wealth generated in the official economy can be almost meaningless for countries with large, underground economies (black markets) or those that extensively employ barter. Second, national production figures alone do not tell whether an economy is growing, static, or shrinking. Third, national averages ignore differences between different regions within a nation. Fourth, simply converting national production figures at official exchange rates does not provide any indication of the quantity of goods that money can actually buy in an economy. Finally, this indicator takes into account only the financial well-being of a people. A: Response to Student #2. The second student attempts to broaden the measure of economic development beyond financial statistics. By trying to say that there are other, noneconomic factors involved in determining development, the student’s point is valid. For example, purchasing power parity relays the quantity of goods that a person can buy in their own country with their own currency. Also, human development indicators such as the United Nations Human Development Index (HDI) could be employed to estimate the extent to which a people have long and healthy lives, a solid education, and decent standards of living. As such, this indicator goes beyond financial wealth and assesses human aspects of development. The fundamental flaw that this student makes is to ignore the central role of a strong GNP per capita in elevating quality of life. In an attempt to emphasize nonfinancial aspects of development, the student has ignored the fundamental resource that allows a people to have long life spans, receive an excellent education, and have a high standard of living.

Practicing International Management Case Cuba Comes Off Its Sugar High 1.

Q: Why do you think the Cuban government requires non-Cuban businesses to hire and pay workers only through the government? Do you think it is ethical for non-Cuban businesses to enter into partnerships with the Cuban government? Why or why not? A: The Cuban government is clearly skimming off the top the difference between what it is being paid for workers and what is actually paid to workers. This allows the government to keep the people under its thumb because they continue to feel powerless with little or no voice in matters. The practice also allows the government to control where these profits go such as into the military, infrastructure, or perhaps into the private offshore bank accounts of politicians and powerful business leaders.

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Q: Do some research on Cuba, and describe a scenario for economic transition in the event that the current regime collapses. How do you think transition to a market economy in Cuba would differ from the experiences of Russia and China? A: There are obviously a large number of possible scenarios. Students should be encouraged to be creative, yet realistic. They should recognize several important differences between these nations. First, Cuba became communist in 1959 (versus 1917 for Russia) and this might mean that the roots of communism are shallower. Second, the tie with the United States is very strong with there being a large Cuban-American population waiting for economic reform to begin in Cuba so they can invest and help their people’s development. Although there are many Russian- and Chinese-Americans, their proportion is not as great as the proportion of Cuban-Americans relative to the population of Cuba. Third, because of the difference in size between Cuba and the United States, U.S. companies will likely dominate the Cuban landscape very quickly—the scale of which could not occur in Russia or China.

Q: How might a Canadian company and its shareholders be affected by the US anti-Cuba Act? A: The United States has enacted a law that permits U.S. companies to sue companies from other nations that traffic in the property of U.S. firms nationalized by Cuba. The law also empowers the U.S. government to deny entry visas to the executives of such firms as well as their families. Implementation and enforcement of this law, called the HelmsBurton Law, have been repeatedly suspended by the United States in fear of reprisals from Canada and European nations. Reasons for the continued embargo are rooted in politics and foreign relations. The main political argument is rooted in continued U.S. policy against allowing a communist nation to operate freely just 90 miles from the United States (the “not in this hemisphere” argument).

Q: The United States is Canada’s largest trading partner. Some Canadian businesses with large investments in the United States may want to support the US embargo on Cuba in order to protect their US investments. Can a Canadian company be sanctioned for honouring the US embargo? Please justify your answer. A: “The Foreign Extraterritorial Measures Act (FEMA) was enacted to counter certain countries’ attempts to apply their export control laws extraterritorially. It is largely an enabling statute to protect Canadian interests against foreign courts and governments. FEMA authorizes the Attorney General to make orders relating to measures of foreign states or foreign tribunals affecting international trade or commerce. The Attorney General has only issued one order (the “Cuba Order”). The Cuba Order is directed at the extraterritorial measures of the U.S. aimed at preventing trade and commerce between Canada and Cuba. More specifically, the Cuba Order was issued to address specific U.S. legislation which aims to prohibit the activities of U.S.-controlled entities domiciled outside the U.S., as they relate to Cuba (e.g. Canadian subsidiaries of U.S. companies). The Cuba Order requires every Canadian corporation, and every director and officer of a Canadian corporation, to provide notice to the Attorney General of Canada of any directive, instruction, intimation of policy, or other communication relating to an extraterritorial measure of the U.S. in respect of any trade or commerce between Canada

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and Cuba that the Canadian corporation, director or officer has received from a person who is in a position to direct or influence the policies of the Canadian corporation in Canada. Beyond the notice requirement, the Cuba Order prohibits any Canadian corporation from complying with any extraterritorial measure of the U.S., or with any directive or other communication relating to such a measure that the Canadian corporation has received from a person who is in a position to direct or influence the policies of the Canadian corporation in Canada. The result of these two jurisdictions’ competing legislation is conflicting and unless properly managed, can result in legal liability for both individuals and corporations.” See more at: http://www.doingbusinessincanada.com/legal-guide-0/importexportconsiderations-1/foreign-extraterritorial-measures-act-142#sthash.JyXKu5uf.dpuf

Ch 6: International Trade

CHAPTER 6 INTERNATIONAL TRADE LEARNING OBJECTIVES: 1. Describe the relation between international trade volume and world output and identify overall trade patterns. 2. Describe the political, economic, and cultural motives behind governmental intervention in trade. 3. List and explain the methods governments use to promote and restrict international trade. 4. Describe mercantilism and explain its impact on world powers and their colonies. 5. Explain the theories of absolute advantage and comparative advantage. 6. Explain the factor proportions and international product life cycle theories. 7. Explain the new trade and national competitive advantage theories.

CHAPTER OUTLINE: Introduction Overview of International Trade Benefits of International Trade Volume of International Trade Trade and World Output International Trade Patterns Who Trades with Whom? Trade Dependence and Independence Effect on Developing and Transition Nations Dangers of Trade Dependency Why Do Governments Intervene in Trade? Political Motives Protect Jobs Preserve National Security Respond To “Unfair” Trade Gain Influence Economic Motives Protect Infant Industries Pursue Strategic Trade Policy Cultural Motives Methods of Promoting Trade Subsidies Drawbacks Of Subsidies Export Financing Foreign Trade Zones Special Government Agencies Methods of Restricting Trade Tariffs Protect Domestic Producers Generate Revenue Quotas Reason For Import Quotas .

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Reasons For Export Quotas Tariff-Quotas Embargoes Local Content Requirements Administrative Delays Currency Controls Theories of International Trade Mercantilism How Mercantilism Worked Trade Surpluses Government Intervention Colonialism Flaws of Mercantilism Absolute Advantage Case: Riceland and Tealand Gains from Specialization and Trade Comparative Advantage Gains from Specialization and Trade Assumptions and Limitations Factor Proportions Theory Labor versus Land and Capital Equipment Evidence on Factor Proportions Theory: The Leontief Paradox International Product Life Cycle Stages of the Product Life Cycle Limitations of the Theory New Trade Theory First-Mover Advantage National Competitive Advantage Factor Conditions Advanced Factors Demand Conditions Related and Supporting Industries Firm Strategy, Structure, and Rivalry Government and Chance Bottom Line for Business Globalization and Trade Supporting Free Trade

A comprehensive set of specially designed PowerPoint slides is available for use with Chapter 6. These slides and the lecture outline below form a completely integrated package that simplifies the teaching of this chapter’s material. Lecture Outline 1.

INTRODUCTION This chapter explores international trade in goods and services, examining its benefits, volume, and patterns. It also explores the main theories of why nations trade. .

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OVERVIEW OF INTERNATIONAL TRADE International trade is the purchase, sale, or exchange of goods and services across national borders. One way to measure the importance of trade is to examine the volume of an economy’s trade relative to total output (see Map 6.1). A.

Benefits of International Trade International trade is an important engine for job creation in many countries. The Department of Foreign Affairs and International Trade Canada estimates that 20 percent of all jobs in Canada are directly or indirectly derived from exports. According to Statistics Canada, over 150,000 business establishments were engaged in goods importing in 2009. These businesses hired over 33 percent of the Canadian labour force Volume of International Trade Today world merchandise exports are valued at more than $18 trillion, and service exports at $4.1 trillion. 3 Table 6.1 shows the world’s largest exporters of merchandise and services. Trade in merchandise is around 80 percent of total trade; services, 20 percent. 1. Trade and World Output Slower world economic output slows international trade; higher output spurs trade. Trade slows in a recession as people are uncertain about the future and buy less. Also, when an economy is in recession, the currency is weak, slowing imports because they are more expensive.

International Trade Patterns Trade volume and world output provide insight into the international trade environment but do not disclose trading partners. Large ocean-going cargo vessels are needed to support these patterns in international trade and deliver merchandise from one shore to another. In fact, more than 90 percent of global trade is carried by sea, typically in containers 1. Who trades with whom? a. Trade among the world’s high-income economies accounts for roughly 60 percent of total world merchandise trade. b. Two-way trade between high-income countries and low- and middle-income nations accounts for about 34 percent of world merchandise trade. c. Intra-regional trade accounts for around 29 percent of Europe’s exports, 52 percent of Asia’s exports, and about 48 percent of North America’s exports.

Trade Dependence and Independence Countries lie on a scale, with total trade dependence at one end and total independence at the other. Complete independence was considered desirable from the sixteenth through eighteenth centuries, but is not desirable today. 1. Effect on Developing and Transition Nations Developing and transition nations often depend on their developed neighbors with whom they share borders. Germany is the single most important trading partner of central and eastern European nations. 2. Dangers of Trade Dependency If a nation experiences economic recession or political turmoil, the dependent nation can experience economic problems. Trade today is

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characterized by a certain degree of interdependency, which often reflects trade between a company’s subsidiaries. Canada has traditionally been dependent upon trade with the United States. Therefore, Canada’s economy suffers every time there is an economic recession in the United States, such as the one in 2009. More recently, the Canadian government has actively sought new trade agreements with other nations such as India, Japan, Korea, the European Union, Singapore, Morocco, and so forth. E.

Why Do Governments Intervene in Trade? In general, they do so for reasons that are political, economic, or cultural—or some combination of the three. Political Motives The main political motives behind government intervention in trade include protecting jobs, preserving national security, responding to other nations’ unfair trade practices, and gaining influence over other nations 1. Protect Jobs Short of an unpopular war, nothing will oust a government faster than high rates of unemployment. 2. Preserve National Security National Security and Imports Certain imports are often restricted in the name of preserving national security. In the event that a war would restrict their availability, governments must have access to a domestic supply of certain items such as weapons; fuel; and air, land, and sea transportation National Security and Exports Governments also have national security motives for banning certain defence-related goods from export to other nations. Most industrialized nations have agencies that review requests to export technologies or products that are said to have dual uses — meaning they have both industrial and military applications. Products designated as dual use are classified as such and require special governmental approval before export can take place. Products on the dual-use lists of most nations include nuclear materials; technological equipment; certain chemicals and toxins; some sensors and lasers; and specific devices related to weapons, navigation, aerospace, and propulsion. 3. Respond To “Unfair” Trade if one government thinks another nation is not “playing fair,” it will often threaten to retaliate unless certain concessions are made. 4. Gain Influence The United States goes to great lengths to gain and maintain control over events in all of Central, North, and South America, and the Caribbean basin. Economic Motives The most common economic reasons for nations’ attempts to influence international trade are the protection of young industries from competition and the promotion of a strategic trade policy. 5. Protect Infant Industries First, the argument requires governments to distinguish between industries that are worth protecting and those that are not. Second, protection from international competition can cause domestic companies to become complacent toward innovation. Third, protection can do more economic harm than good.

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Fourth, the infant industry argument also says that it is not always possible for small, promising companies to obtain funding in capital markets, and thus they need financial support from their government. 6. Pursue Strategic Trade Policy Benefits of Strategic Trade Policy Advocates claim that strategic trade policies helped South Korea build global conglomerates (called chaebol) that dwarf competitors Drawbacks of Strategic Trade Policy Although it sounds as if strategic trade policy has only benefits, there can be drawbacks as well. Lavish government assistance to domestic companies in the past caused inefficiency and high costs for both South Korean and Japanese companies. Large government concessions to local labour unions hiked wages and forced Korea’s chaebol to accept low profit margins. In addition, when governments decide to support specific industries, their choice is often subject to political lobbying by the groups seeking government assistance. It is possible that special interest groups could capture all the gains from assistance with no benefit for consumers. If this were to occur, consumers could end up paying more for lower-quality goods than they could otherwise obtain. 7. Cultural Motives Nations often restrict trade in goods and services to achieve cultural objectives, the most common being protection of national identity. Canada also tries to mitigate the cultural influence of entertainment products imported from the United States. Canada requires at least 35 percent of music played over Canadian radio to be by Canadian artists. In fact, many countries are considering laws to protect their media programming for cultural reasons. Methods of Promoting Trade 1. Subsidies Financial assistance to domestic producers in the form of cash payments, lowinterest loans, tax breaks, product price supports, or other forms is called a subsidy a. Drawbacks Of Subsidies Critics say that subsidies encourage inefficiency and complacency by covering costs that truly competitive industries should be able to absorb on their own. 2. Export Financing Governments often promote exports by helping companies finance their export activities 3. Foreign Trade Zones A designated geographic region through which merchandise is allowed to pass with lower customs duties (taxes) and/or fewer customs procedures 4. Special Government Agencies The governments of most nations have special agencies responsible for promoting exports. Such agencies can be particularly helpful to small and medium-sized businesses that have limited financial resources Methods of Restricting Trade There are two general categories of trade barriers available to governments. A tariff is a government tax levied on a product as it enters or leaves a country. A restriction on the amount (measured in units or weight) of a good that can enter or leave a country during a certain period of time is called a quota. After tariffs, quotas are the second most common type of trade barrier.

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Tariffs a. Protect Domestic Producers an import tariff raises the cost of an imported good and increases the appeal of domestically produced goods b. Generate Revenue Tariffs are also a source of government revenue, but mostly among developing nations. Quotas Restriction on the amount (measured in units or weight) of a good that can enter or leave a country during a certain period of time. a. Reason For Import Quotas A government may impose an import quota to protect its domestic producers by placing a limit on the amount of goods allowed to enter the country. b. Reasons For Export Quotas There are at least two reasons why a country imposes export quotas on its domestic producers. First, it may wish to maintain adequate supplies of a product in the home market. This motive is most common among countries that export natural resources that are essential to domestic business or the long-term survival of a nation. Second, a country may limit the export of a good to restrict its supply on world markets, thereby increasing the international price of the good. i. voluntary export restraint (VER) Unique version of export quota that a nation imposes on its own exports, usually at the request of an importing nation. c. Tariff-Quotas A hybrid form of trade restriction is called a tariff-quota —a lower tariff rate for a certain quantity of imports and a higher rate for quantities that exceed the quota. Embargoes Complete ban on trade (imports and exports) in one or more products with a particular country. Local Content Requirements The purpose of local content requirements is to force companies from other nations to use local resources in their production processes—particularly labour. Administrative Delays Regulatory controls or bureaucratic rules designed to impair the flow of imports into a country. Currency Controls Restrictions on the convertibility of a currency into other currencies.

Think-Pair-Share – slide 19 H.

THEORIES OF INTERNATIONAL TRADE It was not until the fifteenth century that people tried to explain why trade occurs. Efforts continue to refine existing trade theories and develop new ones (Figure 5.1). 1.

Mercantilism Nations should accumulate financial wealth, usually in the form of gold, by encouraging exports and discouraging imports. Other measures of a nation’s well-being, such as living standards or human development, are irrelevant. It was

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practiced from around 1500 to the late 1700s by European nations, including Britain, France, the Netherlands, Portugal, and Spain. a. How Mercantilism Worked Trade was to benefit mother countries; colonies (in Africa, Asia, and North, South, and Central America) were exploitable resources. i. Trade Surpluses Nations increased wealth through a trade surplus—when the value of a nation’s exports exceeds the value of imports. Trade deficits were to be avoided at all costs. ii. Government Intervention Governments intervened in international trade to maintain a trade surplus. They banned certain imports, imposed tariffs or quotas, and subsidized home-based industries to expand exports. Removal of gold and silver from the nation was outlawed. iii. Colonialism Mercantilist nations acquired colonies as sources of inexpensive raw materials and markets for higher-priced finished goods. Trade between mercantilist nations and their colonies expanded wealth and created armies and navies to control colonial empires and protect shipping.

Flaws of Mercantilism The main problem with mercantilism is that it viewed international trade as a zero-sum game—a nation benefits only at the expense of other nations. But if all nations barricade their markets from imports and push their exports onto others, international trade would be severely restricted. Also, it kept colonial markets poor: they received little money for raw materials but were charged high prices for finished goods.

Absolute Advantage Absolute advantage is the ability of a nation to produce a good more efficiently than any other nation (produce a greater output using the same, or fewer, resources). Adam Smith reasoned that international trade should not be burdened by tariffs and quotas, but should flow according to market forces. A country should produce the goods in which it holds an absolute advantage and trade with others to obtain the goods it needs but does not produce efficiently. a. Case: Riceland and Tealand In a world of two countries (Riceland and Tealand) with two products (rice and tea) where transport costs nothing, each produces and consumes its own rice and tea. In Riceland, 1 resource unit produces a ton of rice, but 5 units are needed to produce a ton of tea. In Tealand, 6 resource units produce a ton of rice, but 3 units are needed to produce a ton of tea. Thus, Riceland has an absolute advantage in rice production and Tealand has an absolute advantage in tea production. i. Gains from Specialization and Trade Although each country now specializes and world output increases, both countries face a problem: Riceland consumes only its rice and Tealand consumes only its tea. The problem can be resolved through trade.

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Although Tealand does not gain as much as Riceland, it gets more rice than it would without trade. Actual gains depend on the total resources of each country and the demand for each good in each country (Figure 6.3). The theory of absolute advantage destroys the mercantilist idea that international trade is a zero-sum game. Because both countries gain, international trade is a positive-sum game. The theory argues against restrictive trade policies and for nations to instead open their doors to trade so their people obtain more goods more cheaply in order to raise living standards. 3.

Comparative Advantage Comparative advantage is the inability of a nation to produce a good more efficiently than other nations, but an ability to produce that good more efficiently than it does any other good. Thus, trade is still beneficial even if one country is less efficient in the production of two goods, as long as it is less inefficient in the production of one of the goods. i. Gains from Specialization and Trade Suppose that Riceland now holds absolute advantages in the production of both rice and tea. In Riceland, 1 resource unit produces a ton of rice but 2 are needed to produce a ton of tea. In Tealand, 6 resource units still produce a ton of rice, and 3 units are still needed to produce a ton of tea. Thus, Riceland has absolute advantages in producing both goods. Although Tealand has absolute disadvantages in rice and tea, it has a comparative advantage in tea; Tealand produces tea more efficiently than it produces rice. By specializing and trading, Tealand gets double the rice than if it produced the rice itself, and Riceland gets twice as much tea than if it produced the tea itself (Figure 5.3). Assumptions and Limitations a. Assumes countries are only driven by the maximization of production and consumption. Governments get involved in trade for many reasons (e.g., concerns for workers or consumers). b. Assumes only two countries engaged in the production and consumption of two goods. In reality, more than 180 countries and countless products are produced, traded, and consumed. c. Assumes no transportation costs. In reality, transportation costs are a major expense of international trade. d. Assumes labor is the only resource for production and is mobile within each nation but cannot be transferred. Other resources are clearly needed in production and labor is becoming more mobile. e. Assumes specialization does not result in efficiency gains. In fact, specialization results in increased knowledge of a task and future improvements. Factor Proportions Theory Factor proportions theory states that countries produce and export goods that require resources (factors) that are abundant and import goods that require resources in short supply. Thus, the theory focuses on the productivity of the production process.

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Labor versus Land and Capital Equipment a. Factor proportions theory breaks resources into two categories: (1) labor, and (2) land and capital equipment. It predicts that a country will specialize in products that require labor if labor cost is low relative to land and capital costs, and vice versa. b. Factor proportions theory is conceptually appealing (e.g., Australia has much land and a small population; its exports consist of products that require much land whereas imports consist of manufactured and consumer goods). Evidence on Factor Proportions Theory: The Leontief Paradox a. Theory not supported by studies that examine trade flows. b. Wassily Leontief tested whether the United States, which uses an abundance of capital equipment, exports goods requiring capitalintensive production and imports goods requiring labor-intensive production. He found U.S. exports require more labor-intensive production than its imports; called the Leontief Paradox. c. One explanation is that factor proportions theory considers a country’s production factors to be homogeneous—particularly labor. But labor skills vary greatly within a country.

International Product Life Cycle The international product life cycle theory states that a company will begin exporting its product and later undertake foreign direct investment as the product moves through its life cycle (a country’s export eventually becomes its import). 1. Stages of the Product Life Cycle a. In the new product stage, stage 1, high purchasing power and demand of buyers spur a company to design and introduce a new product concept (Figure 5.4). Although initially there is virtually no export market, exports increase late in the new product stage. b. In the maturing product stage, stage 2, the domestic market and markets abroad become fully aware of the existence of the product and its benefits. Demand rises and is sustained over a fairly lengthy period of time. Near the end of the maturity stage, the product generates sales in developing nations, and manufacturing is established there. c. In the standardized product stage, stage 3, competition from other companies selling similar products pressures companies to lower prices in order to maintain sales levels. An aggressive search for low-cost production bases abroad begins and the home market may begin importing. 2. Limitations of the Theory a. The United States is no longer the sole innovator of products in the world; new products spring up everywhere as the research and development activities globalize. b. Companies today design new products and make product modifications at a very quick pace. c. Companies introduce products in many markets simultaneously to recoup a product’s research and development costs before sales decline.

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The theory is challenged by the fact that more companies are operating in international markets from their inception. The Internet has made this easier particularly for small and midsize companies. Also, small companies are more often teaming up with companies in other markets to develop new products or production technologies. Yet the theory retains explanatory power when applied to technology-based products that are eventually mass-produced.

New Trade Theory New trade theory argues: (1) there are gains to be made from specialization and increasing economies of scale; (2) companies first to market can create barriers to entry; and (3) government may play a role in assisting its home-based companies. It emphasizes productivity rather than resources. 1. First-Mover Advantage a. As specialization and output increase, companies realize economies of scale, and unit production costs decline. Then companies expand, lower prices, and force competitors to produce at a similar level of output to be competitive. b. A first-mover advantage is the economic and strategic advantage gained by being the first company to enter an industry. It creates a barrier to entry for potential rivals and may allow a country to dominate in a product. c. Some make a case for government assistance; by working together to target new industries, a government and its homebased companies can be the first mover in an industry.

National Competitive Advantage National competitive advantage theory states that a nation’s competitiveness in an industry depends on the capacity of the industry to innovate and upgrade. This theory attempts to explain why some nations are more competitive in certain industries. The Porter Diamond (the basis of national competitiveness) consists of: (1) factor conditions; (2) demand conditions; (3) related and supporting industries; and (4) firm strategy, structure, and rivalry. 1. Factor Conditions Porter acknowledges the importance of basic factors (such as labor, natural resources, climate, and surface features) in what a country produces and exports, but adds the significance of advanced factors. a. Advanced Factors Include skill levels of the workforce and quality of the technological infrastructure. Account for the sustained competitive advantage that a country enjoys in a product. 2. Demand Conditions a. Sophisticated buyers in the home market are important to national competitive advantage in a product area. A sophisticated domestic market drives companies to modify existing products to include new design features and develop new products and technologies. 3. Related and Supporting Industries a. Companies in internationally competitive industries do not exist in isolation. Supporting industries provide inputs, forming

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clusters of related activities in the same region that reinforce productivity and competitiveness. b. Exporting clusters are those that export products or make investments to compete outside the local area and can lead to long-term prosperity. Firm Strategy, Structure, and Rivalry a. Strategic decisions of firms have lasting effects on future competitiveness, but equally important is industry structure and rivalry between companies. b. The more intense the struggle to survive between domestic companies, the greater is their competitiveness. This heightened competitiveness helps them to compete against imports and against companies that might develop a production presence in the home market. Government and Chance a. Government policies toward industry and export and import regulations can hurt or help competitiveness. b. Chance events also can influence national competitiveness; they can help competitiveness or threaten it. c. Porter’s theory holds promise but has just begun to be subjected to research using actual data on each of the factors involved and national competitiveness.

BOTTOM LINE FOR BUSINESS This chapter explores the benefits of international trade and its volume and pattern in the world today. Trade can free a nation’s entrepreneurial spirit and bring economic development. As the value and volume of trade continues to expand worldwide, new theories will likely emerge to explain why countries trade and why they have advantages in producing certain products.

Think-Pair-Share – slide 43 Quick Study Questions Quick Study 1 (p. ???) 1.

Q: What portion of world trade occurs in (a) merchandise and (b) services? A: Merchandise (manufactured goods and other physical products) accounts for about 80 percent of worldwide trade; services account for the remaining 20 percent.

Q: What is the relation between trade and world output? A: The volume of international trade outstrips growth in world output. The level of world output of any given year influences the level of international trade in that year. Output and world trade move together. If a country is in recession, people make fewer purchases because of uncertainty about the future and a typically weaker currency relative to other currencies.

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Q: Describe the broad pattern of international trade. A: Trade among the world’s high-income economies accounts for roughly 60 percent of total world merchandise trade. Two-way trade between high-income countries and lowand middle-income nations accounts for about 34 percent of world merchandise trade. Intraregional trade accounts for nearly 70 percent of Europe’s exports, 56 percent of Asia’s exports, and 38 percent of North America’s exports. Some economists call this century the “Pacific century,” referring to the expected future growth of Asian economies and the expected shift in trade flows from the Atlantic to the Pacific Ocean.

Q: Why is a nation’s level of trade dependence or independence important? A: Developing and transition nations that share borders with developed countries are often dependent upon their wealthier neighbors. A nation’s level of trade dependence is important because recession or political turmoil in the dominant nation can cause problems for the dependent nation. Countries try to reduce their dependence on other nations. The level of interdependency between pairs of countries is often reflected by the amount of trade that occurs between a company’s subsidiaries in the two nations.

Quick Study 2 (p. ???) 1.

Q: What are some political reasons why governments intervene in trade? A: In general, they do so for reasons that are political, economic, or cultural—or some combination of the three. Explain the role of national security concerns. In the event that a war would restrict their availability, governments must have access to a domestic supply of certain items such as weapons; fuel; and air, land, and sea transportation. Most industrialized nations have agencies that review requests to export technologies or products that are said to have dual uses —meaning they have both industrial and military applications. Q: Identify the main economic motives for government trade intervention. What are the drawbacks of each method of intervention? 1. A: Political Motives a. The main political motives behind government intervention in trade include protecting jobs, preserving national security, responding to other nations’ unfair trade practices, and gaining influence over other nations 2. Protect Jobs a. Short of an unpopular war, nothing will oust a government faster than high rates of unemployment. 3. Preserve National Security a. National Security and Imports Certain imports are often restricted in the name of preserving national security. In the event that a war would restrict their availability, governments must have access to a domestic supply of certain items such as weapons; fuel; and air, land, and sea transportation b. National Security and Exports Governments also have national security motives for banning certain defence-related goods from export to other nations. Most industrialized nations have agencies that review requests to export technologies or products that are said to have dual uses — meaning they have both industrial and military applications. Products designated as dual use are classified as such and require special governmental approval before export can take place. Products on the dual-use lists of most nations include nuclear materials; technological equipment; certain chemicals and toxins; some sensors and lasers; and specific devices related to weapons, navigation, aerospace, and propulsion.

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4. Respond To “Unfair” Trade a. if one government thinks another nation is not “playing fair,” it will often threaten to retaliate unless certain concessions are made. 5. Gain Influence a. The United States goes to great lengths to gain and maintain control over events in all of Central, North, and South America, and the Caribbean basin. 6. Economic Motives a. The most common economic reasons for nations’ attempts to influence international trade are the protection of young industries from competition and the promotion of a strategic trade policy. 7. Protect Infant Industries a. First, the argument requires governments to distinguish between industries that are worth protecting and those that are not. b. Second, protection from international competition can cause domestic companies to become complacent toward innovation. c. Third, protection can do more economic harm than good. 8. Pursue Strategic Trade Policy a. Benefits of Strategic Trade Policy Advocates claim that strategic trade policies helped South Korea build global conglomerates (called chaebol ) that dwarf competitors b. Drawbacks of Strategic Trade Policy Although it sounds as if strategic trade policy has only benefits, there can be drawbacks as well. Lavish government assistance to domestic companies in the past caused inefficiency and high costs for both South Korean and Japanese companies. Large government concessions to local labour unions hiked wages and forced Korea’s chaebol to accept low profit margins. In addition, when governments decide to support specific industries, their choice is often subject to political lobbying by the groups seeking government assistance. It is possible that special interest groups could capture all the gains from assistance with no benefit for consumers. If this were to occur, consumers could end up paying more for lower-quality goods than they could otherwise obtain. 9. Cultural Motives a. Nations often restrict trade in goods and services to achieve cultural objectives, the most common being protection of national identity. 3.

Q: What cultural motives do nations have for intervening in free trade? A: Nations often restrict trade in goods and services to achieve cultural objectives, the most common being protection of national identity

Quick Study 3 (p. ???) 1. Q: How do governments use subsidies to promote trade? Identify the drawbacks of subsidies. A: Subsidies Financial assistance to domestic producers in the form of cash payments, lowinterest loans, tax breaks, product price supports, or other forms is called a subsidy Drawbacks Of Subsidies Critics say that subsidies encourage inefficiency and complacency by covering costs that truly competitive industries should be able to absorb on their own.

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Q: How does export financing promote trade? Explain its importance to small and medium-sized firms. A: Export Financing Governments often promote exports by helping companies finance their export activities. They can offer loans that a company could otherwise not obtain or charge them an interest rate that is lower than the market rate.

Q: Define the term foreign trade zone. How can it be used to promote trade? A: Foreign Trade Zones A designated geographic region through which merchandise is allowed to pass with lower customs duties (taxes) and/or fewer customs procedures

Q: How can special government agencies help promote trade? A: Special Government Agencies The governments of most nations have special agencies responsible for promoting exports. Such agencies can be particularly helpful to small and medium-sized businesses that have limited financial resources

Quick Study 4 (p. ???) 1. Q: How do tariffs and quotas differ from one another? Identify the different forms each can take. A: A tariff is a government tax levied on a product as it enters or leaves a country. A restriction on the amount (measured in units or weight) of a good that can enter or leave a country during a certain period of time is called a quota. ad valorem tariff Tariff levied as a percentage of the stated price of an imported product. specific tariff Tariff levied as a specific fee for each unit (measured by number, weight, and so forth) of an imported product. compound tariff Tariff levied on an imported product and calculated partly as a percentage of its stated price and partly as a specific fee for each unit. 2.

Q: Describe how a voluntary export restraint works and how it differs from a quota. A: voluntary export restraint (VER) Unique version of export quota that a nation imposes on its own exports, usually at the request of an importing nation.

Q: What is an embargo? Explain why it is seldom used today. A: Complete ban on trade (imports and exports) in one or more products with a particular country. Because they can be very difficult to enforce, embargoes are used less today than they have been in the past.

Q: Explain how local content requirements, administrative delays, and currency controls restrict trade. A: local content requirements such requirements help protect domestic producers from the price advantage of companies based in other, low-wage countries. administrative delays Regulatory controls or bureaucratic rules designed to impair the flow of imports into a country. currency controls Restrictions on the convertibility of a currency into other currencies.

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Quick Study 5 (p. ???) 1.

Q: How did mercantilism work? Identify its three essential pillars. A: Mercantilism states that nations should accumulate financial wealth, usually in the form of gold, by encouraging exports and discouraging imports. Mercantilism was based on colonial powers conducting trade for their own benefit, with colonies being generally treated as exploitable resources. Countries implemented mercantilism by maintaining trade surpluses, active government intervention, and practicing colonization. The three pillars were: (1) trade surpluses, (2) government intervention, and (3) colonialism.

Q: What types of policies might a country have in place to be called neo-mercantilist? A: Today, countries seen as trying to maintain a trade surplus and expanding their national treasuries at the expense of other nations are accused of being neo-mercantilist. Specific policies that can give a nation this label include restrictive import barriers such as quotas and high tariffs, subsidies to domestic companies so they can expand exports, and “dumping” goods in the markets of trading partners, just to name a few.

Q: Describe the main flaws of mercantilism. What is meant by the term zero-sum game? A: One of the main flaws of mercantilism is that it viewed international trade as a zerosum game—that one nation can benefit only at the expense of others. But if all nations barricaded their markets from imports and push their exports onto others, international trade would be severely restricted. Also, colonial policies kept potential markets poor because they received little money for raw materials but were charged high prices for finished goods. Thus, markets of colonial powers always had limited potential.

Quick Study 6 (p. ???) 1.

Q: What is meant by the term absolute advantage? Describe how it works using a numerical example. A: An absolute advantage is the ability of a nation to produce a good more efficiently than any other nation. The theory emphasizes productivity. Chapter 5 (pp. 147–149) outlines the method that a numerical example should follow with Riceland and Tealand.

Q: What is meant by the term comparative advantage? How does it differ from an absolute advantage? A: A comparative advantage is the inability of a nation to produce a good more efficiently than other nations, but an ability to produce that good more efficiently than it does any other good. This is different from an absolute advantage in that it focuses on production efficiency within nations, not just between nations. [See Chapter 5 (pp. 149– 151) for a numerical example of Riceland and Tealand.]

Q: Explain why countries can gain from trade even without having an absolute advantage. A: Trade between two nations can still be beneficial even if one country is less efficient in the production of two goods, so long as it is less inefficient in the production of one of the goods. Even when one country is more efficient at producing both of the goods in question, both nations benefit from trade because of the gains from specialization. The country more efficient at producing both goods still gets more after specialization and trade than it would if it were to produce both goods on its own.

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Quick Study 7 (p. ???) 1.

Q: What does the factor proportions theory have to say about a nation’s imports and exports? A: Factor proportions theory says countries produce and export goods that require resources that are abundant and import goods that require resources in short supply.

Q: Identify the two categories of national resources in factor proportions theory. What is the Leontief Paradox? A: The theory states that a nation has two types of resources at its disposal: land on the one hand and labor and capital equipment on the other. The theory predicts that a country will specialize in products that require labor if the cost of labor is low relative to the cost of land and capital, and vice versa. The Leontief Paradox reflects the gap between the predictions using this theory and the actual trade flows in the world economy.

Q: What are the three stages of the international product life cycle theory? Identify its limitations. A: The international product life cycle theory states that a company will begin by exporting its product and later undertake foreign direct investment as the product moves through its life cycle. In the new product stage, high purchasing power and demand of buyers in an industrialized country spurs a company to design and introduce a new product concept and production remains at home. In the maturing product stage, the domestic and markets abroad become aware of the existence of the product and its benefits. Exports rise and some production in markets abroad may begin. In the standardized product stage, competition from other companies selling similar products pressures companies to lower prices in order to maintain sales levels. An aggressive search for low-cost production bases abroad begins and the home market may even begin importing from these other markets. Limitations include the U.S. bias of the theory, the speed in which firms today create new products, and the fact that today more firms actually are operating internationally since their inceptions.

Quick Study 8 (p. ???) 1.

Q: What is the new trade theory? Explain what is meant by the term first-mover advantage. A: The new trade theory argues that: (1) there are gains to be had from specialization and increasing economies of scale; (2) those companies first to market can create barriers to entry; and (3) government may have a role to play in assisting its home-based companies. A first-mover advantage is the economic and strategic advantage gained by being the first company to enter an industry.

Q: Describe the national competitive advantage theory. What is an “advanced” factor? A: National competitive advantage theory states that a nation’s competitiveness in an industry depends on the capacity of the industry to innovate and upgrade. An “advanced” factor is indicative of factors such as skill levels of workers and the quality of technology in a nation.

Q: What are the four elements and two influential factors of the Porter Diamond? A: The Porter Diamond consists of four elements that form the basis of competitiveness, plus the roles of government and chance. Factor conditions include a nation’s basic .

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factors (e.g., land, labor, and natural resources) and advanced factors (e.g., skills of the workforce, technological infrastructure). Today, advanced factors are increasingly important to competitiveness. Demand conditions refer to the sophistication of buyers in a market—finicky buyers help a nation to be more competitive. Related and supporting industries that spring up around a competitive industry form geographic clusters of related economic activity that reinforce productivity and competitiveness. Firm strategy, structure, and rivalry also influence competitiveness. Managers committed to producing quality products and an industry structure that intensifies firm rivalry will help improve competitiveness. Government and chance play roles in fostering the competitiveness of industries. Government policies toward industry and export and import regulations can hurt or help competitiveness. Chance events also can influence national competitiveness. Talk It Over 1.

Q: If the nations of the world were to suddenly cut off all trade with one another, what products might you no longer be able to obtain in your country? Choose one other country, and identify the products it would need to do without. A: Students should be encouraged to think not just of consumer goods, but industrial products and services that would be unavailable to them and people in other nations. To expand this question, ask students to discuss how the absence of these products would influence their own standards of living, the activities of domestic companies, and, perhaps, the functioning of their own and other governments.

Q: Many economists believe that China will soon achieve “superpower” status because of its economic reforms, along with the work ethic and high education of its population. How is the rise of China affecting trade among Asia, Europe, and North America? A: Reasons for the twenty-first century often being dubbed the “Pacific Century” lie in the economic performance of Asian economies in recent decades. Rapid growth in national output among Asian nations is causing these nations to account for a growing portion of world output and trade. Meanwhile, as personal incomes rise across Asia, products flowing from Canada, the United States, and low-cost production bases in Mexico cross the Pacific Ocean in the opposite direction. Thus, the amount of goods crossing the Pacific is expected to be far greater than the amount of goods crossing the Atlantic Ocean in the twenty-first century.

Q: Despite its abundance of natural resources, Brazil was once considered an economic “basket case.” Yet in recent years Brazil’s economy has performed very well. What forces do you think are propelling Brazil’s economic progress? A: Significant to Brazil’s recent rise is its elimination of hyperinflation. Thus, many consumers are able to afford consumer products such as televisions and refrigerators for the first time in their lives. Hyperinflation had been a persistent problem, holding back any hope of strengthening the nation’s economy. Since then, Brazil has successfully pulled itself through a prolonged economic recession and enjoys low unemployment and inward flowing investment.

Q: Discuss which industries are Canada’s main export industries based on national competitive advantage. A: The Canadian province of Ontario is home to the Ontario Food Cluster, the largest food and beverage processing jurisdiction in Canada and the second-largest in North .

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America. The Ontario Food Cluster’s mission is to grow its national dominance in the food industry to international dominance. 24 Ontario’s expanding agri-food cluster includes internationally focused companies such as General Mills Canada, H.J. Heinz Company of Canada, Labatt Breweries of Canada, Maple Leaf Foods, Kellogg Canada, Saputo, Sleeman Breweries, Dare Foods, Ferrero Canada, Dr. Oetker Canada, McCormick Canada, Cargill Canada, George Weston Ltd., and Unilever. Canada is also home to two wine clusters, one in Ontario’s Niagara region and the other in British Columbia’s Okanagan region. The BC Okanagan wine cluster has been crucial for growth in the region, prompting the establishment of small wineries that are working together to establish an international reputation for good quality wine by launching a certification system and attracting tourism to the Okanagan.

Practicing International Management Case Down with Dumping First in Asia and the World Q: “You can’t tell consumers that the low price they are paying for that fax machine or automobile is somehow unfair. They’re not concerned with the profits of some company. To them, it’s just a great bargain, and they want it to continue.” Do you agree with this statement? Do you think that people from different cultures would respond differently to this statement? Explain your answers. A: It would seem most people support free trade and the resulting benefits, until it impacts them in a negative way. As an example, most Canadian consumers would gladly pay $1000’s less for a new car purchased in the United States. However those employed in the Canadian auto dealerships vigorously oppose this purchase behavior. http://www.huffingtonpost.ca/2013/11/22/canadian-car-buyers-blockedus_n_4322200.html?utm_hp_ref=canada-business

It is likely this is a universal response as is evidenced by “On average, 234 antidumping cases are initiated each year with nearly 70 percent of disputes being settled by negotiation. And whereas the United States and the European Union initiated half of all WTO cases in prior years, they now initiate only about a quarter of all cases.” Q: As we have seen, currently the WTO cannot get involved in punishing individual companies—its actions can only be directed toward governments of countries. Do you think this is a wise policy? Why or why not? Why do you think the WTO was not given authority to charge individual companies with dumping? Explain. A: The WTO is a government supported body and makes decisions at a National Level which apply to all companies within an industry. It would be inefficient and unruly to have the WTO making a number of rulings on behalf of multiple companies within the same industry.

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Q: Identify a recent Canadian antidumping case that was brought before the WTO (different from the ones mentioned in the case). Locate as many articles in the press as you can that discuss the case. Identify the nations, product(s), and potential punitive measures involved. If you were part of the WTO dispute settlement body, would you vote in favour of the measures taken by the retaliating nation? Why or why not? A: Student activity

Ch 7: Foreign Direct Investment

CHAPTER 7 FOREIGN DIRECT INVESTMENT LEARNING OBJECTIVES: 1. Describe worldwide patterns of foreign direct investment and reasons for these patterns. 2. Describe each of the theories that attempt to explain why foreign direct investment occurs. 3. Discuss the important management issues in the foreign direct investment decision. 4. Explain why governments intervene in the free flow of foreign direct investment. 5. Discuss the policy instruments that governments use to promote and restrict foreign direct investment.

CHAPTER OUTLINE: Introduction Patterns of Foreign Direct Investment Ups and Downs of Foreign Direct Investment Globalization Mergers and Acquisitions Worldwide Flows of FDI Canada Flows of FDI Explanations for Foreign Direct Investment International Product Life Cycle Market Imperfections (Internalization) Trade Barriers Specialized Knowledge Eclectic Theory Market Power Management Issues in the FDI Decision Control Partnership Requirements Benefits of Cooperation Purchase-or-Build Decision Production Costs Rationalized Production Mexico’s Maquiladora Cost of Research and Development Customer Knowledge Following Clients Following Rivals Government Intervention in Foreign Direct Investment Balance of Payments Current Account Capital Account Reasons for Intervention by the Host Country Control Balance of Payments Obtain Resources and Benefits Access to Technology Management Skills and Employment .

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Reasons for Intervention by the Home Country Government Policy Instruments and FDI Host Countries: Promotion Financial Incentives Infrastructure Improvements Host Countries: Restriction Ownership Restrictions Performance Demands Home Countries: Promotion Home Countries: Restriction Bottom Line for Business

A comprehensive set of specially designed PowerPoint slides is available for use with Chapter 7. These slides and the lecture outline below form a completely integrated package that simplifies the teaching of this chapter’s material. Lecture Outline 1.

INTRODUCTION Foreign direct investment (FDI) is the purchase of physical assets or a significant amount of the ownership (stock) of a company in another country to gain a measure of management control. It differs from portfolio investment—an investment that does not involve obtaining a degree of control in a company. Most governments set the threshold for an investment to be called FDI at anywhere from 10 to 25 percent of stock ownership in a company abroad. Interestingly—the U.S. Commerce Department sets it at 10 percent.

PATTERNS OF FOREIGN DIRECT INVESTMENT A. Ups and Downs of Foreign Direct Investment FDI inflows grew by about 30 percent through the 1990s. FDI peaked at $1.4 trillion in 2000, slowed for a few years, and then rebounded in 2004, 2005, 2006, and reached an all-time high of $1.9 trillion in 2007 (see Figure 7.1). Global FDI inflows slowed considerably during the global credit crisis of 2008–2009 amid shrinking corporate profits and plummeting stock prices. However, FDI inflows started to recover during 2010 and 2011, and are expected to keep rising as the global economy emerges from recession. The long-term trend points toward greater FDI inflows worldwide, which are expected to reach between $1.7 trillion and $2.1 trillion by the end of 2014. 1. Globalization Companies got around trade barriers in the 1980s through FDI. a. Uruguay Round of GATT further cut trade barriers, letting firms b. produce in the most efficient locations and export to markets. Set off further FDI into newly industrialized and emerging markets. c. Globalization also lets emerging-market companies use FDI. 2. Mergers and Acquisitions a. M&As and their rising values propelled long-term growth in FDI, but are falling off lately due to global credit crisis. .

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Power of largest multinationals seems to multiply each year. Many cross-border M&A deals are done to: i. Get a foothold in a new geographic market ii. Increase a firm’s global competitiveness iii. Fill gaps in companies’ product lines in a global industry iv. Reduce costs in R&D, production, or distribution Entrepreneurs and small businesses also engage in FDI and account for more of its growth.

Worldwide Flows of FDI 1. More than 82,000 MNCs with more than 810,000 affiliates drive FDI flows. 2. In terms of share of global FDI inflows, developed countries account for about 57 percent, and developing countries account for about 37 percent. 3. The EU, United States, and Japan attract the vast amount of world FDI inflows. 4. FDI inflows to developing nations were mixed, with China attracting most in Asia and India attracting a fair amount. 5. Outflows of FDI from developing nations also on the rise.

Canada’s Flows of FDI 1. Canada has generally been losing its attractiveness as a destination for FDI, partially due to the lucrative investment opportunities available in Brazil, Russia, India, and China (the BRIC countries) and the improved manufacturing capability of Mexico. 2. Canada’s share of global inward FDI has fallen since the mid-1980’s, as firms developed production facilities in the United States or Mexico to serve the North American market. The Organization for Economic CoOperation and Development (OEDC) considers Canada to be one of the most restrictive countries for FDI.

EXPLANATIONS FOR FOREIGN DIRECT INVESTMENT

International Product Life Cycle 1. States a company will begin by exporting its product and later undertake foreign direct investment as a product moves through its life cycle. 2. In the new product stage, a good is produced entirely in the home market. In the maturing product stage, a good is produced in the home market and in markets abroad that are large enough to warrant production facilities. In the standardized product stage, a company builds production capacity in low-cost developing nations to serve its markets around the world. 3. Yet the international product life cycle theory does not explain why companies choose FDI over other forms of market entry.

Market Imperfections (Internalization) Theory When an imperfection in the market makes a transaction less efficient, a company will undertake FDI to internalize the transaction and remove the imperfection. In a perfect market, prices are as low as possible and goods are

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easily available. Flaws in the efficient operation of an industry are market imperfections. 1. Trade Barriers a. A trade barrier such as a tariff is a common market imperfection. b. Firms undertake FDI when market imperfections are present. 2. Specialized Knowledge a. A unique competitive advantage may consist of specialized knowledge, technical expertise, or special marketing abilities. b. Companies charge fees for product knowledge, but when a company’s specialized knowledge is embodied in its employees, the only way to exploit an opportunity may be FDI. c. A company may undertake FDI if charging another company for access to its knowledge might create a future competitor.

Eclectic Theory 1. States that firms undertake foreign direct investment when the features of a location combine with ownership and internalization advantages to make a location appealing for investment. When each advantage is present, a company will undertake FDI. 2. A location advantage is the advantage of locating a particular economic activity in a specific location because of the characteristics (natural or acquired) of the location. 3. An ownership advantage is the advantage that a company has due to its ownership of some special asset, such as a powerful brand, technical knowledge, or management ability. 4. An internalization advantage is the advantage that arises from internalizing a business activity rather than leaving it to a relatively inefficient market.

Market Power 1. The market power theory states that a firm tries to establish a dominant market presence in an industry by undertaking foreign direct investment. 2. The benefit of market power is greater profit because the firm is better able to dictate the cost of its inputs or the price of its output. 3. Companies can gain market power through vertical integration—the extension of activities into production that provide a firm’s inputs (backward integration) or absorb its output (forward integration).

MANAGEMENT ISSUES IN THE FDI DECISION A.

Control Many companies invest abroad because they wish to control activities in the local market (e.g., to ensure the selling price remains the same across markets). Yet complete ownership does not guarantee control. 1. Partnership Requirements a. Many companies have strict policies regarding how much ownership they take in firms in other nations. b. Yet a nation may demand shared ownership in return for market access. Governments may use such requirements to shield workers and industries from exploitation or domination by large multinationals.

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Benefits of Cooperation a. Greater harmony exists today between governments and international companies. Developing nations and emerging markets need investment, employment, tax revenues, training, and technology transfers. b. A country with a reputation for overly restricting the operations of multinationals can see its inward investment dry up. c. Cooperation can open communication channels to maintain positive relationships in the host country.

Purchase-or-Build Decision 1. The purchase-or-build decision of managers entails deciding whether to purchase an existing business or build a subsidiary abroad from the ground up—called a greenfield investment. 2. An acquiring firm may benefit from the goodwill the existing company has built over the years and, perhaps, brand recognition of the existing firm. The purchase of an existing business also may allow for alternative methods of financing, such as an exchange of stock ownership. 3. Factors that reduce the appeal of purchasing existing facilities are obsolete equipment, poor labor relations, and an unsuitable location. 4. Adequate facilities are sometimes unavailable and a company must go ahead with a greenfield investment. Greenfield investments have their own drawbacks—obtaining the necessary permits and financing and hiring local personnel can be difficult in some markets.

Production Costs Labor regulations increase the hourly cost of production, and benefits packages and training programs add to wage costs. Although the cost of land and tax rate on profits can be lower locally, they may not remain constant. 1. Rationalized Production a. Production in which components are produced where the cost of production is lowest. The components are brought together at one central location for assembly into the final product. b. Potential problem is that a work stoppage in one country can halt the entire production process. 2. Mexico’s Maquiladora a. The 130-mile-wide strip along the U.S.–Mexican border. b. Low-wage regional economy next to a prosperous giant is a model for other regions split by wage or technology gaps. c. Ethical dilemmas arise over the wage gap between Mexico and the United States and lost U.S. union jobs to maquiladora nonunion jobs. Maquiladoras do not operate under the stringent regulations that firms in the United States do. 3. Cost of Research and Development a. Cost of developing subsequent stages of technology has led to cross-border alliances and acquisitions. b. One indicator of the significance of technology in foreign direct investment is the amount of R&D conducted by affiliates of parent companies in other countries. FDI in R&D appears to be spurred by supply factors such as access to high-quality scientific and technical human capital.

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Customer Knowledge 1. The behavior of buyers is an important issue in the decision of whether to undertake FDI. A local presence can give companies valuable knowledge of customers that is unobtainable in the home market. 2. Some countries have quality reputations in certain product categories that make it profitable to produce there.

Following Clients 1. FDI puts companies near those firms they supply. “Following clients” occurs in industries in which component parts are obtained from suppliers with whom a manufacturer has a close working relationship.

Following Rivals 1. FDI decisions resemble a “follow the leader” scenario in industries with a limited number of large firms. 2. Many firms believe that not making a move parallel to that of the “first mover” might result in being shut out of a lucrative market.

Think-Pair-Share – slide 20 GOVERNMENT INTERVENTION IN FDI Nations enact laws, create regulations, or construct administrative hurdles for foreign companies. A bias toward protectionism or openness is rooted in a nation’s culture, history, and politics. But FDI tends to raise output and enhance standards of living. Besides philosophical ideals, countries intervene in FDI for practical reasons.

Balance of Payments National accounting system that records all payments to entities in other countries and all receipts coming into the nation. International transactions that result in payments (outflows) to entities in other nations are reductions in the balance of payments accounts and recorded with a minus (–) sign (see Table 7.3). International transactions that result in receipts (inflows) from other nations are additions to the balance of payments accounts and recorded with a plus (+) sign. 1 Current Account a. National account that records transactions involving the import and export of goods and services, income receipts on assets abroad, and income payments on foreign assets inside the country. b. A current account surplus occurs when a country exports more goods and services and receives more income from abroad than it imports and pays abroad. c. A current account deficit occurs when a country imports more goods and services and pays more abroad than it exports and receives from abroad. 2. Capital Account a. National account that records transactions involving the purchase or sale of assets.

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Financial assets such as stocks and bonds and physical assets such as investments in plants and equipment.

Reasons for Intervention by the Host Country 1. Control Balance of Payments a. Many governments see intervention as the only way to keep their balance of payments under control. b. Host countries get a balance-of-payments boost from initial FDI flows. Local content requirements can lower imports, providing an added balance-of-payments boost. Exports from the FDI can further help the balance-of-payments position. c. When companies repatriate profits, they deplete the foreign exchange reserves of their host countries; these capital outflows decrease the balance of payments. Thus, a host nation may prohibit or restrict nondomestic firms from removing profits. d. But host countries conserve their foreign exchange reserves when international companies reinvest their earnings in local manufacturing facilities. This improves the competitiveness of local producers and boosts a host nation’s exports—improving its balance-of-payments position. 2.

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Obtain Resources and Benefits a. Access to Technology Nations encourage FDI in technology because it increases productivity and competitiveness. b. Management Skills and Employment FDI allows talented foreign managers to train local managers in how to operate the local facilities. Some of these managers will also go on to establish their own businesses.

Reasons for Intervention by the Home Country There are fewer concerns regarding the outflow of FDI among home nations because they tend to be prosperous, industrialized nations. 1. Reasons for discouraging outward FDI a. Investing in other nations sends resources out of the home country and can lessen investment at home. b. Outgoing FDI may damage a nation’s balance of payments by reducing exports otherwise sent to international markets. c. Jobs resulting from FDI outflows may replace jobs at home. 2. Reasons for promoting outgoing FDI a. Outward FDI can increase long-run competitiveness (e.g., partnering as a learning opportunity). b. Nations may encourage FDI in industries that use obsolete technology or employ low-wage workers with few skills.

GOVERNMENT POLICY INSTRUMENTS AND FDI A.

Host Countries: Promotion 1. Financial Incentives a. Host governments commonly offer tax incentives or low-interest loans to attract investment.

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Host Countries: Restriction 1. Ownership Restrictions a. Governments impose ownership restrictions that prohibit nondomestic companies from investing in certain industries or owning certain types of business. b. Another restriction is a requirement that nondomestic investors hold less than a 50 percent stake in local firms. Nations are eliminating such restrictions because companies can choose another location. 2.

But incentives can create bidding wars between locations vying for investment; the cost to taxpayers of snaring FDI can be more than what the actual jobs pay. Infrastructure Improvements a. Lasting benefits for communities surrounding the investment location can result from local infrastructure improvements— better seaports for containerized shipping, improved roads, and increased telecommunications systems.

Performance Demands a. Some performance demands dictate the portion of a product’s content that originates locally, stipulates the portion of output that must be exported, or requires that certain technologies be transferred to local businesses.

Home Countries: Promotion 1. Offer insurance to cover the risks of investments abroad. 2. Grant loans to firms wishing to increase their investments abroad. 3. Offer tax breaks on profits earned abroad or negotiate special tax treaties. 4. Apply political pressure on other nations to get them to relax their restrictions on inbound investments.

Home Countries: Restriction 1. Impose differential tax rates that charge income from earnings abroad at a higher rate than domestic earnings. 2. Impose sanctions that prohibit domestic firms from making investments in certain nations.

BOTTOM LINE FOR BUSINESS This chapter presents foreign direct investment (FDI). Like trade decisions, many factors influence a company’s decision about whether to invest in markets abroad. Depending on the philosophy of home or host nations and the impact of FDI on their economic health, a firm can be encouraged or dissuaded to invest in a nation.

Think-Pair-Share – slide 34

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Quick Study Questions Quick Study 1 (p. ???) 1.

Q: What is the difference between foreign direct investment and portfolio investment? A: Foreign direct investment is the purchase of physical assets or a significant amount of the ownership (stock) of a company in another country to gain a measure of management control. It differs from portfolio investment—an investment that does not involve obtaining a degree of control in a company.

Q: What factors influence global flows of foreign direct investment? A: Three main reasons for the large increases in FDI flows over the past couple of decades are: (1) globalization, (2) mergers and acquisitions, and (3) increasing FDI on the part of entrepreneurs and small businesses.

Q: Identify the main destinations of foreign direct investment. Is the pattern shifting? A: Highly industrialized countries are the destination for most FDI inflows, with the EU, United States, and Japan attracting the vast majority of world FDI inflows. But highly developed nations are attracting a declining share of global FDI. Developed countries account for about 57 percent of global FDI inflows and developing countries account for about 37 percent of global FDI inflows. For developing nations, China attracts the most FDI in Asia and India attracts the most on the subcontinent. Newly industrialized and emerging markets (particularly in Asia) are also a growing source of FDI.

Quick Study 2 (p. ???) 1.

Q: Explain the international product life cycle theory of FDI. A: The international product life cycle theory says that a company will invest in production facilities in other countries as a product moves through its life cycle. In the new product stage, the production of a good remains in the home country because of uncertain domestic demand and to keep production close to the research department that developed the product. In the maturing product stage, the company directly invests in production facilities in those countries where demand is great enough to warrant its own production facilities. In the final standardized product stage, increased competition creates pressures to reduce production costs. In response, the company builds production capacity in low-cost developing nations to serve its markets around the world.

Q: How does the theory of market imperfections (internalization) explain FDI? A: Market imperfections theory states that when an imperfection in the market makes a transaction less efficient than it could be, a company will undertake FDI to internalize the transaction and thereby remove the imperfection. Two important market imperfections are trade barriers and specialized knowledge, such as technical expertise of engineers or the special marketing abilities of managers. Companies can eliminate the inefficiency of trade barriers (they increase the cost of getting a product to market) by developing production facilities within the market. Sometimes the only way a company can exploit the specialized knowledge of its employees is to engage in FDI—the knowledge simply cannot be licensed to another firm. Firms also can undertake FDI when they want to lessen the risk of giving away a competitive advantage to other companies through licensing agreements.

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Q: Explain the eclectic theory, and identify the three advantages necessary for FDI to occur. A: The eclectic theory states that firms undertake foreign direct investment when the features of a particular location combine with ownership and internalization advantages to make a location appealing for investment. A location advantage is the advantage of locating a particular economic activity in a specific location because of the characteristics (natural or acquired) of that location. These advantages have historically been natural resources but can also be acquired advantages such as a productive workforce. An ownership advantage is the advantage that a company has due to its ownership of some special asset, such as a powerful brand, technical knowledge, or management ability. An internalization advantage is the advantage that arises from internalizing a business activity rather than leaving it to a relatively inefficient market. The theory states that when all these advantages are present, a company will undertake FDI.

Q: How does the theory of market power explain the occurrence of FDI? A: The market power theory states that a firm tries to establish a dominant market presence in an industry by undertaking foreign direct investment. The benefit of market power is greater profit because the firm is far better able to dictate the cost of its inputs or the price of its output.

Quick Study 3 (p. ???) 1.

Q: Why is control important to companies considering the FDI decision? A: When many companies invest abroad, they are greatly concerned with controlling their companies’ activities in the local market for a variety of reasons. They may want to be certain that its product is being marketed the same in the local market as it is at home. They may also want to ensure that the selling price remains the same in both markets. Some companies try to maintain ownership of a large portion of the local operations, say even up to 100 percent, in the belief that greater ownership gives them greater control. But even complete ownership does not guarantee control. For example, the local government might intervene and require a company to hire some local managers rather than bring them all in from the home office. Governments might also require that all goods produced in the local facility be exported so they do not compete with products of the country’s domestic firms.

Q: What is the role of production costs in the FDI decision? Define rationalized production. A: Production cost can be very important in the FDI decision. Labor regulations can increase the hourly cost of production several times. Companies can be required to offer benefits packages that are over and above hourly wages. The time required to train workers and increase productivity can be expensive. The soaring cost of R&D is leading multinationals to engage in cross-border alliances and acquisitions. Rationalized production is when each of a good’s components is produced where the cost of producing that component is lowest. A potential problem with this production model is that a work stoppage in one country can bring the entire production process to a standstill.

Q: Explain the need for customer knowledge, following clients, and following rivals in the FDI decision. A: Obtaining customer knowledge can be a motivator for FDI. A local presence might help companies gain valuable knowledge about its customers that it cannot obtain by .

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remaining in the home country. Firms also commonly engage in FDI when doing so puts them close to firms for whom they act as suppliers. This reduces lead times in getting products to customers because the distance from which goods must be shipped can be just a few miles rather than halfway around the world. Finally, when a few large firms dominate an industry, FDI decisions frequently resemble a “follow the leader” scenario in which not making a parallel move to that of the “first mover” might result in being shut out of a potentially lucrative market. Quick Study 4 (p. ???) 1.

Q: What is a country’s balance of payments? Briefly explain its usefulness. A: A country’s balance of payments is a national accounting system that records all payments to entities in other countries and all receipts coming into the nation. The balance of payments helps a country monitor the flows of goods, services, income, and transfer of assets between itself and other nations. The balance of payments position sends warning signals about trade deficits with other nations. The main question surrounding the persistent U.S. trade deficit is whether the deficit is borrowing to finance consumption or borrowing to purchase equipment that will have productivity payoffs.

Q: Explain the difference between the current account and the capital account. A: The current account is a national account that records transactions that involve the import and export of goods and services, income receipts on assets abroad, and income payments on foreign assets inside the country. The capital account is a national account that records transactions that involve the purchase or sale of assets. These assets include financial assets such as stocks and bonds and physical assets such as investments in plants and equipment.

Q: For what reasons do host countries intervene in FDI? A: One reason host governments intervene in FDI is to control their balance of payments. (1) Countries get a balance-of-payments boost from initial FDI flow into their economies. (2) Local content requirements can lower imports, thereby providing a balance-ofpayments boost. (3) Exports generated by production resulting from FDI can help the balance-of-payments position. Another reason for intervening in FDI is to obtain resources and benefits. (1) They may want access to technology. Nations encourage the import of technology because it tends to increase the productivity and competitiveness of nations. (2) They may want to obtain management skills and increase employment levels. By encouraging FDI, nations can allow in talented managers to train local managers in how to operate the local facilities—particularly important for former communist nations that lack skilled managers. (3) Some of these managers will go on to establish their own businesses, thereby expanding the economy and employment opportunities within the nation.

Q: For what reasons do home countries intervene in FDI? A: There are generally fewer concerns regarding the outflow of FDI among home nations because they tend to be prosperous, industrialized nations. FDI outflows do not drastically affect the domestic economy. Nevertheless, there are reasons why home countries discourage outward FDI. (1) Investing in other nations sends resources out of the home country. (2) Outgoing FDI may ultimately damage a nation’s balance of payments by reducing exports that would otherwise be sent to international markets. (3) Jobs resulting from outgoing investments may replace jobs at home. .

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Home countries also promote outgoing FDI. (1) They may do so because outward FDI can increase long-run competitiveness. (2) Nations may encourage FDI in industries that they have determined to be “sunset” industries. Quick Study 5 (p. ???) 1.

Q: Identify the main methods host countries use to promote and restrict FDI. A: Host countries promote FDI by giving tax incentives, low-interest loans, and infrastructure improvements. Host nations restrict FDI through ownership restrictions and performance demands.

Q: What methods do home countries use to promote and restrict FDI? A: To promote FDI, home countries can offer insurance, low-interest loans, tax breaks, and apply political pressure. Home countries may try to restrict FDI by using differential tax rates and sanctions.

Talk It Over 1.

Q: You overhear your superior tell another manager in the company, “I’m fed up with our nation’s companies sending manufacturing jobs abroad and off-shoring service work to low-wage nations. Don’t any of them have any national pride?” The other manager responds, “I disagree. It is every company’s duty to make as much profit as possible for its owners. If that means going abroad to reduce costs, so be it.” Do you agree with either of these managers? Why or why not? Now step into the conversation and explain where you stand on the issue. A: By this point in the course, students should be able to give a detailed response to why they agree or disagree with either of these managers. They should understand the role of culture, politics, and law in international business and have examined how different economic systems function. They also should have a grasp of the theories of international trade and foreign direct investment and why governments intervene in their free flow. Thus, students should include in their response a rational discussion of how culture, politics, law, and economics influence their own opinion. The opinions of most students will likely lie somewhere in-between those of the two managers quoted.

Q: The global carmaker you work for is investing in an automobile assembly facility in Costa Rica with a local partner. Explain the potential reasons for this investment. Will your company want to exercise a great deal of control over this operation? Why or why not? In what areas might your company want to exercise control and in what areas might it cede control to the partner? A: Students might be better equipped to answer this question if given time between class periods to do some research on the structure of the car industry and its global nature. But students should be able to suggest answers even if they are not given time to prepare. First, the company might be investing in the Costa Rican market with a partner in order to get a foothold there. Second, the (fictitious) local partner could control a good portion of the local car market with a successful model or two. Third, the local market could represent great potential as a production base for one component in the global carmaker’s global production network—an example of the rationalization concept. One area in which the global carmaker might want to maintain control is in strategy so that the local operation fits well with the company’s activities in other nations. .

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Another is in local R&D if any is to be done in Costa Rica. The reason for this is so that the global company can incorporate special knowledge from other markets into the new product development efforts in Costa Rica. However, the global partner might want to cede control in the area of human resource management to the local company—it likely better understands the culture and the needs of the local workforce. 3.

Q: This chapter presented several theories that attempt to explain why firms undertake foreign direct investment. Which of these theories seems most appealing to you? Why is it appealing? Can you think of one or more companies that seem to fit the pattern described by the theory? In your opinion, what faults do the alternative theories have? A: This question probably is best suited to advanced undergraduates and MBA students. To arrive at more informed answers to this question, students could be asked to research the theories in more depth. They could go to the original work(s) that advanced the theory and trace the major research that has been done to test or update it.

Practicing International Management Case Is Canada Open for Business? A few good places to begin to find answers related to these questions are the BHP web page http://www.bhpbilliton.com/home/investors/news/Pages/Articles/BHP%20Billiton%20With draws%20Its%20Offer%20To%20Acquire%20PotashCorp%20And%20Reactivates%20It s%20Buy-back%20Program.aspx And this link which provides a very thoughtful analysis from a Government / Canadian perspective http://www.irpp.org/en/po/the-year-in-review-2/the-potash-takeover-bid-the-deal-thatwasnt/

Q: Why do you think BHP was not able to prove a “net benefit” for Canada? A: Many external factors may have influenced ICA’s decision. First, potash is considered by many to be a strategic natural resource as countries around the world work to maximize crop yields. The media, therefore, were able to make a case against the acquisition through articles addressing “the loss of a strategic resource to a foreign investor.” Second, it was an election year for both the federal and provincial governments. Brad Wall, then premier of Saskatchewan, voiced his concerns to the federal Minister of Industry and to the public, stating that BHP’s bid failed the net benefit test in three areas: jobs and investment, Canadian control of a strategic resource, and provincial revenues—the government stood to lose about $100 million annually in corporate tax. Certainly the takeover bid had the potential to destabilize Saskatchewan’s finances, since Potash Corp is a significant source of tax revenue for the provincial government. The expatriation of revenues was also a concern: If the takeover were to be approved, revenues would go to BHP stakeholders in Australia rather than to Saskatchewan, where profits were being re-invested to fund roads, schools, and hospitals. The revenue to the province also allowed the local government to keep tax levels at a lower rate, which made the local economy more competitive.

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Q:Why did ICA approve the acquisition of Nexen but not that of Potash Corp? A: From the information provided in the case, we can conclude the CNOC acquisition of Nexen passed the “net benefit” test. A thoughtful analysis can be found here

http://www.ipolitics.ca/2012/11/08/nexen-china-and-net-benefit-what-you-need-to-know/ 3.

Q:Was it correct for the Canadian government to restrict FDI in this case? Explain your answer. A:Certainly the takeover bid had the potential to destabilize Saskatchewan’s finances, since Potash Corp is a significant source of tax revenue for the provincial government. The expatriation of revenues was also a concern: If the takeover were to be approved, revenues would go to BHP stakeholders in Australia rather than to Saskatchewan, where profits were being re-invested to fund roads, schools, and hospitals. The revenue to the province also allowed the local government to keep tax levels at a lower rate, which made the local economy more competitive.

Q:What are the global implications for Canadian business because of ICA’s decision? A:This decision has the potential for retaliation when Canadian business looks for acquisitions, especially in Australia, however the subsequent successful CNOC-Nexen takeover may put many apprehensions to rest.

Q: Do you think the decision might have been different if it had not been an election year? A: There is a long and sometimes tumultuous history of the relationship between the Potash Industry and the government of Saskatchewan. It is unlikely the outcome would have differed.

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CHAPTER 8 REGIONAL ECONOMIC INTEGRATION LEARNING OBJECTIVES: 1. Define regional economic integration and identify its five levels. 2. Discuss the benefits and drawbacks of regional economic integration and identify the implications for Canadian businesses. 3. Describe regional integration in Europe and its pattern of enlargement. 4. Discuss and analyze regional integration in the Americas, particularly regarding NAFTA and Canada’s bilateral trade agreements. 5. Characterize regional integration in Asia and how it differs from integration elsewhere. 6. Describe integration in the Middle East and Africa and explain the slow progress.

CHAPTER OUTLINE: Introduction What Is Regional Economic Integration? Levels of Regional Integration Free-Trade Area Customs Union Common Market Economic Union Political Union Effects of Regional Economic Integration Benefits of Regional Integration Trade Creation Greater Consensus Political Cooperation Employment Opportunities Drawbacks of Regional Integration Trade Diversion Shifts in Employment Loss of National Sovereignty Integration in Europe European Union Early Years Single European Act Maastricht Treaty European Monetary Union Management Implications of the Euro Enlargement of the European Union Structure of the European Union European Parliament Council of the European Union European Commission Court of Justice Court of Auditors Canada–UE Free Trade Agreement .

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European Free Trade Association (EFTA) Integration in the Americas North American Free Trade Agreement (NAFTA) Local Content Requirements and Rules of Origin Effects of NAFTA NAFTA and the Environment NAFTA’s Contentious Clauses Trade Disputes Within NAFTA Bilateral Agreements Beyond Nafta Andean Community (CAN) Latin American Integration Association (ALADI) Southern Common Market (MERCOSUR) Central America and the Caribbean Caribbean Community and Common Market (CARICOM) Central American Common Market (CACM) Free Trade Area of the Americas (FTAA) Integration in Asia Association of Southeast Asian Nations (ASEAN) Asia Pacific Economic Cooperation (APEC) The Record of APEC Closer Economic Relations Agreement (CER) Integration in the Middle East and Africa Gulf Cooperation Council (GCC) Economic Community of West African States (ECOWAS) African Union (AU) Bottom Line for Business

A comprehensive set of specially designed PowerPoint slides is available for use with Chapter 8. These slides and the lecture outline below form a completely integrated package that simplifies the teaching of this chapter’s material. Lecture Outline 1.

INTRODUCTION This chapter focuses on regional efforts to encourage freer trade and investment. Regional integration is defined and its benefits and drawbacks are identified. The chapter also explores several long-established trading agreements and some agreements in the earliest stages of development.

WHAT IS REGIONAL ECONOMIC INTEGRATION? Regional economic integration is countries of a region cooperating to reduce or eliminate barriers to the international flow of products, people, or capital. A regional trading bloc is a group of nations in a geographic region undergoing economic integration. The goal is greater cross-border trade and investment and higher living standards. Specialization and trade allow more choice, lower prices, and increased productivity. Regional trade agreements help nations accomplish these objectives and protect intellectual property rights, the environment, or even eventual political union. .

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Levels of Regional Integration There are five levels. Free trade area is the lowest extent of national integration, political union the greatest. Each level of integration incorporates the properties of those levels that precede it. 1. Free Trade Area a. Countries remove all barriers to trade among members, but each country determines its own barriers against nonmembers. b. Policies differ greatly against nonmember countries from one country to another. Countries in a free trade area also establish a process to resolve trade disputes between members. 2. Customs Union a. Countries remove all barriers to trade among members but erect a common trade policy against nonmembers. b. Differs from a free trade area in that members treat all nonmembers similarly. Countries might also negotiate as a single entity with other supranational organizations such as the WTO. 3. Common Market a. Countries remove all barriers to trade and the movement of labor and capital among themselves, but erect a common trade policy against nonmembers. b. Adds the free movement of important factors of production such as people and cross-border investment. It can be difficult for nations to cooperate on economic and labor policies. 4. Economic Union a. Countries remove barriers to trade and the movement of labor and capital, erect a common trade policy against nonmembers, and coordinate their economic policies. b. Requires members to harmonize their tax, monetary, and fiscal policies, create a common currency, and concede a certain amount of sovereignty to the supranational organization. 5. Political Union a. Countries coordinate aspects of economic and political systems. b. Members accept a common stance on economic and political policies regarding nonmember nations. Nations are allowed a degree of freedom in setting certain political and economic policies within their territories.

EFFECTS OF REGIONAL ECONOMIC INTEGRATION There are debates over effects on people, jobs, companies, culture, and living standards. A.

Benefits of Regional Integration Nations engage in specialization and trade because of the gains in output and consumption. Higher levels of trade between nations should increase specialization, efficiency, and consumption, and raise standards of living. 1. Trade Creation a. Increase in trade that results from regional economic integration. b. Gives consumers and industrial buyers a wider selection of goods and services not available beforehand. c. Buyers can acquire goods and services more cheaply following the lowering of trade barriers such as tariffs. Lower costs lead to

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higher demand for goods because people have more money after a purchase to buy other products. Greater Consensus Eliminating trade barriers in smaller groups of countries may make it easier to gain consensus as opposed to working in the far larger WTO. Political Cooperation A group of nations can have significantly greater political weight than nations have individually. The group may have more clout in negotiating in a forum like the WTO. Integration involving political cooperation reduces the potential for military conflict among members. Employment Opportunities Regional integration can expand employment by enabling people to move from country to country for work, or to earn a higher wage.

Drawbacks of Regional Integration 1. Trade Diversion a. Diversion of trade away from nations not belonging to a trading bloc and toward member nations. Trade diversion can occur after formation of a trading bloc because of the lower tariffs charged between member nations. b. Can result in reduced trade with a more efficient nonmember nation in favor of trade with a less efficient member nation. Unless there is other internal competition, buyers will pay more due to inefficient production methods. 2. Shifts in Employment a. Because trading blocs reduce or eliminate barriers to trade, the producer of a particular good or service will be decided by relative productivity. Industries requiring unskilled labor shift production to low-wage nations within a trading bloc. b. Figures on jobs lost or gained vary with the source. But job dislocation allows a nation to upgrade the economy toward higher-wage-paying industries that can increase competitiveness due to a more educated and skilled workforce. 3. Loss of National Sovereignty a. Successive levels of integration require nations to surrender more sovereignty. Political union requires nations to give up a high degree of sovereignty in foreign policy. b. Because some members have delicate ties with nonmember nations whereas others have strong ties, the setting of a common foreign policy is difficult.

INTEGRATION IN EUROPE European efforts at integration began shortly after the Second World War among a small group of countries and involved a few select industries. Regional integration now encompasses practically all of Western Europe and all industries. A.

European Union 1. Early Years a. Europe in 1945 faced two challenges: (1) to rebuild itself and avoid further conflict, and (2) to increase its industrial strength to stay competitive with the United States.

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Belgium, France, West Germany, Italy, Luxembourg, and the Netherlands signed the Treaty of Paris in 1951, creating the European Coal and Steel Community to remove barriers to trade in coal, iron, steel, and scrap metal. c. Members of the European Coal and Steel Community signed the Treaty of Rome in 1957, creating the European Economic Community (EEC), which outlined a future common market. d. In 1967 the Community’s scope was broadened to include additional industries, notably atomic energy, and changed its name to the European Community. Enlargement continued and in 1994 the bloc changed its name to the European Union (EU). e. Today the 27-member European Union has a population of about 500 million people and a GDP of around $15 trillion. f. Single European ACT (SEA) Remove remaining barriers, increase harmonization, and enhance competitiveness of EU companies. M&As swept Europe as large firms combined their understanding of European needs, capabilities, and cultures with economies of scale. g. Maastricht Treaty The 1991 Maastricht Treaty (effective in 1993): (1) created single, common currency; (2) set monetary and fiscal targets for countries taking part in monetary union; and (3) proposed eventual political union—including a common foreign and defense policy and common citizenship. European Monetary Union a. Opting out of the euro are Britain, Denmark, and Sweden. b. The euro eliminates exchange-rate risk for business deals among member nations using the euro. Transparency in prices harmonizes prices across markets. Enlargement of the European Union a. Expansion in 2004 and 2007 from 15 to 27 members today. b. Candidates for membership are Croatia, Iceland, Montenegro, Serbia, Turkey, and the former Yugoslav Republic of Macedoniac. New members must meet the Copenhagen Criteria. Structure of the European Union a. European Parliament i. Composed of 736 members elected by popular vote within each member nation every five years. ii. Parliament acts as a consultative rather than a legislative body by debating and amending legislation proposed by the European Commission. b. Council of the European Union i. The legislative body of the EU. Council members change depending on the topic under discussion (e.g., for agriculture, the Council is comprised of agriculture ministers of each member). ii. No proposed legislation becomes EU law unless the Council votes it into law. Some legislation today requires only a simple majority to win approval.

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European Commission i. The executive body of the EU whose commissioners are appointed by each country—larger nations get two commissioners, smaller countries one. ii. Drafts legislation, manages and implements policy, and monitors compliance with EU law. Court of Justice i. Acts as the EU court of appeals and is composed of 27 members (one from each member nation). ii. One type of case heard is when a member nation is accused of not meeting its treaty obligations. iii. Justices are required to act in the interest of the EU as a whole, not in the interest of their own countries. Court of Auditors i. Composed of 27 members (one from each member nation) appointed for six-year terms. ii. Duty is to audit EU accounts and implement EU budget, improve EU financial management, and report to member nations’ citizens on the use of public funds. Canada–UE Free Trade Agreement The main purpose of this agreement is to generate more trade, investment, and jobs on both sides of the Atlantic. Once implemented—by 2015—duties will be eliminated in 98 percent of products. The agreement is expected to increase trade in goods and services by 23 percent or CAD$38 billion. It provides Canadian businesses with access to 500 million EU consumers.

European Free Trade Association (EFTA) 1. Some nations wanted the benefits of a free-trade area but were wary of a full common market. In 1960, they formed the European Free Trade Association (EFTA) to focus on trade in industrial goods. Today members are Iceland, Liechtenstein, Norway, and Switzerland. 2. EFTA has 12.5 million people and a combined GDP of $707 billion. 3. The EFTA and EU cooperate on the free movement of goods, persons, services, and capital. They also cooperate in other areas, including the environment, social policy, and education.

INTEGRATION IN THE AMERICAS Latin American countries began forming regional trading arrangements in the early 1960s but made substantial progress only in the 1980s and 1990s. North America is taking major steps toward economic integration. A.

North American Free Trade Agreement (NAFTA) • NAFTA (January 1994) seeks to eliminate most tariffs and nontariff trade barriers on most goods originating from North America. • Calls for liberalized rules regarding government procurement practices, the granting of subsidies, and the imposition of countervailing duties. • Other provisions deal with trade in services, intellectual property rights, and standards of health, safety, and the environment. 1. Local Content Requirements and Rules of Origin

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Producers and distributors must determine if their products meet NAFTA rules to qualify for tariff-free status. The producer or distributor must also provide a NAFTA “certificate of origin” to an importer to claim an exemption from tariffs. Four criteria to meet NAFTA rules of origin: (1) goods wholly produced or obtained in the NAFTA region; (2) goods containing nonoriginating inputs but meeting origin rules; (3) goods produced in the NAFTA region wholly from originating materials; and (4) unassembled goods with sufficient North American regional value content. Effects of NAFTA a. Trade among Canada, Mexico, and the United States has grown from $297 billion in 1993 to around $1 trillion. b. Mexico’s exports to the United States rose to about $211 billion, and U.S. exports to Mexico grew to more than $136 billion. c. Canada’s exports to the United States more than doubled to approximately $300 billion, and U.S. exports to Canada grew to $176 billion. d. Canada’s exports to Mexico grew more than threefold to nearly $2.7 billion. e. The agreement’s effect on employment and wages is not easy to determine. The U.S. Trade Representative Office and the AFL-CIO group of unions debate NAFTA’s effect on jobs. NAFTA and the Environment a. Opponents claim that NAFTA has damaged the environment, particularly along the United States– Mexico border. Although the agreement included provisions for environmental protection b. NAFTA’s Contentious Clauses Article 605 of NAFTA, called the “proportional sharing provision,” grants NAFTA countries rights in perpetuity to share natural resources. What does this mean for Canada? Under the agreement, two thirds of Canadian oil needs to be available for export to the United States, even if Canadians experience shortages. Canada must also make the majority of its natural gas supplies available for export to the United States, which accounts for 60 percent of Canada’s current natural gas production. c. Many Canadians think that NAFTA should be renegotiated to eliminate proportionality. d. Another controversial section of the NAFTA agreement is Chapter 11, which sets out a framework for investment. Chapter 11 allows corporations or individuals to sue NAFTA member governments for compensation over any government measure that has an effect on their ability to conduct business. For example, US-based Ethyl Corporation sued the Canadian government, claiming that its ban on

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MMT, a neurotoxin gasoline additive, was an unfair performance requirement. After a NAFTA tribunal ruled against Canada, the Canadian government withdrew the ban and settled out of court for $13 million Trade Disputes Within NAFTA a. Although theoretically an agreement between three equal parties, NAFTA has huge market size asymmetries. The US market predominance over Mexico and Canada appears to encourage the United States to use tactics such as bans, dumping, and protectionist measures to impose its own trade terms. By its nature, NAFTA runs the risk of becoming an extension of hegemonic US policy. Disputes, such as the softwood lumber case between Canada and the United States (which also involved the World Trade Organization’s arbitration system) and the US ban on Mexican trucks operating on US roads, are examples of power-politics prevailing over international trade rules and agreements such as NAFTA.

Think – Pare – Share Slide 22 5

Bilateral Agreements Beyond NAFTA Although NAFTA has not expanded beyond the original three countries due to opposition groups and political obstacles, each member of NAFTA has entered into bilateral agreements with other countries in the Americas. For example, Canada has signed bilateral free trade agreements with Colombia, Costa Rica, Chile, Peru, and Panama.

Andean Community (CAN) 1. Formed in 1969 and today includes Bolivia, Colombia, Ecuador, and Peru. It comprises a market of around 97 million consumers and a combined GDP of about $220 billion. 2. Objectives include tariff reduction, a common external tariff, and common policies in both transportation and certain industries. But each member is given exceptions in the common tariff structure for 3. trade with nonmembers. The group has yet to create a customs union.

Latin American Integration Association (ALADI) 1. Formed in 1980, called for preferential tariff agreements between pairs of members (reflecting their economic development levels). 2. ALADI did not significantly increase cross-border trade despite 24 bilateral agreements and 5 subregional pacts.

Southern Common Market (MERCOSUR) MERCOSUR members: Argentina, Brazil, Paraguay, Uruguay, and 1. Venezuela (Bolivia, Chile, Colombia, Ecuador, and Peru are associate members). 2. Acts as customs union and liberalizing trade and investment—emerging as the most powerful trading bloc throughout Latin America.

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Central America and the Caribbean Integration efforts here have been modest. 1. Caribbean Community and Common Market (CARICOM) a. Formed in 1973. Bahamas is a member of the Community but does not belong to the Common Market. Has combined GDP of nearly $30 billion and a market of almost 6 million people. 2. Central American Common Market (CACM) a. Intended to create a common market between Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua. Progress was constrained by civil wars and wars among members. Comprises a market of 33 million and combined GDP of $120 billion. b. Not yet a customs union, but officials say goal is integration, closer political ties, and a single currency—likely the dollar. El Salvador adopted the dollar as its official currency in 2000.

Free Trade Area of the Americas (FTAA) 1. Intends to create a trading bloc stretching from Alaska to Tierra del Fuego in South America. The FTAA would comprise 34 nations and 830 million consumers—with Cuba being the only Western Hemisphere nation excluded. 2. Would remove tariffs and nontariff barriers among members, but continues to face opposition from labor organizations, environmentalists, and others against globalization. 3. The Third Summit of the Americas, hosted in Quebec City in 2001, met with fierce protests. FTAA’s ambitious plan means that it will likely be many years before such an agreement can be realized. Currently, FTAA negotiations have ceased, with no dates set for the resumption of talks.

INTEGRATION IN ASIA

Association of Southeast Asian Nations (ASEAN) 1. Market of 560 million consumers and a GDP of $1.1 trillion. 2. Objectives: (1) promote economic, cultural, and social development; (2) safeguard economic and political stability; and (3) serve as a forum in which differences can be resolved fairly and peacefully. 3. Adding Cambodia, Laos, and Myanmar, may help counter China’s strength and resources of cheap labor and abundant raw materials.

Asian Pacific Economic Cooperation (APEC) 1. Comprise more than 40 percent of world trade and a GDP of more than $19 trillion. 2. Aims to strengthen the multilateral trading system and expand the global economy by simplifying and liberalizing trade and investment procedures. 3. Hopes to have completely free trade and investment throughout the region by 2020. 4. Record of APEC a. Succeeded in halving members’ tariff rates from an average of 15 to 7.5 percent. Less progress more recently.

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Is a political body as much as it is a movement toward free trade. Open dialogue and cooperation should encourage progress toward APEC goals, however slowly. Grants region-wide business visas without requiring multiple visas, and recommends regional recognition of national qualifications for professionals.

Closer Economic Relations Agreement (CER) 1. Australia and New Zealand created a free trade agreement in 1966 that slashed tariffs and quotas 80 percent by 1980. 2. The agreement’s success encouraged the pair to form the Closer Economic Relations (CER) Agreement in 1983 to advance free trade and further integrate their two economies. 3. The two nations totally eliminated tariffs and quotas in 1990, five years ahead of schedule. 4. Each nation allows goods (and most services) to be sold within its borders that can be legally sold in the other country. Each nation also recognizes most professionals who are registered to practice their occupation in the other country.

INTEGRATION IN THE MIDDLE EAST AND AFRICA

Gulf Cooperation Council (GCC) 1. Members are Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates. Formed to cooperate with the increasingly powerful trading blocs in Europe. 2. Main achievements: allowing citizens to travel freely among member nations, and allowing citizens to own land, businesses, and other property in fellow member nations without the need for local partners.

Economic Community of West African States (ECOWAS) 1. Intends to form a customs union and an eventual common market and monetary union among its members. The ECOWAS nations comprise a large portion of the economic activity in sub-Saharan Africa. 2. Progress on market integration is almost nonexistent, but ECOWAS has made progress in the free movement of people, construction of international roads, and development of telecommunication links. 3. Problems for ECOWAS arise because of political instability, poor governance, weak national economies, poor infrastructure, and poor economic policies.

African Union (AU) 1. Group of 53 nations joined forces in 2002 to create the African Union. 2. Aims: (1) rid vestiges of colonialism and apartheid; (2) promote unity and solidarity; (3) coordinate and intensify cooperation for development; (4) safeguard members’ sovereignty and territorial integrity; (5) promote international cooperation within the United Nations. 3. But problems abound (e.g., ethnic violence in Darfur region of Sudan despite heavy AU involvement).

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Think – Pare – Share Slide 36

BOTTOM LINE FOR BUSINESS This chapter describes regional integration efforts occurring today. There is much debate about the merits and demerits of regional trade agreements. Some governments and independent organizations act to counter the negative effects of integration. Although there are drawbacks to integration, governments will continue to be enticed by the potential gains from increased trade and by the desire to raise standards of living. Regional economic integration will likely continue to roll back barriers to trade between nations and between existing trading blocs of nations.

Quick Study Questions Quick Study 1 (p. ???) 1.

Q: What is the ultimate goal of regional economic integration? A: Regional economic integration is the process whereby countries in a geographic region cooperate with one another to reduce or eliminate barriers to the international flow of products, people, or capital. The ultimate goal is to raise living standards by expanding cross-border trade and investment.

Q: What are the five levels, or degrees, of regional integration? Briefly describe each one. A: The first (and lowest) level of regional integration is a free trade area—economic integration whereby countries remove all barriers to trade between themselves but each country determines its own barriers against nonmembers. Each country is able to maintain whatever policy it sees fit against nonmember countries. These policies can differ widely from country to country. The second level of regional integration is a customs union—economic integration whereby countries remove all barriers to trade among themselves, but erect a common trade policy against nonmembers. What makes it different from a free trade area is that members treat all nonmembers similarly. The third level of regional integration is a common market—economic integration whereby countries remove all barriers to trade and the movement of labor and capital between themselves, but erect a common trade policy against nonmembers. Common markets integrate the elements of free trade areas and customs unions while adding the free movement of important factors of production such as people and crossborder investment. The fourth level of regional integration is an economic union—economic integration whereby countries remove barriers to trade and the movement of labor and capital, erect a common trade policy against nonmembers, and coordinate their economic policies. Economic union requires that member countries harmonize their tax, monetary, and fiscal policies, create a common currency, and concede a certain amount of sovereignty to the supranational organization to which they belong. The fifth (and highest) level of regional integration is a political union— economic and political integration whereby countries coordinate aspects of their

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economic and political systems. A political union requires member nations to accept a common stance on economic and political policies regarding nonmember nations. 3.

Q: Identify several potential benefits and several potential drawbacks of regional integration. A: One main benefit of regional integration is trade creation—the increase in the level of trade among nations that results from regional economic integration. It gives consumers and industrial buyers in member nations a wider selection of goods and services, and lowers the cost of imported goods and services following the lowering of trade barriers such as tariffs. Another potential benefit is greater consensus on trade issues relative to that experienced in the WTO. A third potential benefit is greater political cooperation that can reduce the potential for military conflict among member nations. There also are several potential drawbacks of regional integration. First, formation of regional trading blocs can result in trade diversion—the diversion of trade away from nations not belonging to a trading bloc and toward member nations. It can actually result in reduced trade with a more efficient nonmember nation in favor of trade with a less efficient member nation. A second potential drawback is shifts in employment or dislocations in labor markets—some jobs are lost while others are gained. This can occur because the formation of trading blocs results in the producer of a particular good or service being decided by relative productivity. A third potential drawback is loss of national sovereignty. Because successive levels of integration require that nations surrender more of their national sovereignty, higher levels of integration are more difficult to achieve.

Q: What is meant by the terms trade creation and trade diversion? Why are these concepts important? A: Trade creation is the increase in the level of trade among nations that results from regional economic integration. Trade diversion is the diversion of trade away from nations not belonging to a trading bloc and toward member nations. These two concepts are important because trade creation gives consumers and industrial buyers in member nations a wider selection of goods and services, and lowers the cost of imported goods and services following the lowering of trade barriers. This increases efficiency among members of the regional trading bloc. However, trade diversion can result in reduced trade with a more efficient nonmember nation in favor of trade with a less efficient member nation. Thus, the significance of trade diversion is that it works against the rationale for the formation of trading blocs.

Quick Study 2 (p. ???) 1.

Q: Why did Europe initially desire to form a regional trading bloc? A: First, Europe needed to rebuild itself in the mid-1900s after another devastating war and to avoid further conflict. Nations saw cooperation as a way to interweave their economies and make military confrontation very costly to all. Second, Europe needed to increase its industrial strength to stay competitive with an increasingly powerful United States. A regional trading bloc would let a united Europe reduce cross-border inefficiencies (such as tariffs and long waits at border crossings for goods transport) and increase the competitiveness of its companies.

Q: Describe the evolution of the European Union. What are its five primary institutions? A: The members of the European Coal and Steel Community signed the Treaty of Rome in 1957, creating the European Economic Community (EEC), which outlined a future .

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common market. In 1967, the Community’s scope was broadened to include additional industries, notably atomic energy. It changed its name to the European Community. Enlargement occurred, and in 1994 the bloc changed its name to the European Union (EU). Two important milestones contributed to the EU: the Single European Act and the Maastricht Treaty. Today the 27-member European Union has a population of about 500 million people and a GDP of around $15 trillion. The five main institutions that play important roles in monitoring and enforcing economic and political integration are as follows: • The European Parliament is composed of nearly 736 members who are elected by popular vote within each member nation every 5 years. Parliament acts as a consultative rather than legislative body by debating and amending legislation proposed by the European Commission. • The Council of the European Union is the legislative body of the EU. It consists of the ministerial representatives of member states. No proposed legislation becomes EU law unless the Council votes it into law. • The European Commission is the executive body of the EU. It comprises commissioners appointed by each member country—larger countries get two commissioners, smaller countries get one. It has the right to draft legislation, is responsible for managing and implementing policy, and monitoring members’ implementation of and compliance with EU law. • The Court of Justice is the court of appeals of the EU and is composed of one justice from each member country. One type of case that the Court of Justice hears is one in which a member nation is accused of not meeting its treaty obligations. Like the commissioners, justices are required to act in the interest of the EU as a whole, not in the interest of their own countries. • The Court of Auditors comprises 27 members (one from each member nation) appointed for 6-year terms. The Court is assigned the duty of auditing the EU accounts and implementing its budget. It also aims to improve financial management in the EU and report to member nations’ citizens on the use of public funds. 3.

Q: What is European monetary union? Explain its importance to business in Europe. A: European monetary union is Europe’s plan that created its own central bank and issued a single currency. A single currency eliminates exchange-rate risk among the countries that previously had their own currencies, reduces transaction costs, and makes prices more transparent.

Q: Briefly describe the European Free Trade Association. A: The European Free Trade Association (EFTA) is a trading bloc consisting of Iceland, Liechtenstein, Norway, and Switzerland. It was formed in 1960 by seven nations (only two of which—Norway and Switzerland—are current members) with a focus on trade in industrial, not consumer, goods. However, member nations remain committed to free trade principles and raising standards of living. The group has a combined population of about 12.5 million people and a combined GDP of about $707 billion.

Quick Study 3 (p.???) 1.

Q: What was the impetus for the formation of the North American Free Trade Agreement? .

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A: The three nations belonging to the North American Free Trade Agreement (NAFTA) are Canada, Mexico, and the United States. Trade had been significant, especially between Canada and the United States. The main impetus for integration was the accelerating progress made in Europe in the late 1980s and early 1990s. 2.

Q: What effect has NAFTA had on Canadian Trade? A: Trade among Canada, Mexico, and the United States has grown from $297 billion in 1993 to about $1 trillion. Mexico’s exports to the United States rose to $211 billion. Meanwhile, U.S. exports to Mexico grew to more than $136 billion. Canada’s exports to the United States more than doubled to around $300 billion, while U.S. exports to Canada grew to $176 billion. Canada’s exports to Mexico grew more than threefold to nearly $2.7 billion. The agreement’s effect on employment and wages is not as easy to determine. The U.S. Trade Representative Office claims that exports to Mexico and Canada support 2.9 million U.S. jobs which pay 13 to 18 percent more than national averages for production workers. But the AFL-CIO says that since its formation, NAFTA has cost the United States more than 1 million jobs and job opportunities. According to Foreign Affairs, Trade and Development Canada, one in five jobs in Canada is related in part to trade. More than 4.3 million net new jobs were created in Canada between 1993 and 2008

Q: List the main benefits Canada from signing free trade agreements with other nations in the Americas. A: The goal of all these agreements is to strengthen economic relations between the two signatory countries by increasing bilateral trade, improving labour and environmental cooperation, and reducing or eliminating duties and non-tariff barriers to trade and investment.

Quick Study 4 (p. ???) 1.

Q: What is the Andean Community? Identify why its progress is behind schedule. A: The Andean Community was formed in 1969 and today includes Bolivia, Colombia, Ecuador, and Peru. It is a market of about 97 million consumers with a combined GDP of about $220 billion. The main hindrance to formation of the common market is that each member is given many exceptions in the common tariff structure for trade with nonmember nations.

Q: Identify the members of the Southern Common Market (MERCOSUR). How has it performed? A: The Southern Common Market (MERCOSUR) includes Argentina, Brazil, Paraguay, Uruguay, and Venezuela (Bolivia, Chile, Colombia, Ecuador, and Peru are associate members). MERCOSUR acts as a customs union and continues to make progress on trade and investment liberalization—emerging as the most powerful trading bloc throughout Latin America. Recent economic difficulties in Argentina have produced problems for MERCOSUR.

Q: Characterize economic integration efforts throughout Central America and the Caribbean. A: Attempts at economic integration in Central American countries and throughout the Caribbean basin have been much more modest than efforts elsewhere in the Americas. The Caribbean Community and Common Market (CARICOM) trading bloc was formed .

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in 1973 and comprises 15 nations with a combined GDP of nearly $30 billion and a market of almost 6 million people. In early 2000, CARICOM members signed an agreement calling for the establishment of the CARICOM Single Market, which seeks free movement of factors of production. The main difficulty CARICOM will continue to face is that most members trade more with nonmembers than they do with one another simply because members do not have the imports each other needs. The Central American Common Market (CACM) was formed in 1961 to create a common market between Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua. Together, the members of CACM comprise a market of 33 million consumers and have a combined GDP of $120 billion. Renewed peace is creating more business confidence and optimism, which is driving double-digit growth in trade among members, but the group has not yet created a customs union. Officials are positive, saying their ultimate goal is European-style integration, closer political ties, and adoption of a single currency— probably the dollar. In fact, El Salvador adopted the U.S. dollar as its official currency in 2000, and Guatemala already uses the dollar alongside its quetzal. 4.

Q: What is the objective of the Free Trade Area of the Americas? What are its current prospects for success? How would FTAA benefit Canadian businesses? A: The Free Trade Area of the Americas (FTAA) is intended to create a trading bloc stretching from the northern tip of Alaska to the southern tip of Tierra del Fuego in South America. The FTAA would remove tariffs and nontariff barriers among all member countries over an unspecified number of years once agreement is reached. A number of challenges face further integration in the Americas including debates over farm subsidies, disparate income among countries, and corruption in Latin America. According to Foreign Affairs and International Trade Canada, FTAA would create the world’s largest free trade area. With Canadian trade accounting for nearly 40 percent of Canada’s economy, Canada would greatly benefit from seeking access to the growing markets of the region.

Quick Study 5 (p. ???) 1.

Q: Identify the three main objectives of the Association of Southeast Asian Nations. A: Main objectives of ASEAN are to: (1) promote economic, cultural, and social development in the region; (2) safeguard the region’s economic and political stability; and (3) serve as a forum in which differences can be resolved fairly and peacefully.

Q: How do the goals of the Asia Pacific Economic Cooperation forum differ from those of other regional blocs? A: The organization for Asia Pacific Economic Cooperation (APEC) includes 21 nations. Its aim is not to build another trading bloc. Its purpose is to strengthen the multilateral trading system and expand the global economy by simplifying and liberalizing trade and investment procedures among member nations.

Q: What is the Gulf Cooperation Council? Identify its members. A: The Gulf Cooperation Council (GCC) is a trading bloc of six nations in the Middle East. Its membership includes Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates. The main achievements of the GCC are allowing citizens to travel freely among member nations, and allowing citizens to own land, businesses, and other property in other member nations without local partners.

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Q: List the aims of both the Economic Community of West African States and the African Union. A: One of the most important goals of ECOWAS is the formation of a customs union and eventual common market and monetary union. Progress on market integration is almost nonexistent: the value of trade occurring among ECOWAS nations is just 11 percent of the value of the trade that members undertake with third parties. But ECOWAS has made progress in the free movement of people, construction of international roads, and development of international telecommunication links. The AU is based on the vision of a united and strong Africa and on the need to build a partnership between governments and all segments of civil society to strengthen cohesion among the peoples of Africa. Its ambitious goals are to promote peace, security, and stability across Africa, and to accelerate economic and political integration while addressing problems compounded by globalization. Specifically, the stated aims of the AU are to: (1) rid the continent of the remaining vestiges of colonization and apartheid; (2) promote unity and solidarity among African States; (3) coordinate and intensify cooperation for development; (4) safeguard the sovereignty and territorial integrity of members; and (5) promote international cooperation within the framework of the United Nations.

Talk It Over 1.

Q: Proliferation and growth of regional trading blocs will likely continue into the foreseeable future. At what point do you think the integration process will stop (if ever)? Explain your answer. A: In theory, the integration process could continue until all the separate trading blocs merge into one global free trade bloc with a total absence of barriers to trade and investment. In practice, this is highly unlikely because of the relative lack of economic development of certain nations. However, this too could potentially be overcome eventually in a manner similar to that being attempted in the EU whereby the wealthier nations such as France and Germany are funding large economic development in the relatively poorer countries of Central and Eastern Europe. But to believe that all the nations of the world will eventually cast aside nationalism in totality and throw open their doors completely to free trade seems highly utopian.

Q: Some people believe the rise of regional trading blocs threatens free trade progress made by the World Trade Organization (WTO). Do you agree? Why or why not? A: This is a debate that perhaps will never be fully resolved. Some observers say that regional trade agreements do not override the power of the WTO and that they in fact follow the letter and spirit of the WTO. They credit regional trading blocs with advancing the cause of lowering trade and investment barriers because consensus is easier to obtain in a smaller group of nations than in the WTO. Others argue that trading blocs discriminate against companies from nonmember states in many different ways. For example, they can levy a higher tariff on products coming from nonmember nations as opposed to those from member nations. They could also implement local content requirements and force companies to produce within the bloc to have access to the bloc’s markets. In this sense, it might be argued successfully that such measures act against the objectives of the WTO.

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Q: Certain groups of countries, particularly in Africa, are far less economically developed than other regions, such as Europe and North America. What sort of integration arrangement do you think developed countries could create with lessdeveloped nations to improve living standards? Be as specific as you can. A: First of all, developed nations could extend to less-developed countries the same favorable treatment that they receive as members of their particular trading agreements. This would probably cause nationalist sentiment in developed nations to rise as labor groups, populist politicians, and others complain of cheap imports destroying domestic jobs. However, this is likely an inevitable byproduct of such an arrangement. Another option would be to grant each less-developed country the same preferential treatment that members of a trading bloc receive, but in only a single product category that suits their national competitive advantage. Then, according to Porter’s national competitive advantage theory, the nation would benefit from the cluster of supporting industries that would spring up around this core industry. However, this industry has to be involved in some high value-added activity. It probably would not be very effective if based on some commodity such as minerals or agricultural products, or other product with a low valueadded.

Q: Should Canada and Mexico seek greater economic integration with the United States,

such as a customs or an economic union that would make the US dollar the common currency in the region? Explain and provide pros and cons. What are the economic and political implications? A: Although theoretically an agreement between three equal parties, NAFTA has huge market size asymmetries. The US market predominance over Mexico and Canada appears to encourage the United States to use tactics such as bans, dumping, and protectionist measures to impose its own trade terms. By its nature, NAFTA runs the risk of becoming an extension of hegemonic US policy. Disputes, such as the softwood lumber case between Canada and the United States (which also involved the World Trade Organization’s arbitration system) and the US ban on Mexican trucks operating on US roads, are examples of power-politics prevailing over international trade rules and agreements such as NAFTA. Besides the claims of job losses and negative environmental impact due to NAFTA and NAFTA’s contentious clauses, Canada remains dependent on its trade relationship with the United States. According to Peter Hall, vice-president and chief economist of Export Development Canada, “Canadians know the adage well: The US economy sneezes and we catch pneumonia. The pros are mostly economic justifications, and the cons are predominantly environmental, political and social

Practicing International Management Case NAFTA Doesn’t Guarantee Free Trade After All: United States vs. Canada in the Softwood Lumber Case Q: Do you think that the softwood lumber case and the subsequent agreement are examples of NAFTA’s failure A: It would appear for the most part NAFTA has been successful. Softwood amounts to 3% of trade within NAFTA. Perhaps this sector is managed by individuals who are very tenacious in holding on to pre-NAFTA ways of doing business.

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Q: What are the opportunities and threats that the agreement poses to Canadian producers? A: It is helpful to American producers as it guarantees a floor price for their products. For many Canadian producers, sales forecasts are influenced not only by supply and demand, but also what looks like a Voluntary Export Restraint

Q: Do you think Bill C-24 effectively resolves the softwood lumber dispute? Please explain your reasoning. A: With Canada agreeing to what appears to be a Voluntary Export Restraint, the agreement appears to guarantee a “floor price” to US producers of $355 per thousand feet. In the short run it may help US producers, but the agreement is not permanent, so the potential for new disagreements is very real.

Q: If you were an international trade manager of a Canadian softwood lumber company, what strategic moves would you make to reduce dependence on the agreement? (Base your response on what you have learned in this chapter.) A: Perhaps to explore other export markets for Canadian softwood, or acquire an Eastern Canadian or US producer.

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CHAPTER 9 INTERNATIONAL FINANCIAL MARKETS AND FOREIGN EXCHANGE LEARNING OBJECTIVES: 1. Discuss the purposes, development, and financial centers of the international capital market. 2. Describe the international bond, international equity, and Eurocurrency markets. 3. Discuss the four primary functions of the foreign exchange market. 4. Understand how currencies are quoted and the different rates given. 5. Explain how exchange rates influence the activities of domestic and international companies. 6. Describe the primary methods of forecasting exchange rates. 7. Identify the main instruments of the foreign exchange market. 8. Explain why and how governments restrict currency convertibility. CHAPTER OUTLINE: Introduction International Capital Market Purposes of National Capital Markets Role of Debt Role of Equity Purposes of the International Capital Market Expands the Money Supply for Borrowers Reduces the Cost of Money for Borrowers Reduces Risk for Lenders Forces Expanding the International Capital Market World Financial Centers Offshore Financial Centers Main Components of the International Capital Market International Bond Market Types of International Bonds Interest Rates: A Driving Force International Equity Market Spread of Privatization Economic Growth in Emerging Markets Activity of Investment Banks Advent of Cybermarkets Eurocurrency Market Appeal of the Eurocurrency Market Foreign Exchange Market Functions of the Foreign Exchange Market Currency Conversion Currency Hedging Currency Arbitrage Interest Arbitrage Currency Speculation How the Foreign Exchange Market Works Quoting Currencies Calculating Percent Change Cross Rates .

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Spot Rates Buy and Sell Rates Forward Rates Forward Contracts Swaps, Options, and Futures Currency Swaps Currency Options Currency Futures Contracts How Exchange Rates Influence Business Activities Desire For Stability And Predictability Efficient Market View Inefficient Market View Forecasting Techniques Fundamental Analysis Technical Analysis Difficulties Of Forecasting Foreign Exchange Market Today Trading Centers Important Currencies Over-the-Counter Market Currency Convertibility Goals of Currency Restriction Policies for Restricting Currencies Countertrade Bottom Line for Business

A comprehensive set of specially designed PowerPoint slides is available for use with Chapter 9. These slides and the lecture outline below form a completely integrated package that simplifies the teaching of this chapter’s material. Lecture Outline 1.

INTRODUCTION This chapter explores the two interrelated systems that comprise the international financial markets, which are the international capital market and the foreign exchange market.

INTERNATIONAL CAPITAL MARKET A capital market is a system that allocates financial resources in the form of debt and equity according to their most efficient uses. Its main purpose is to provide a mechanism to borrow or invest money efficiently. A.

Purposes of National Capital Markets Help individuals and institutions borrow money from lenders; intermediaries exist to facilitate financial exchanges.

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Role of Debt a. Loans in which borrower repays borrowed amount (the principal) plus interest. Company debt normally takes the form of bonds—debt instruments specifying the timing of principal and interest payments. b. Holder of a bond (the lender) can force the borrower into bankruptcy if payment is not made on a timely basis. Bonds to fund investments are issued by private-sector companies and by municipal, regional, and national governments. Role of Equity a. Equity is part ownership of a company in which the equity holder participates with other part owners in the company’s financial gains and losses. Equity normally takes the form of stock—shares of ownership in a company’s assets that give shareholders a claim on the company’s future cash flows. b. Shareholders may be rewarded with dividends or by increases in the value of their shares. They may also suffer losses through decreases in the value of their shares. Dividend payments are not guaranteed, but decided by the company’s board of directors and based on financial performance. c. Shareholders can sell one stock and buy another or liquidate exchange stock for cash. Liquidity refers to the ease with which bondholders and shareholders convert investments into cash.

Purposes of the International Capital Market The international capital market is a network of individuals, companies, financial institutions, and governments that invest and borrow across national boundaries. Large international banks gather excess cash of investors and savers around the world and then channel it to global borrowers. 1. Expands the Money Supply for Borrowers a. Companies unable to obtain funds from investors in the domestic market seek financing in the international capital market. b. Essential for firms in countries with small or developing capital markets or emerging stock markets. c. An expanded supply of money benefits small companies that might not get financing under intense competition for capital. 2. Reduces the Cost of Money for Borrowers a. An expanded money supply reduces the cost of borrowing. The “price” reflects supply and demand. Excess funds create a buyer’s market, forcing interest rates lower. b. Projects regarded as infeasible because of low expected returns might be viable at a lower financing cost. 3. Reduces Risk for Lenders a. The international capital market expands the available set of lending opportunities. Investors reduce portfolio risk by spreading their money over many debt and equity instruments. b. Investing in international securities benefits investors because some economies are growing while others are in decline.

Ch 9: International Financial Markets and Foreign Exchange C.

Forces Expanding the International Capital Market 1. Information Technology Reduces time and money needed to communicate globally. Electronic trading after close of formal exchanges facilitates fast response times. 2.

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Deregulation Increases competition, lowers cost of financial transactions, and opens many national markets to global investing and borrowing. Yet greater regulation flowing out of the credit crisis of 2008–2009 may curtail growth in this market. Financial Instruments Increased competition is creating the need to develop innovative financial instruments. Securitization is the unbundling and repackaging of hard-to-trade financial assets into more liquid, negotiable, and marketable financial instruments, or securities. Here, too, regulation of securitization may curtail growth of this market.

World Financial Centers The three most important financial centers are London, New York, and Tokyo. 1. Offshore Financial Centers Country or territory where financial sector features few regulations and few, if any, taxes. They (1) are economically and politically stable; (2) are advanced in telecommunications; (3) offer large amounts of funding in many currencies; and (4) provide a less costly source of financing. a. Operational centers see a great deal of financial activity (e.g., London for currencies; Switzerland for investment capital). b. Booking centers are usually located on a small, island nation or territory with favorable tax or secrecy laws. Funds pass through on their way to large operational centers. Typically are offshore branches of domestic banks used to record tax and currency exchange information.

MAIN COMPONENTS OF THE INTERNATIONAL CAPITAL MARKET A.

International Bond Market Consists of all bonds sold by issuing companies, governments, and other organizations outside their own countries. Buyers include medium- to large-size banks, pension funds, mutual funds, and governments. 1. Types of International Bonds a. Eurobond Issued outside the country in whose currency it is denominated (e.g., issued in Venezuela in U.S. dollars, and sold in Britain, France, and Germany). It accounts for 75 to 80 percent of all international bonds. Absence of regulation reduces the cost of issuing a bond but increases its risk. b. Foreign Bond Sold outside borrower’s country and denominated in currency of country in which it is sold (e.g., yen-denominated bond issued by German carmaker BMW in Japan’s bond market). It accounts for 20 to 25 percent of all international bonds. Issuers must meet

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certain regulatory requirements and disclose details about company activities, owners, and upper management. Interest Rates: A Driving Force a. Borrowers from newly industrialized and developing countries borrow money from nations where interest rates are lower. b. Investors in developed countries buy bonds in newly industrialized and developing nations to obtain a higher return. c. Many emerging countries see the need to develop their own national markets. Volatility in currency market hurts projects that earn funds in those currencies and pay debts in dollars.

International Equity Market Consists of all stocks bought and sold outside the issuer’s home country. Companies and governments issue equity and buyers include other companies, banks, mutual funds, pension funds, and individuals. 1. Spread of Privatization a. A single privatization often places billions of dollars of new equity on stock markets. b. Increased privatization in Europe is expanding worldwide equity. European Union integration has made investors willing to invest in stocks from other European nations. 2. Economic Growth in Emerging Markets a. Growth in newly industrialized and developing countries contributes to growth in the international equity market. b. Because of a limited supply of funds in emerging economies, the international equity market is a major source of funding. 3. Activity of Investment Banks a. Global banks facilitate the sale of stock worldwide by bringing together sellers and large potential buyers. b. Becoming more common than listing a company’s shares on another country’s stock exchange. 4. Advent of Cybermarkets a. Stock markets consisting of online global trading activities that allow listing of stocks worldwide for electronic 24-hour trading.

Eurocurrency Market 1. All the world’s currencies banked outside their countries of origin are Eurocurrency and trade on the Eurocurrency market (e.g., Eurodollars, Europounds). It involves large transactions by the largest companies, banks, and governments. 2. Four Sources of Deposits: a. Governments with excess funds from prolonged trade surplus b. Commercial banks with excess currency c. International companies with excess cash d. Extremely wealthy individuals 3. Eurocurrency market is valued at around $6 trillion, with London accounting for about 20 percent of all deposits. 4. Appeal of the Eurocurrency Market a. Complete absence of regulation lowers costs. Banks charge borrowers less and pay investors more but still earn profit. b. Low transaction costs because transactions are large.

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Interbank interest rates are interest rates that the world’s largest banks charge one another for loans. London Interbank Offer Rate (LIBOR) is the interest rate charged by London banks to other large banks borrowing Eurocurrency. London Interbank Bid Rate (LIBID) is the interest rate offered by London banks to large investors for Eurocurrency deposits. Downside of Eurocurrency market is greater risk due to a lack of government regulation. Still, Eurocurrency transactions are fairly safe because of the size of the banks involved.

Think – Pair – Share slide 13 4.

FOREIGN EXCHANGE MARKET Market in which currencies are bought and sold and in which currency prices are determined. Exchange rates reflect the size of the transaction, the trader conducting it, general economic conditions, and sometimes, government mandate. If the British pound is quoted in U.S. dollars at $1.5054, the bank may bid $1.5052 to buy British pounds and offer to sell them at $1.5056. The difference is the bidask spread; banks buy low and sell high, earning profits from the bid-ask spread. A.

Functions of the Foreign Exchange Market 1. Currency Conversion Companies use the foreign exchange market to convert currencies. 2. Currency Hedging Insuring against potential losses that result from adverse changes in exchange rates. Companies use it to: (1) lessen the risk of international transfers; and (2) reduce exposure in transactions where a time lag exists between billing and receipt of payment. Currency Arbitrage 3. Instantaneous purchase and sale of a currency in different markets for profit. Common among experienced foreign exchange traders, large investors, and firms in arbitrage business. Interest arbitrage is the profit-motivated purchase and sale of a. interest-paying securities denominated in different currencies. Companies use interest arbitrage to find higher interest rates abroad in government treasury bills, corporate and government bonds, and even bank deposits. 4. Currency Speculation Purchase or sale of a currency with the expectation that its value will change and generate a profit. Much riskier than arbitrage because the value, or price, of currencies is quite volatile.

HOW THE FOREIGN EXCHANGE MARKET WORKS

Quoting Currencies Two components to every quoted exchange rate: the quoted currency and the base currency. In (¥/$), the yen is the quoted currency, the dollar is the base currency. The quoted currency is always the numerator, and the base currency is always the denominator.

Ch 9: International Financial Markets and Foreign Exchange 1.

Direct and Indirect Rate Quotes a. In ¥ 90/$, the yen is the quoted currency; this is called a direct quote on the yen and an indirect quote on the dollar.

Calculating Percent Change a. Exchange rate risk can jeopardize profits from current and future international transactions. Managers minimize this risk by tracking percent changes in exchange rates.

Cross Rate Used when no access to the exchange rate between two nation’s currencies, but have exchange rates for each nation’s currency with that of a third nation. Cross rates can be calculated using either currency’s indirect or direct exchange rates with another currency.

Spot Rate Exchange rate that requires delivery of a traded currency within two business days. The spot market helps companies to: • Convert income from sales abroad into the home-country currency. • Convert funds into the currency of an international supplier. • Convert funds into the currency of a country in which it will invest. 1. Buy and Sell Rates The spot rate is available only to banks and foreign exchange brokers. Small businesspeople exchanging currencies at their local bank receive a buy rate (the bank’s rate to buy a currency) and an ask rate (the bank’s rate to sell a currency). For example, if a bank quotes you an exchange rate between dollars and euros of $1.268/78 per euro (€), it will buy dollars at $1.268/€ and sell them at peso $1.278/€.

Forward Rate Exchange rate at which two parties agree to exchange currencies on a specified future date. Represent traders’ and bankers’ expectations of a currency’s future spot rate. Used to insure against unfavorable changes in exchange rates. 1.

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Forward Contract a. Requires exchange of an agreed-upon amount of a currency on an agreed-upon date at a specific exchange rate. Belong to a family of financial instruments known as derivatives. b. Commonly signed for 30, 90, and 180 days into the future, but customized contracts are also possible.

Swaps, Options, and Futures Three other types of currency instruments are used in the forward market. 1. Currency Swap Simultaneous purchase and sale of foreign exchange for two different dates. Used to reduce exchange-rate risk and lock in a future exchange rate. Can be viewed as a complex forward contract. 2. Currency Option Right, or option, to exchange a specific amount of a currency on a specific date at a specific rate. Used to hedge against exchange-rate risk or obtain foreign currency at a favorable rate.

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Currency Futures Contract Contract requiring the exchange of a specific amount of currency on a specific date at a specific exchange rate, with all conditions fixed and not adjustable.

HOW EXCHANGE RATES INFLUENCE BUSINESS ACTIVITIES A country with a currency that is weak (valued low relative to other currencies) will see a decline in the price of its exports and an increase in the price of its imports. Lower prices for the country’s exports on world markets can give companies the opportunity to take market share away from companies whose products are priced high in comparison. Furthermore, a company improves profits if it sells its products in a country with a strong currency (one that is valued high relative to other currencies) while sourcing from a country with a weak currency. The intentional lowering of the value of a currency by the nation’s government is called devaluation. The reverse, the intentional raising of its value by the nation’s government, is called revaluation. These concepts are not to be confused with the terms weak currency and strong currency, although their effects are similar. A. Desire for Stability and Predictability stable exchange rates improve the accuracy of financial planning and make cash flow forecasts more precise. Predictable exchange rates reduce the likelihood that companies will be caught off-guard by sudden and unexpected rate changes.

FORECASTING EXCHANGE RATES A. Efficient Market View The efficient market view thus holds that prices of financial instruments reflect all publicly available information at any given time. As applied to exchange rates, this means that forward exchange rates are accurate forecasts of future exchange rates. B. Inefficient Market View The inefficient market view holds that prices of financial instruments do not reflect all publicly available information. Proponents of this view believe companies can search for new pieces of information to improve forecasting. But the cost of searching for further information must not outweigh the benefits of its discovery. C. Forecasting Techniques 1. Fundamental Analysis Fundamental analysis uses statistical models based on fundamental economic indicators to forecast exchange rates. 2. Technical Analysis Another method of forecasting exchange rates is technical analysis — a technique that uses charts of past trends in currency prices and other factors to forecast exchange rates. D. Difficulties of Forecasting Beyond the problems associated with the data used by these techniques, failings can be traced to the human element involved in forecasting. For example, people might miscalculate the importance of economic news becoming available to the market, placing too much emphasis on some elements and ignoring others.

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FOREIGN EXCHANGE MARKET TODAY Electronic network of foreign exchange traders, currency trading banks, and investment firms among major financial centers. Single-day trading volume on the foreign exchange market (currency swaps and spot and forward contracts) is $4 trillion.

Trading Centers The United Kingdom, United States, and Japan account for half of all global currency trading. London dominates the foreign exchange market for historic and geographic reasons.

Important Currencies A vehicle currency is used as an intermediary to convert funds between two other currencies. Currencies most often involved in currency transactions are the U.S. dollar, British pound, Japanese yen, and European Union euro.

Over-the-Counter (OTC) Market Consists of a global computer network of foreign exchange traders and other market participants, but with no central trading location. Major players in the OTC market are large financial institutions and investment banks. The OTC market has grown because of several benefits: a. Businesspeople search for the institution that provides the best (lowest) price for transactions. b. It offers greater opportunities for designing customized transactions.

CURRENCY CONVERTIBILITY A convertible (hard) currency is one that trades freely in the foreign exchange market, with its price determined by the forces of supply and demand. But some countries do not permit the free convertibility of their currencies.

Goals of Currency Restriction 1. Preserve nation’s hard currencies to repay debts owed to other nations. 2. Preserve hard currencies to pay for imports and finance trade deficits. 3. Protect a currency from speculators. 4. Keep individuals and businesses from investing in other nations.

Policies for Restricting Currencies 1. Nation’s central bank must perform all foreign exchange transactions. 2. Government controls amount of foreign currency leaving the country by requiring importers to obtain import licenses. 3. Implement systems of multiple exchange rates that specify higher rates on the imports of certain goods or on the imports from certain nations. 4. Issue import deposit requirements that require businesses to deposit certain percentages of their foreign exchange holdings in special accounts before being granted import licenses. 5. Issue quantity restrictions that limit the amount of foreign currency that individuals can take out of the country when traveling abroad. 6. Countertrade Exchange of goods or services between two parties without the use of money. International companies can circumvent currency convertibility restrictions and yet conduct business.

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Think – Pair – Share slide 35 BOTTOM LINE FOR BUSINESS Key components of international financial markets are the international bond, equity, and Eurocurrency markets. Continued growth in the international capital market is expected. It is crucial that managers understand the fundamentals of exchange rates and how the foreign exchange market is structured. The next chapter covers how market forces (including interest rates and inflation) affect exchange rates. We explore the roles of government and international institutions in managing movements in exchange rates.

Quick Study Questions Quick Study 1 (p. ???) 1.

Q: What are the three main purposes of the international capital market? Explain each briefly. A: First, it expands the money supply for borrowers. Companies unable to obtain funds from investors in the domestic market can seek financing in the international capital market. The option of going outside the home nation is particularly important to firms in countries with small or developing capital markets of their own, particularly those with emerging stock markets. Second, it reduces the cost of money for borrowers. The “price” of money is determined by supply and demand—if its supply increases, price (in the form of interest rates) falls. Thus, excess supply creates a buyer’s market, forcing down interest rates and the cost of borrowing. Third, it reduces risk for lenders. The international capital market expands the available set of lending opportunities. Investors enjoy a greater set of opportunities from which to choose. They can thus reduce overall portfolio risk by spreading their money over a greater number of debt and equity instruments. Investing in international securities also benefits investors because some economies grow while others decline.

Q: Identify the factors expanding the international capital market. What is meant by the term securitization? A: (1) Large investments in information technology over the past two decades have drastically reduced the costs, in both time and money, of communicating around the globe. Developing and emerging markets are quickly installing state-of-the-art technologies relatively cheaply because they are implementing them right from the start rather than having to graft new technology onto old systems. (2) Deregulation increases competition, lowers the cost of financial transactions, and opens national markets to global investing and borrowing. (3) Increased competition in the financial industry is creating the need to develop innovative financial instruments. This increases the number of options available to lenders and borrowers. Much innovation in financial instruments has been accomplished through securitization—unbundling and repackaging hard-to-trade financial assets into more liquid, negotiable, and marketable financial instruments (or securities). For example, a mortgage loan from a bank is not liquid or negotiable because it is a customized contract between the bank and the borrower. However, U.S. government agencies, such as the Federal National Mortgage Association (FNMA, known as “Fannie Mae”), can sell .

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securities on open markets that are in turn based on a very large number of similar mortgage loans. Securitization makes hard-to-trade assets marketable securities. It remains to be seen whether greater securitization efforts will continue in light of events that occurred during the credit crisis of 2008–2009. 3.

Q: What is an offshore financial center? Explain its appeal to businesses. A: An offshore financial center is a country or territory whose financial sector features very few regulations and few, if any, taxes. Offshore financial centers offer large amounts of funding in many currencies and are a cheap source of financing for multinationals. They tend to be characterized by economic and political stability and typically have excellent telecommunications infrastructures. Some offshore centers are located on small, island nations or territories with favorable tax or secrecy laws.

Quick Study 2 (p. ???) 1.

Q: Describe the international bond market. What single factor is most responsible for fueling its growth? A: The international bond market is the market consisting of all bonds sold by issuing companies, governments, or other organizations outside their own countries. The international bond market is growing at about 10 percent per year. The most important factor fueling the growth in the international bond market was the low interest rates (the cost of borrowing money). Low interest rates in developed nations meant low rates of return for investors in government and corporate bonds. Thus, investors turned to bonds issued by entities in developing and emerging markets where higher returns reflected their greater risk. Low interest rates in developed markets and high rates in developing and emerging markets caused growth in the international bond market.

Q: What is the international equity market? Identify the factors responsible for its expansion. A: The international equity market consists of all stocks bought and sold outside the issuer’s home country. Stock exchanges listing the greatest number of companies from outside their own borders are Frankfurt, London, and New York. Four factors are responsible for much of its growth. First, the spread of privatization is a direct result of the efforts of many countries in abandoning central planning and socialist-style economics. A single privatization often places billions of dollars of new equity on stock markets. Second, economic growth in developing countries is increasing the demand for greater investment there. Because only a limited supply of funds are available in these nations, the international equity market is a major source of funding. Third, the activity of investment banks in internationalizing themselves is spurring growth in the international equity market. Fourth, the advent of cybermarkets (stock markets that have no central geographic locations and consist of supercomputers, high-speed data lines, satellite uplinks, and individual personal computers that match buyers and sellers in nanoseconds) is encouraging growth in the international equity market.

Q: Describe the Eurocurrency market. What is its main appeal? A: All the world’s currencies that are banked outside their countries of origin are referred to as Eurocurrency and traded on the Eurocurrency market. For example, U.S. dollars deposited in Tokyo’s Sumitomo Bank are called Eurodollars, and British pounds deposited in New York’s Chase Manhattan are called Europounds. Deposits of .

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Eurocurrency originate from governments with excess funds, commercial banks with excess currency, international companies with excess cash, and wealthy individuals. Because the world’s largest financial institutions operate in the Eurocurrency market, individual transactions are worth very large sums of money. This allows the banks to lower transaction costs and charge one another what are called interbank interest rates—interest rates that the world’s largest banks charge one another for loans. The London Interbank Offer Rate (LIBOR) is the interest rate charged by London banks to other large banks borrowing Eurocurrency. The London Interbank Bid Rate (LIBID) is the interest rate offered by London banks to large investors for Eurocurrency deposits. The main appeal of the Eurocurrency market is the complete absence of regulation—allowing it to operate at lower cost than traditional banking. This means that banks can charge borrowers less, pay investors more, and still earn healthy profits. 4.

Q: For what four reasons do investors use the foreign exchange market? A: First, companies use the foreign exchange market to convert one currency into another. Companies convert to local currencies for FDI and repatriate profits in the home currency. Second, currency hedging insures against potential losses that result from adverse changes in exchange rates. It helps firms: (1) lessen the risk of international transfers; and (2) reduce exposure in transactions where a time lag exists between billing and receipt of payment. Third, currency arbitrage is the instantaneous purchase and sale of a currency in different markets for profit. Common among experienced foreign exchange traders, large investors, and firms in arbitrage business. Fourth, currency speculation is the purchase or sale of a currency with the expectation that its value will change and generate a profit. It is much riskier than arbitrage because the value, or price, of currencies is quite volatile.

Quick Study 3 (p. ???) 1.

Q: Why is exchange-rate risk important to companies? A: Exchange-rate risk is important to companies because changes in exchange rates can either help or harm profit from international transactions.

Q: What is meant by the term cross rate? A: A cross rate is an exchange rate calculated using two other exchange rates. This rate is helpful to a businessperson that does not have access to the exchange rate between their nation’s currency and that of another, but does have the exchange rates for each nation’s currency relative to a third nation. It is important when businesspeople from two less commonly traded currencies want to exchange their two currencies as opposed to using a vehicle currency to conduct the transaction.

Q: Explain how a spot rate and forward rate are used in the foreign exchange market. A: A spot rate is the exchange rate that requires delivery of the traded currency within two business days. The spot rate is available only to banks and foreign exchange brokers because their trades are worth many millions of dollars. The spot market assists companies in: • Converting income from sales abroad into the home-country currency. • Converting funds into the currency of an international supplier. • Converting funds into the currency of a country in which it will invest. A forward rate is an exchange rate at which two parties agree to exchange currencies on a specified future date. Forward rates are helpful to a company that knows .

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it will need a certain amount of a currency on a certain future date. Companies often use the forward market to insure against unfavorable changes in exchange rates. 4.

Q: What are the main differences between currency swaps, options, and futures? A: A currency swap is the simultaneous purchase and sale of foreign exchange for two different dates. A currency option is a right, or option, to exchange a specific amount of a currency on a specific date at a specific rate. A currency futures contract is a contract requiring the exchange of a specific amount of currency on a specific date at a specific exchange rate.

Quick Study 4 (p. ???) 1. Q: Why are exchange rates important to managers’ decisions? A country with a currency that is weak (valued low relative to other currencies) will see a decline in the price of its exports and an increase in the price of its imports. Lower prices for the country’s exports on world markets can give companies the opportunity to take market share away from companies whose products are priced high in comparison. Furthermore, a company improves profits if it sells its products in a country with a strong currency (one that is valued high relative to other currencies) while sourcing from a country with a weak currency. 2. Q: Explain the difference between devaluation and revaluation. A: The intentional lowering of the value of a currency by the nation’s government is called devaluation. The reverse, the intentional raising of its value by the nation’s government, is called revaluation. These concepts are not to be confused with the terms weak currency and strong currency, although their effects are similar. 3. Q: Why is it desirable for exchange rates to be stable and predictable? A. Desire for Stability and Predictability stable exchange rates improve the accuracy of financial planning and make cash flow forecasts more precise. Predictable exchange rates reduce the likelihood that companies will be caught off-guard by sudden and unexpected rate changes. Quick Study 5 (P???) 1.

Q: What are the two market views regarding exchange-rate forecasting? Explain each briefly. A: Efficient Market View The efficient market view thus holds that prices of financial instruments reflect all publicly available information at any given time. As applied to exchange rates, this means that forward exchange rates are accurate forecasts of future exchange rates. Inefficient Market View The inefficient market view holds that prices of financial instruments do not reflect all publicly available information. Proponents of this view believe companies can search for new pieces of information to improve forecasting. But the cost of searching for further information must not outweigh the benefits of its discovery.

Q: Identify the two main methods of forecasting exchange rates. What are the difficulties of forecasting? .

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A: Forecasting Techniques 1. Fundamental Analysis Fundamental analysis uses statistical models based on fundamental economic indicators to forecast exchange rates. 2. Technical Analysis Another method of forecasting exchange rates is technical analysis — a technique that uses charts of past trends in currency prices and other factors to forecast exchange rates. 3. Difficulties of Forecasting Beyond the problems associated with the data used by these techniques, failings can be traced to the human element involved in forecasting. For example, people might miscalculate the importance of economic news becoming available to the market, placing too much emphasis on some elements and ignoring others.

Talk It Over 1.

Q: What factors do you think are holding back the creation of a truly global capital market? How might a global capital market function differently from the present-day international market? (Hint: Some factors to consider are interest rates, currencies, regulations, and financial crises for some countries.) A: The international capital market will not likely become a truly global pool of funds for several reasons. First, governments would lose control over an important tool of economic policy. Individual governments would be less effective at manipulating interest rates or the money supply to slow down or increase the pace of economic expansion in their own nation. Second, governments use certain regulations to influence the domestic economy and their balance of payments situation. Third, the different national markets are working more closely together than ever before but the technology needed to create one global capital market seems not to exist today.

Q: The use of different national currencies creates a barrier to further growth in international business activity. What are the pros and cons, among companies and governments, of replacing national currencies with regional currencies? Do you think a global currency would be possible someday? Why or why not? A: The issue of replacing national currencies with a regional or global one creates a problem for national governments because they lose a great deal of their ability to manipulate the domestic economy through monetary and fiscal policies. This is perhaps the main impediment to the creation of one global currency for all the nations of the world. On the other hand, companies would benefit greatly from such a move because exchange rate risk would be eliminated, the costs of converting currencies would disappear, and estimating future earnings and expenses in currencies other than the homecountry currency would be far simpler.

Q: Governments dislike the fact that offshore financial centers facilitate money laundering. Do you think that electronic commerce makes it easier or harder to launder money and camouflage other illegal activities? Do you think offshore financial centers should be allowed to operate as freely as they do now, or do you favor regulation? Explain your answers. .

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A: The reason (at least in the near-term) that greater corruption could go undetected by many governmental law enforcement agencies is that their monitoring systems are outdated relative to the computer systems of international companies and certain wealthy individuals. Because such governmental agencies typically employ many thousands of people and are very bureaucratic, introduction of the latest technological advances in detecting e-commerce crimes can be extremely costly. Therefore, although some corrupt companies or individuals are implementing the latest technologies in covering their financial transactions, many governments cannot afford the equipment needed to track such transactions. For these same reasons, the elimination of illegal or questionable transactions through greater regulation of offshore financial centers is difficult to accomplish.

Practicing International Management Case

Managing an International Business Despite a Strong Loonie Q1. If you were hired by a company that exports only to the United States, what strategies would you recommend the company use to cope with a strong loonie? A: Break into new markets and to grow their businesses. More than half the respondents named investing and outsourcing abroad as very effective strategies. Another 22 percent of those surveyed said that despite the high-value Canadian dollar their export sales have increased. These businesses tended to be ones with high-demand often exclusive products, which were less price sensitive. Q2. What strategies do you recommend for companies with price-sensitive products? A: The Business Development Bank of Canada (BDC) suggests several ways to structure a business to offset currency fluctuations, including finding foreign suppliers; setting up a foreign bank account to offset currency inflows and outflows; adding foreign operations; and buying and selling currencies using forwards, futures, and options. BDC also proposes using currency options to buy equipment. Let’s say you decide to buy a machine for your factory in the United States, and the transaction closes in eight months. An option can protect you against the loonie devaluating during that eight-month period; however, if it appreciates against the US dollar, you can let the option expire and benefit from the higher exchange rate. Q3. Do you think a strong loonie is a problem or an opportunity for Canadian exporters? Explain your answer. A: The emergence of the loonie as a strong currency has prompted Canadian businesses to develop new strategies. Canadian exporters and multinationals in Canada are using three main strategies: cutting costs, increasing innovation, and improving operating efficiencies.

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CHAPTER 11 INTERNATIONAL STRATEGY AND ORGANIZATION LEARNING OBJECTIVES: 1. Explain the stages of identification and analysis that precede strategy selection. 2. Identify the two international strategies and the corporate-level strategies that companies use. 3. Identify the business-level strategies of companies and the role of department-level strategies. 4. Discuss the important issues that influence the choice of organizational structure. 5. Describe each type of international organizational structure and explain the importance of work teams.

CHAPTER OUTLINE: Introduction International Strategy Strategy Formulation Identify Company Mission and Goals Types of Mission Statements Identify Core Competency and Value-Creating Activities Unique Abilities of Companies Value-Chain Analysis Primary Activities Support Activities National and International Business Environments Formulate Strategies Two International Strategies Multinational Strategy Global Strategy Corporate-Level Strategies Growth Strategy Retrenchment Strategy Stability Strategy Combination Strategy Business-Level Strategies Low-Cost Leadership Strategy Differentiation Strategy Focus Strategy Department-Level Strategies Primary and Support Activities International Organizational Structure Centralization versus Decentralization When to Centralize When to Decentralize Participative Management and Accountability Coordination and Flexibility Structure and Coordination Structure and Flexibility Types of Organizational Structure .

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International Division Structure International Area Structure Global Product Structure Global Matrix Structure Work Teams Self-Managed Teams Cross-Functional Teams Global Teams Bottom Line for Business

A comprehensive set of specially designed PowerPoint slides is available for use with Chapter 11. These slides and the lecture outline below form a completely integrated package that simplifies the teaching of this chapter’s material. Lecture Outline 1.

INTRODUCTION Planning is the process of identifying and selecting an organization’s objectives and deciding how the organization will achieve those objectives. Strategy is the set of planned actions taken by managers to meet company objectives. Developing an effective strategy requires a clear definition of objectives (or goals) and a plan to achieve them. An analysis of capabilities and strengths identifies what a company does better than the competition. Assessing the competitive environment, the national, and the international business environments are part of the analysis. A well-defined strategy coordinates divisions and departments to reach companywide goals effectively and efficiently. A clear, appropriate strategy focuses on the activities performed best to avoid mediocre performance or total failure.

INTERNATIONAL STRATEGY Firms must determine what products to produce, where to produce them, and where and how to market them. Whether a site for operations or potential market, each international location has a rich mixture of cultural, political, legal, and economic traditions and processes. All these factors add to the complexity of planning and strategy.

Strategy Formulation Strategy formulation permits managers to step back from day-to-day activities and get a fresh perspective on the direction of the company and its industry.

Identify Company Mission and Goals Mission statement: written statement of why a company exists and what it plans to accomplish (e.g., supply the highest level of service in a market segment). 1. Types of Mission Statements Mission statements often describe how a company’s operations a. affect stakeholders—all parties, ranging from suppliers and employees to stockholders and consumers, affected by a company’s activities. The mission statement of an international business depends on b. the type of business, the stakeholders, and the most important

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aspect of the business for goal achievement. Companies must be sensitive to the needs of stakeholders in different nations. Stockholders’ needs for financial returns must be balanced against the public interest in countries where production is located. Managers must define global objectives. High-level objectives are stated in general terms, “to be the largest global company in each industry in which we compete.” Business-unit objectives are more specific, “to mass produce a zero-pollution emissions automobile by 2015.” Department-level objectives often carry numerical performance targets, “to increase global market share by 5 percent in each of the next three years.”

Identify Core Competency and Value-Creating Activities Before managers formulate strategies, they analyze the company, industry, and the national business environment(s). They should examine industries and nations targeted for potential future entry. Analysis helps managers discover core competency and abilities, and the activities that create customer value. 1. Unique Abilities of Companies a. Core competency: an ability of a company that competitors find extremely difficult or impossible to equal. Refers to multiple skills coordinated to form a single technological outcome. b. Skills are learned through on-the-job training and personal experience, whereas core competencies develop over a long period and are difficult to teach. 2. Value-Chain Analysis Value-chain analysis is the process of dividing a company’s activities into primary and support activities and identifying those that create value for customers. Primary activities include inbound and outbound logistics, manufacturing, marketing and sales, and customer service. Support activities include firm infrastructure, human resource management, technology development, and procurement. Each activity is a source of strength or weakness for a company. a. Primary Activities When analyzing primary activities, managers look for areas in which the company can increase customer value. b. Support Activities Support activities assist in performing primary activities. A sophisticated infrastructure improves internal communication and supports organizational culture and each primary activity. 3. National and International Business Environments a. National differences in language, religious beliefs, customs, traditions, and climate complicate strategy formulation. b. Manufacturing processes must sometimes be adapted to the supply of local workers, local customs, traditions, and practices. c. Differences in political and legal systems complicate international strategies. d. Different national economies complicate strategy formulation.

Formulate Strategies

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Strengths and capabilities of international companies and environmental forces play a role in strategy. 1. Two International Strategies a. Multinational Strategy i. Adapts products and marketing strategies in each national market to suit local preferences. ii. Benefit: monitor buyer preferences in each local market and respond quickly and effectively to new buyer preferences. Drawback: cannot exploit scale economies in product development, manufacturing, or marketing. iii. Not suited to industries in which price competitiveness is a key to success. b. Global Strategy i. Offers the same products using the same marketing strategy in all markets. ii. Firms take advantage of scale and location economies by producing entire inventories or components in a few optimal locations. They perform product R&D in one or a few locations and design promotional campaigns and advertising strategies at headquarters. iii. Benefit: cost savings from standardized products and marketing; lessons learned in a market are shared. iv. Yet a firm employing this strategy may overlook differences in buyer preferences. Only simple modifications in features. Competitors can step in and satisfy unmet local needs creating a niche market. Think – Pair – Share Slide 13 2.

Corporate-Level Strategies Companies in more than one business must formulate a corporate-level strategy by identifying the markets and industries in which to operate. Overall objectives for different business units are developed and the role of each unit in reaching those objectives is determined. a. Growth Strategy i. A growth strategy is designed to increase the scale or scope of a corporation’s operations. Scale refers to the size of a corporation’s activities; scope to the kinds of activities it performs. ii. Organic growth relies on internally generated growth. iii. Other methods of growth are mergers and acquisitions, joint ventures, and strategic alliances. Partners in pursuing these include competitors, suppliers, and buyers; firms join competitors to reduce competition, expand product lines, or expand geographically. b. Retrenchment Strategy Reduces the scale or scope of a corporation’s businesses. i. Corporations cut back the scale of operations when economic conditions worsen or competition increases by closing factories with unused capacity and laying-off

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employees. Corporations reduce the scope of activities by selling unprofitable business units. c.

Stability Strategy i. Guards against change and used to avoid either growth or retrenchment. ii. Corporations have met objectives, are satisfied with accomplishments, and see no opportunities or threats. d. Combination Strategy i. Mixes growth, retrenchment, and stability strategies across a corporation’s business units. ii. Common because rarely do international corporations follow identical strategies in each business unit. Business-Level Strategies A company may need only one strategy for its one line of business or others may need many strategies. Key to an effective business-level strategy is a general competitive strategy in the marketplace. a. Low-Cost Leadership Strategy i. Exploits economies of scale to have the lowest cost structure of any competitor in an industry. ii. Companies contain administrative costs and the costs of its various primary activities, including marketing, advertising, and distribution. iii. Low-cost leadership based on efficient production in large quantities guards against attack by competitors because of the large start-up costs. iv. A negative aspect of the low-cost leadership strategy is low customer loyalty—buyers will purchase from the low-cost leader if everything else is equal. A low-cost leadership strategy works best with mass-marketed products aimed at price-sensitive buyers. b. Differentiation Strategy i. Company designs products to be perceived as unique. ii. Tends to force a company into a lower-market-share position because it involves the perception of exclusivity or meeting the needs of a certain group. iii. Companies develop loyal customer bases to offset smaller market shares and higher costs of producing and marketing a unique product. iv. Products can be differentiated on the basis of quality, brand image, and product design. Special features differentiate goods and services in the minds of consumers. Manufacturers combine differentiation factors in formulating their strategies. c. Focus Strategy i. Company focuses on the needs of a narrowly defined market segment by being the low-cost leader, by differentiating its product, or both. ii. Competition forces more products to be distinguished by price, quality, or design. Greater product range leads to refinement of market segments.

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Some firms serve the needs of one ethnic or racial group, whereas others focus on a single geographic area.

Department-Level Strategies Reaching corporate- and business-level objectives depends on effective departmental strategies that focus on activities that transform resources into products. Department-level strategies rely on capabilities—primary and support activities that create value for customers. a. Primary and Support Activities i. Each department creates customer value through lower costs or differentiated products. ii. For primary activities, manufacturing strategies cut production costs and improve product quality; marketing strategies promote differences in products; and efficient logistics result in cost savings. iii. Support activities create customer value (e.g., R&D identifies market segments with unsatisfied needs and designs products to meet them).

INTERNATIONAL ORGANIZATIONAL STRUCTURE Organizational structure is the way in which a company divides its activities among separate units and coordinates activities between those units. An appropriate organizational structure for a firm’s strategic plans will help it achieve its goals. A.

Centralization versus Decentralization Centralized decision making occurs at a high level in one location such as headquarters. Decentralized decision making occurs at lower levels, such as in international subsidiaries. Managers cannot get involved in every hiring decision or task assignment, but overall corporate strategy cannot be delegated to subsidiaries because only top management has the appropriate perspective. Companies rarely centralize or decentralize all decision making, but seek the approach that creates the greatest efficiency and effectiveness. International companies may centralize decision making in certain geographic markets, but decentralize it in others. 1. When to Centralize a. Centralization helps coordinate international subsidiaries; important when one subsidiary’s output is another’s input. b. Companies maintain strong central control over financial resources by channeling all subsidiary profits back to the parent for redistribution to subsidiaries. c. Other companies centrally design policies, procedures, and standards to stimulate a single global organizational culture. 2. When to Decentralize a. Decentralized decision making is beneficial when fast changing business environments require local responsiveness. b. Because subsidiary managers are in contact with local culture, politics, laws, and economies, decentralized decisions result in products suited to the needs and preferences of local buyers. c. Delayed response and misinterpreted events result in lost orders, stalled production, and weakened competitiveness.

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Participative Management and Accountability i. Decentralization fosters participative management practices. Employee morale is higher if subsidiary managers and subordinates are involved in decisions. ii. If delegated to subsidiaries, decisions about production, promotion, distribution, and pricing can generate greater commitment from managers and workers. iii. Decentralization improves personal accountability. When local managers are rewarded (or punished) for their decisions, they invest more effort in making and executing them.

Coordination and Flexibility Key questions: What is the most efficient way to link divisions? Who should coordinate the divisions? How should the company process and deliver information? How should it use corrective measures? 1. Structure and Coordination a. Companies need structure to define responsibility and chains of command—lines of authority that run from top management to each employee and specify internal reporting relationships. b. Companies need structures to bind areas requiring cooperation, such as linking R&D and manufacturing to avoid product designs that complicate manufacturing. 2. Structure and Flexibility a. Organizational structure is not permanent, but is modified to suit changes within a company and in its external environment. b. Changes in strategy and in the business environment force modifications in organizational structure; some countries are characterized by rapidly shifting business environments.

Types of Organizational Structure Four organizational structures are common for most international companies. 1. International Division Structure a. An international division with its own manager keeps domestic and international activities separate. A general manager for each nation in which a company operates then controls product manufacturing and marketing within that market. b. Concentrates international expertise in one division where the manager becomes a specialist in foreign exchange, exporting, and so on. Firm reduces costs, increases efficiency, and prevents international activities from disrupting home operations. c. Potential problems with this structure are: (1) poor coordination between the international division and the rest of the company can hurt performance; and (2) destructive rivalries may arise between different country managers within the division. 2. International Area Structure a. Organizes a company’s global operations into countries or regions. The more countries in which a company operates, the greater the likelihood it will organize into regions, not countries. b. Each geographic division operates as a self-contained unit, with decision making decentralized to country or regional managers.

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Useful structure when there are vast cultural, political, or economic differences among nations or regions. d. By controlling activities in their environments, general managers become experts on the unique needs of their buyers. But because units act independently, resources may overlap, and crossfertilization of knowledge across units can be limited. Global Product Structure a. Divides worldwide operations according to a company’s product areas. Suitable when a firm has a diverse set of products. b. Because the primary focus is on the product, domestic and international managers for each product division must coordinate their activities so they do not conflict. Global Matrix Structure a. Splits the chain of command between product and area divisions. Each manager reports to two bosses—the president of the product division and the president of the geographic area. b. Brings together geographic area managers and product area managers in joint decision making. c. Bringing specialists together creates a team-type organization. Increases local responsiveness, reduces costs, coordinates worldwide operations, and can increase coordination while improving agility and local responsiveness. d. Two major shortcomings: (1) The matrix form can be quite cumbersome as the need for complex coordination tends to make decision making time consuming and slows the reaction time. (2) Individual responsibility and accountability are blurred in the matrix organization structure; because of shared responsibility, managers may attribute poor performance to the other manager.

Work Teams Work teams can be useful in improving responsiveness by cutting across functional boundaries (between production and marketing) that slow decision making in an organization. Work teams coordinate their efforts to arrive at solutions and implement corrective action. 1. Self-Managed Teams a. Employees from a single department accept responsibilities of former supervisors. In production settings, self-managed teams reduce the need for direct supervisors and increase productivity, product quality, customer satisfaction, employee morale, and company loyalty. b. Quality-improvement teams are the most common type of selfmanaged team in many manufacturing companies because they reduce production waste and cut costs. c. Cultural differences can cause resistance to the concept of selfmanagement and the use of teams. Experts suggest that international managers use caution when implementing them. d. Certain cultures are less individualistic and more collectivist; some harbor greater respect for differences in status. In cultures in which people are hard working, teams will be productive if given greater autonomy.

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Cross-Functional Teams a. Composed of employees who work at similar levels in different functional departments. Such teams can help improve interdepartmental coordination and help boost product quality. b. Break down interdepartmental barriers and reorganize operations around processes, not functional departments. Global Teams a. Group of top managers from both headquarters and subsidiaries who meet to develop solutions to company-wide problems. b. Large distances between team members, lengthy travel times to meetings, and the inconvenience of working across several time zones can hamper global teams.

Think – Pair – Share Slide 34

Bottom Line for Business Managers have the important and complicated task of formulating international strategies at the levels of the corporation, business unit, and department. International managers must identify the company’s mission and goals. Managers often analyze the company’s operations by performing a value-chain analysis. This process lets managers identify and implement strategies suited to a company’s unique capabilities. The strategies managers select then determine a firm’s organizational structure. Business environments can affect managers’ strategy and structure decisions, including whether to alter their products (standardization or adaptation), where to locate facilities (centralized or decentralized production), and what type of decision making to implement (centralized or decentralized decision making).

Quick Study Questions Quick Study 1 (p. ???) 1.

Q: What are the three stages of the strategy-formulation process? Describe what is involved at each stage. A: The three stages are: (1) identify the company’s mission and goals; (2) identify its core competency and value-creating activities; and (3) formulate strategies. Most companies have a general purpose for why they exist that they express in a mission statement—a written statement of why a company exists and what it plans to accomplish. The strengths, or core competencies, and special capabilities of international companies, along with the environmental forces they face, play a large role in the type of strategy that managers choose. Before managers formulate effective strategies, they must analyze the company, its industry (or industries), and the national business environments in which it is involved. They should also examine industries and countries being targeted for potential future entry. A clearly focused strategy can then be identified and defined.

Q: Define what is meant by the term core competency. How does it differ from a skill? A: A core competency is a special company ability that competitors find extremely difficult or impossible to equal. It is not a skill. Individuals possess skills such as the .

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ability to hit 70 home runs in professional baseball. A core competency refers to multiple skills that are coordinated to form a single technological outcome. Core competencies develop over long periods of time and are difficult to teach or transfer. 3.

Q: What is value-chain analysis? Explain the difference between primary and secondary activities. A: Value-chain analysis is the process of dividing a company’s activities into primary and support activities and identifying those that create value for customers. Primary activities include inbound and outbound logistics, manufacturing (or operations), marketing and sales, and customer service. Support activities include firm infrastructure, human resource management, technology development, and procurement. Each primary and support activity is a source of strength or weakness for a company.

Q: How do national and international business environments influence strategy formulation? A: National differences in language, religious beliefs, customs, traditions, and climate complicate strategy formulation. Differences in political, legal, and economic systems also complicate international strategy. Companies must consider these differences in their strategy formulation or risk making terrible blunders abroad.

Quick Study 2 (p. ???) 1.

Q: Compare and contrast multinational strategy and global strategy. When is each appropriate? A: A multinational (multidomestic) strategy is a strategy of adapting products and their marketing strategies in each national market to suit local preferences. The main benefit of a multinational strategy is that it allows companies to closely monitor buyer preferences in each local market and respond quickly and effectively as new buyer preferences emerge. The main drawback of a multinational strategy is that it does not allow companies to exploit scale economies in product development, manufacturing, or marketing. A global strategy is a strategy of offering the same products using the same marketing strategy in all national markets. The main benefit of a global strategy is its cost savings due to product and marketing standardization. The main problem with a global strategy is that it may cause a company to overlook important differences in buyer preferences from one market to another.

Q: What are the four corporate-level strategies? Identify the main characteristics of each. A: Companies involved in more than one line of business must formulate a corporatelevel strategy. A growth strategy is one that is designed to increase the scale or scope of a corporation’s operations. Some methods of growth include mergers and acquisitions, joint ventures, strategic alliances, and organic growth—growth from within the company. A retrenchment strategy is one that is designed to reduce the scale or scope of a corporation’s businesses. A stability strategy is one that is designed to guard against change. Corporations following this strategy have typically met their stated objectives or are satisfied with what they have already accomplished. It is a relatively uncommon strategy. A combination strategy is one that mixes growth, retrenchment, and stability strategies across a corporation’s business units. Corporate combination strategies are quite common because rarely do international corporations follow identical strategies in each of their business units. .

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Q: Identify the three business-level strategies. Describe how they differ from one another. A: A low-cost leadership strategy is one in which a company exploits economies of scale to have the lowest cost structure of any competitor in its industry. A low-cost leadership strategy works best with mass-marketed products aimed at price-sensitive buyers. A differentiation strategy is one in which a company designs its products to be perceived as unique by buyers throughout its industry. It tends to force a company into a lower market share position because it involves the perception of exclusivity or as meeting the needs of only a certain group of buyers. Products can be differentiated on the basis of quality, brand image, and product design. A focus strategy is one in which a company focuses on serving the needs of a narrowly defined market segment by being the low-cost leader, by differentiating its product, or both. A focus strategy often means designing products and promotions aimed at consumers who are either dissatisfied with existing choices or who want something distinctive.

Q: Explain the importance of department-level strategies. How do primary and support activities help a firm achieve its goals? A: Achieving corporate- and business-level objectives depends on effective departmental strategies that focus on specific activities that transform resources into products. Formulation of department-level strategies brings us back to the analysis of a company’s capabilities that support its strategy—primary and support activities that create value for customers. Each department is instrumental in creating customer value through lower costs or differentiated products.

Quick Study 3 (p. ???) 1.

Q: Explain what is meant by organizational structure. What is the difference between centralized and decentralized decision making? A: Organizational structure is the way in which a company divides its activities among separate units and coordinates activities between those units. If a company’s organizational structure is appropriate for its strategic plans, it will be more effective in working toward its goals. Centralized decision making is the degree to which decision making is centralized at a high level in one location such as headquarters. Decentralized decision making is the degree to which decisions are made at lower levels, such as in international subsidiaries.

Q: Why are coordination and flexibility important when designing organizational structure? A: When designing organizational structure, managers seek answers to certain key questions. What is the most efficient method of linking divisions to one another? Who should coordinate the activities of different divisions in order to achieve overall strategies? How should information be processed and delivered to managers when it is required? What sorts of monitoring mechanisms and reward structures should be established? How should the company introduce corrective measures, and whose responsibility should it be to execute them? To answer these types of questions, we must look at the issues of coordination and flexibility.

Q: Describe what is meant by the term chains of command? A: Each company needs a structure that clearly defines areas of responsibility and chains of command—the lines of authority that run from top management to individual employees and specify internal reporting relationships. .

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Quick Study 4 (p. ???) 1.

Q: What four main types of organizational structure are used in international business? A: The four types of organizational structure used in international business are: (1) international division structure, (2) international area structure, (3) global product structure, and (4) global matrix structure.

Q: Explain how each type of organizational structure differs from the other three. A: The international division structure separates domestic from international business activities by creating a separate international division with its own manager. The manager of the international division becomes a specialist in a wide variety of activities such as foreign exchange, export documentation, and host-government lobbying. Two potential problems with this structure are: 1) poor coordination between the international division and the rest of the company can hurt performance, and 2) destructive rivalries may arise between different country managers within the division. The international area structure organizes a company’s global operations into countries or regions. The international area structure is particularly useful when there are vast cultural, political, or economic differences between nations or regions. The global product structure divides worldwide operations according to a company’s product areas. The global product structure is suitable for companies offering diverse sets of products or services. The global matrix structure splits the chain of command between product and area divisions. A main goal of the global matrix structure is to bring together geographic area managers and product area managers in joint decision making.

Q: Identify the three different types of work teams. How does each improve responsiveness and effectiveness? A: A self-managed team is one in which employees from a single department take on responsibilities of their former supervisors. In production settings, self-managed teams can reduce the need for direct supervisors and can increase productivity, product quality, customer satisfaction, employee morale, and company loyalty. However, companies must consider culture when implementing the self-managed team concept. A cross-functional team is one that is composed of employees who work at similar levels in different functional departments. Such teams can improve coordination between departments, improve product quality, and help companies in reorganizing themselves around processes. A global team is a group of top managers from both headquarters and international subsidiaries who meet to develop solutions to company-wide problems. Some of these teams are temporary whereas others move on to tackle new problems after resolving an important issue. Large distances between team members, lengthy travel times to meetings, and the inconvenience of working across several time zones can hamper global teams.

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Practicing International Management Case IKEA’s Global Strategy 1.

Q: Has IKEA taken a standardization approach or an adaptation approach in its markets around the world? Do you think the company’s approach is the right one for the future? Explain. A: IKEA has standardized its brand image and main marketing concept worldwide. It has only adapted its facilities in terms of size to suit the U.S. market. The approach certainly seems to be working well for IKEA.

Q: Which retailers do you think will be IKEA’s biggest competitors in Canada? Why? A: Some main competition will come from stores such as Home Outfitters, JYSK, and all the chain stores that appeal to the “do-it-yourself” furniture buyer.

Q: When company founder Kamprad decided to expand into China his decision was not based on market research but, rather, on his own intuition. How well is IKEA doing in China? Did Kamprad’s decision pay off? A: So far IKEA’s stores in Beijing and Shanghai are performing well. IKEA changed some elements of its global strategy in culturally diverse China. In China, the company balances the implementation of its global polices and the need for greater localization. IKEA has improved its responsiveness to the needs of the China market regarding its corporate culture, structure, and strategy.

Q: After failing in Japan two decades earlier, IKEA returned to Japan in 2006. Conduct some research into how IKEA fared the second time around in Japan. Was IKEA able to avoid the mistakes it made in its first failed attempt? A: So far, IKEA’s stores in Japan are performing very well. The second time around, IKEA conducted a thorough market study and visited several Japanese homes to understand consumers’ requirements. IKEA then formulated its strategy for the Japanese market based on “small space living.” IKEA brought products to Japan suitable to the Japanese, such as storage boxes, sofa beds, two-seater sofas, and so forth.

Ch 11: Selecting and Managing Entry Modes

CHAPTER 11 SELECTING AND MANAGING ENTRY MODES LEARNING OBJECTIVES: 1. Explain how companies use exporting, importing, and countertrade. 2. Explain the various means of financing export and import activities. 3. Describe the different contractual entry modes that are available to companies. 4. Explain the various types of investment entry modes. 5. Discuss the important strategic factors in selecting an entry mode.

CHAPTER OUTLINE: Introduction Exporting, Importing, and Countertrade Why Companies Export Developing an Export Strategy: A Four-Step Model Step 1: Identify a Potential Market Step 2: Match Needs to Abilities Step 3: Initiate Meetings Step 4: Commit Resources Degree of Export Involvement Direct Exporting Sales Representatives Distributors Indirect Exporting Agents Export Management Companies Export Trading Companies Avoiding Export and Import Blunders Countertrade Types of Countertrade Export and Import Financing Advance Payment Documentary Collection Letter of Credit Open Account Contractual Entry Modes Licensing Advantages of Licensing Disadvantages of Licensing Franchising Advantages of Franchising Disadvantages of Franchising Management Contracts Advantages of Management Contracts Disadvantages of Management Contracts Turnkey Projects Advantages of Turnkey Projects .

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Disadvantages of Turnkey Projects Investment Entry Modes Wholly Owned Subsidiaries Advantages of Wholly Owned Subsidiaries Disadvantages of Wholly Owned Subsidiaries Joint Ventures Joint Venture Configurations Forward Integration Joint Venture Backward Integration Joint Venture Buyback Joint Venture Multistage Joint Venture Advantages of Joint Ventures Disadvantages of Joint Ventures Strategic Alliances Advantages of Strategic Alliances Disadvantages of Strategic Alliances Selecting Partners for Cooperation Strategic Factors in Selecting an Entry Mode Cultural Environment Political and Legal Environments Market Size Production and Shipping Costs International Experience Bottom Line for Business

INTRODUCTION An entry mode is the institutional arrangement by which a firm gets its products, technologies, human skills, or other resources into a market. Companies seek entry to new marketplaces for manufacturing or selling products. Entry mode selection depends on market experience, level of control desired, and market size.

EXPORTING, IMPORTING, AND COUNTERTRADE The most common method of buying and selling goods internationally is exporting and importing. Companies use countertrade when exporting and importing products when using currencies is not an option. A.

Why Companies Export 1. Expand total sales when the domestic market is saturated. Diversify sales to level off cash flow, making it easier to coordinate 2. payments to creditors with receipts from customers.

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Owners and managers with little or no knowledge of how to conduct business in other cultures, use exporting as a low-cost, low-risk way of gaining valuable international experience.

Developing an Export Strategy: A Four-Step Model A logical approach to exporting is to research and analyze international opportunities and develop a coherent export strategy. A firm with such a strategy pursues export markets rather than waiting for orders to arrive. 1. Step 1: Identify a Potential Market a. To identify clearly whether demand exists in a target market, market research should be performed and results interpreted. b. Novice exporters should focus on one or a few markets that are culturally understood. c. A new exporter should seek advice on regulations, exporting in general and to a target market in particular. 2. Step 2: Match Needs to Abilities a. Assess a company’s ability to satisfy market needs. 3. Step 3: Initiate Meetings a. Early meetings with potential distributors, buyers, and others. Initial contact should focus on building trust and cooperation. b. Later meetings can estimate potential success of an agreement. c. In the most advanced stage, negotiations take place and details of agreements are finalized. 4. Step 4: Commit Resources a. After all the meetings and negotiations, it is time to put the company’s human, financial, and physical resources to work. b. The objectives of the export program must be clearly stated and should extend out at least 3 to 5 years. c. As companies expand activities, they discover the need for an export department or division.

Degree of Export Involvement Some companies use intermediaries to get their products in a market abroad. Other companies perform all of their export activities themselves, with an infrastructure that bridges the gap between the two markets. 1. Direct Exporting Company sells directly to buyers in a target market. Need not sell directly to end-users; can rely on local representatives or distributors. a. Sales representatives represent their own company’s products, not those of other companies. Promote products by attending trade fairs and making personal visits to local retailers and wholesalers. Do not take title to the merchandise. b. Distributors take ownership of merchandise when it enters their country, accept risks associated with local sales, and sell to retailers, wholesalers, or end users through their own channels of distribution. This reduces an exporter’s risk and its control. 2. Indirect Exporting Company sells to intermediaries who resell to buyers in a target market. The choice of intermediary depends on the ratio of international sales to total sales, available resources, and the growth rate of the target market.

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Agents i. Individuals or organizations that represent one or more indirect exporters in a target market. Compensated with commissions on sales. ii. Represent several indirect exporters and might focus their promotional efforts on the products of the company paying the highest commission. b. Export Management Companies i. EMC exports on behalf of indirect exporters, operating contractually, either as an agent or as a distributor. ii. Provides services on a retainer basis: gather market information, formulate promotional strategies, perform promotional duties, research customer credit, arrange shipping, and coordinate export documents. iii. Advantage: deep understanding of the cultural, political, legal, and economic conditions of target market. Disadvantage: breadth and depth of an EMC’s service hinders exporter’s international skills development. iv. After the EMC contract expires, a company can go at it alone in exporting its products. c. Export Trading Companies i. ETC provides services in addition to those directly related to clients’ exporting activities: import, export, and countertrade services, distribution channels, storage facilities, trade and investment projects, and manufacturing. ii. Concept met limited success in the United States; remain small and are dwarfed by Asian counterparts. Governments, financial institutions, and companies have closer working relationships in Asia. The Ontario Association of Trading Houses ( www.oath.on.ca ) is an example of an ETC in Canada Avoiding Export and Import Blunders 1. Companies new to exporting often make errors; many fail to conduct adequate market research and obtain adequate export advice. 2. Companies can hire a freight forwarder—a specialist in such exportrelated activities as customs clearing, tariff schedules, and shipping and insurance fees. Can pack shipments for export and take responsibility for getting a shipment from the port of export to the port of import. Countertrade Selling goods or services that are paid for, in whole or part, with other goods or services. Developing and emerging markets often rely on countertrade to import goods due to lack of hard currency. Formerly communist countries in Eastern and Central Europe use countertrade as well as nations in Africa, Asia, and the Middle East. Requires an extensive network of international contacts, but smaller companies can take advantage of its benefits. 1. Types of Countertrade a. Barter: Exchange of goods or services directly for other goods or services without the use of money.

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Counterpurchase: Sale of goods or services to a country by a company that promises to make a future purchase of a country’s product. c. Offset: Agreement that a company will offset a hard-currency sale to a nation by making a hard-currency purchase of an unspecified product from that nation in the future. d. Switch trading: One company sells to another its obligation to make a purchase in a given country. e. Buyback: Export of industrial equipment in return for products produced by that equipment. Countertrade can provide access to markets otherwise off-limits because of a lack of hard currency. But typically involves commodity and agricultural products such as oil, wheat, or corn—products whose prices on world markets fluctuate. Problems arise when the price of a product declines between the barter time and the selling time; fluctuating prices generate the same type of risk as in currency markets. Managers might hedge this risk on commodity futures markets as they hedge against currency fluctuations in currency markets.

Export and Import Financing International trade poses risks for both exporters and importers. Exporters risk not receiving payment after delivery, whereas importers fear that delivery might not occur once payment is made. Export and import financing methods: 1. Advance Payment a. Importer pays for merchandise before it is shipped. Used when two parties are unfamiliar with each other, the transaction is small, or the buyer has a poor credit rating. b. Prior payment eliminates the risk of nonpayment, but creates the complementary risk of nonshipment—importers might pay for goods but not receive them. 2. Documentary Collection a. Bank acts as an intermediary without accepting financial risk. Used in ongoing business relationships between two parties. b. A draft (bill of exchange) is a document ordering an importer to pay an exporter a specified sum of money at a specified time. A bill of lading is a contract between an exporter and a shipper that specifies merchandise destination and shipping costs. c. After receiving the appropriate documents from the exporter, the exporter’s bank sends the documents to the importer’s bank. d. Documentary collection reduces the risk of nonshipment because the packing list details the contents of the shipment, and the bill of lading is proof that the merchandise was shipped. The risk of nonpayment is increased because the importer does not pay until he receives the necessary documents. 3. Letter of Credit a. Importer’s bank issues a document stating that the bank will pay the exporter when the exporter fulfills the terms of the document. b. Used when an importer’s credit rating is questionable, when the exporter needs it to obtain financing, and when a market’s regulations require it.

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Banks issue letters of credit after an importer has deposited a sum equal to the value of the imported merchandise. The bank pays the exporter, but the deposit protects the bank if the importer fails to pay for the merchandise. d. Several types of letters of credit: i. An irrevocable letter of credit allows the bank issuing the letter to modify its terms only after obtaining the approval of both exporter and importer. ii. A revocable letter of credit can be modified by the issuing bank without obtaining approval from either the exporter or the importer. iii. A confirmed letter of credit is guaranteed by both the exporter’s bank in the country of export and the importer’s bank in the country of import. e. Letter of credit reduces the risk of nonshipment because of proof of shipment before payment. f. Although risk of nonpayment is increased, this is more secure because the importer’s bank accepts nonpayment risk when it pays the exporter’s bank. Open Account a. Exporter ships merchandise and later bills the importer. b. Used for sales between two subsidiaries within an international company and when the parties are familiar with each other. c. Reduces risk of nonshipment for importer but increases the risk of nonpayment for exporter.

CONTRACTUAL ENTRY MODES Some products simply cannot be traded in open markets because they are intangible. Companies can use a variety of contracts to market highly specialized assets and skills in international markets. A.

Licensing 1. Contractual entry mode in which a company owning intangible property (the licensor) grants another firm (the licensee) the right to use that property for a specified period of time. 2. Licensors receive royalty payments based on a percentage of revenue generated by the property. Commonly licensed intangible property includes patents, copyrights, special formulas and designs, trademarks, and brand names. 3. Licensing often involves granting companies the right to use process technologies inherent to production. 4. Cross licensing occurs when companies employ licensing agreements to swap intangible property (e.g., Fujitsu and Texas Instruments use crosslicensing to use each other’s technology, saving R&D costs). 5. Advantages a. Finance international expansion. b. Less risky method of international expansion. c. Can reduce likelihood of product appearing on black market. d. Licensees can upgrade existing production technologies.

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Disadvantages a. Can restrict a licensor’s future activities. b. Might reduce the global consistency of the quality and marketing of a product. c. Might amount to “lending” strategically important property to future competitors.

Franchising 1. Contractual entry mode in which one company (the franchiser) supplies another (the franchisee) with intangible property and assistance over an extended period of time. Franchisers typically receive compensation as flat fees, royalty payments, or both. 2. The brand name or trademark of a company is normally the single most important item desired by the franchisee. 3. Franchising differs from licensing in three ways: a. Gives greater control over sale of a product in a target market. b. Although licensing is fairly common in manufacturing industries, franchising is primarily used in the service sector. c. Although licensing normally involves a one-time transfer of property, franchising requires ongoing assistance from the franchiser. 4. Companies based in the United States dominate the world of international franchising. Canada is also considered a good candidate for franchising development because a large portion of the population can afford products and services offered by franchises. In addition, there is a relatively low income inequality in Canada, and it is considered a service-oriented country, where doing business is relatively safe and easy Franchising is growing in the EU with the single currency and a unified set of franchise laws. In Eastern Europe, expansion suffers from a lack of capital, high interest rates and taxes, bureaucracy, restrictive laws, and corruption. 5. Advantages a. Low-cost, low-risk mode of entry into new markets. b. Allows for rapid geographic expansion. c. Uses cultural knowledge and know-how of local managers. 6. Disadvantages a. Cumbersome to manage many franchisees in several nations. b. Franchisees can experience a loss of organizational flexibility in franchising agreements.

Think – Pair – Share Slide 20

Management Contracts One company supplies another with managerial expertise for a specific 1. period of time. The supplier of expertise is compensated with either a lump-sum payment or a fee based on sales. 2. Used to transfer two types of knowledge: (1) specialized knowledge of technical managers, and (2) business-management skills. 3. Advantages a. Exploit an international opportunity but risk few physical assets.

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Nation can award contract to operate and upgrade public utilities when a nation is short of investment financing. c. Help nations develop skills of local workers and managers. Disadvantages a. Places the lives of managers in danger in developing or emerging nations undergoing political or social turmoil. b. Suppliers of expertise may nurture a formidable new competitor in the local market.

Turnkey Projects 1. Designing, constructing, and testing a production facility for a client. Are often large-scale and often involve government agencies. 2. Transfer special process technologies or production-facility designs to a client (e.g., power plants, telecommunications, petrochemical facilities). 3. Advantages a. Firm specializes in core competency to exploit opportunities. b. Governments can obtain designs for infrastructure from the world’s leading companies. 4. Disadvantages a. Company may be awarded a project for political reasons rather than for technological know-how. b. Can create future competitors.

INVESTMENT ENTRY MODES Investment entry modes entail the direct investment in plant and equipment in a country coupled with ongoing involvement in the local operation.

Wholly Owned Subsidiaries 1. Facility entirely owned and controlled by a single parent company. Can establish by purchasing an existing company or by forming a new company from the ground up. 2. Whether an international subsidiary is purchased or newly created depends on its operations; for high-tech products, a company may build new facilities because state-of-the-art operations are hard to locate. 3. Major drawback of “greenfield” is the time it takes to construct new facilities, hire and train employees, and launch production. 4. Advantages a. Managers have complete control over day-to-day operations in the target market and over access to valuable technologies, processes, and other intangible properties within the subsidiary. b. Firm can coordinate activities of its national subsidiaries. 5. Disadvantages a. Expensive, so difficult for small and medium-size firms. b. Requires substantial resources so risk exposure is high.

Joint Ventures Separate company is created and jointly owned by two or more independent entities to achieve an objective. 1. Joint Venture Configurations a. Forward Integration Joint Venture

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Parties invest together in downstream business activities. Backward Integration Joint Venture Parties invest together in upstream business activities. Buyback Joint Venture Input provided by, and output absorbed by, each partner. Multistage Joint Venture One partner integrates downstream, and the other, upstream.

Advantages a. Can reduce risk. b. Penetrate international markets that are otherwise off-limits. c. Access another company’s international distribution network. d. Defensiveness: local government or government-controlled company gives authorities a direct stake in venture’s success. Disadvantages a. Can result in conflict between partners. b. Loss of control over a joint venture’s operations can also result when the local government is a partner in the joint venture.

Strategic Alliances 1. Two or more entities cooperate (but do not form a separate company) to achieve the strategic goals of each. 2. Like joint ventures, can be formed for short or long periods, depending on the goals of the participants. 3. Can be established between a company and its suppliers, its buyers, and even competitors; sometimes each partner purchases the other’s stock. 4. Advantages of Strategic Alliances a. Share the cost of an international investment project. b. Tap into competitors’ specific strengths. c. Similar reasons as for entering into joint ventures. 5. Disadvantages of Strategic Alliances a. Can create a future local or even global competitor. b. Conflict can arise and eventually undermine cooperation.

Selecting Partners for Cooperation 1. Each partner must be firmly committed to the stated goals of the cooperative arrangement. Detailing duties and contributions of each party through prior negotiations helps ensure continued cooperation. 2. Although the importance of locating a trustworthy partner seems obvious, cooperation should be approached with caution. 3. Each party’s managers must be comfortable working with people of other cultures and traveling to (perhaps even living in) other cultures. 4. A suitable partner must have something valuable to offer. Managers must evaluate the benefits of a potential international cooperative arrangement as they would any other investment opportunity.

STRATEGIC FACTORS IN SELECTING AN ENTRY MODE Because entering a new market requires an investment of time and money, and because of the strategic implications of the entry mode, selection must be done carefully. A. .

Cultural Environment

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Culture can differ greatly, and managers can feel less confident in their ability to manage operations in the host country. Company may avoid investment entry modes in favor of exporting or a contractual mode; cultural similarity encourages manager confidence and thus the likelihood of investment. Importance of cultural differences diminishes when managers are knowledgeable about the culture of the target market.

Political and Legal Environment 1. Political instability in a target market increases the risk exposure of assets. Significant political differences and instability cause companies to avoid large investments in favor of entry modes that shelter assets. Target market’s legal system influences the choice of entry mode: certain 2. import regulations such as high tariffs or low quota limits can encourage investment. Company producing locally avoids tariffs that increase product cost; it 3. does not have to worry about making it into the market below quota. 4. Governments may enact laws that ban certain types of investment.

Market Size 1. Size of a potential market influences choice of entry mode. Rising incomes encourage investment entry because a firm can prepare for growing demand and better understand the target market. Growing demand in China is attracting investment in joint ventures, 2. strategic alliances, and wholly owned subsidiaries. Investors believing a market will remain small may prefer exporting or contractual entry.

Production and Shipping Costs 1. By helping to control total costs, low-cost production and shipping can give a company an advantage. 2. Setting up production in a market is desirable when the total cost of production is lower than at home. Low-cost local production might encourage contractual entry through licensing or franchising. 3. Companies producing products with high shipping costs prefer local production; exporting is feasible when products have low shipping costs.

International Experience As companies gain international experience, they select entry modes that 1. require deeper involvement. This also means that they must accept greater risk in return for greater control over operations and strategy. 2. They initially explore the advantages of licensing, franchising, management contracts, and turnkey projects. 3. Once they become comfortable in a market, joint ventures, strategic alliances, and wholly owned subsidiaries become viable options. 4. Advances in technology and transportation allow small companies to undertake entry modes requiring more commitment to the local market.

Think – Pair – Share Slide 31 .

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Bottom Line For Business This chapter explains important factors in selecting entry modes and key aspects in their management. It details the circumstances in which each entry mode is most appropriate and the advantages and disadvantages that each provides. The choice of which entry mode(s) to use in entering international markets should match a company’s international strategy. Some companies want entry modes that give them tight control over activities abroad because they are pursuing a global strategy. Another company might not require an entry mode with central control because it is pursuing a multinational strategy. The entry mode must also be chosen to align well with an organization’s structure.

Quick Study Questions Quick Study 1 (p. ???) 1.

Q: Briefly describe each of the four steps involved in building an export strategy. A: Companies should not simply respond to international requests for their products, but develop a detailed export strategy. First, they should identify a potential market. In order to identify clearly whether demand exists in a particular target market, market research should be performed and results interpreted. Second, they should match the needs of the market to their abilities to satisfy the needs of the market. Third, they should initiate meetings. Early meetings with potential distributors, buyers, and others are a must. Initial contact should focus on building trust and a cooperative climate among all parties. Beyond building trust, successive meetings are designed to estimate the potential success of any agreement if interest is shown on both sides. Fourth, they must be willing to commit the resources needed to get the job done. After all the meetings, negotiations, and contract signings, it is time to put the company’s human, financial, and physical resources to work.

Q: How does direct exporting differ from indirect exporting? A: Direct exporting occurs when a company sells its products directly to buyers in a target market. Direct exporters need not sell directly to end-users. Typically, they rely on either local sales representatives or distributors. Indirect exporting, on the other hand, occurs when a company sells its products to intermediaries who then resell to buyers in a target market. Indirect exporters can use several different types of intermediaries including agents, export management companies, and export trading companies.

Q: Compare and contrast export management companies and export trading companies. A: An export management company (EMC) is one that exports products on behalf of indirect exporters. An EMC operates contractually, either as an agent or as a distributor. An export trading company (ETC), on the other hand, is one that provides services to indirect exporters in addition to those activities directly related to clients’ exporting activities. Furthermore, whereas an export management company is restricted to exportrelated activities, an ETC can assist its clients by providing import, export, and countertrade services, developing and expanding distribution channels, providing storage facilities, financing trading and investment projects, and even manufacturing products.

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Quick Study 2 (p. ???) 1.

Q: Why do companies engage in countertrade? List each of its five types. A: Countertrade is the practice of selling goods or services that are paid for, in whole or part, with other goods or services. Countertrade can provide access to markets that are otherwise off-limits because of a lack of hard currency. 1. Barter is the exchange of goods or services directly for other goods or services without the use of money. 2. Counterpurchase is the sale of goods and services to a country by a company that promises to make a future purchase of a specific product from that country. 3. Offset is an agreement that a company will offset a hard-currency sale to a nation by making a hard-currency purchase of an unspecified product from that nation in the future. 4. Switch trading is countertrade whereby one company sells to another its obligation to make a purchase in a given country. 5. Buyback is the export of industrial equipment in return for products produced by that equipment.

Q: What are the four main methods of export and import financing? A: Advance payment is export and import financing in which an importer pays an exporter for merchandise before it is shipped. It is common when two parties are unfamiliar with each other, the transaction is relatively small, or the buyer is unable to obtain credit due to poor credit rating at banks. Documentary collection is export and import financing in which a bank acts as an intermediary without accepting financial risk. This method is common when there is an ongoing business relationship between two parties. Letter of credit is export and import financing in which the importer’s bank issues a document stating that the bank will pay the exporter when the exporter fulfills the terms of the document. Types of letters of credit are: 1) an irrevocable letter of credit, 2) a revocable letter of credit, and 3) a confirmed letter of credit. Open account is export and import financing in which an exporter ships merchandise and later bills the importer for its value. This payment method is often used for sales between two subsidiaries within an international company and when the parties are very familiar with each other.

Q: Describe the various risks that each financing method poses for exporters and importers. A: Although advance payment eliminates the risk of nonpayment for exporters, it creates the complementary risk of nonshipment for importers—importers might pay for goods, but not receive them. Documentary collection reduces the importer’s risk of nonshipment because the packing list details the contents of the shipment, and the bill of lading is proof that the merchandise was shipped. The exporter’s risk of nonpayment is increased because although the exporter retains title to the goods until acceptance of the merchandise, the importer does not pay until he receives all the necessary documents. Letter of credit reduces the importer’s risk of nonshipment (relative to advance payment) because the importer receives proof of shipment before making payment. Although the exporter’s risk of nonpayment is slightly increased, it is a more secure form of payment for exporters because the nonpayment risk is accepted by the importer’s bank when it issues payment to the exporter’s bank. .

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Open account reduces the risk of nonshipment that the importer faces under the advance payment method. However, it increases the risk of nonpayment for exporters. Quick Study 3 (p. ???) 1.

Q: Identify the advantages and disadvantages of licensing for the licensor and the licensee. A: Licensing is a contractual entry mode in which a company owning intangible property (the licensor) grants another firm (the licensee) the right to use that property for a specified period of time. There are several advantages of licensing. First, licensors can use licensing to finance their international expansion. Second, licensing can be a less risky method of international expansion for a licensor than other entry modes. Third, licensing can help reduce the likelihood that a licensor’s product will appear on the black market. Fourth, licensees can also benefit from licensing by using it as a method of upgrading existing production technologies. There are also several disadvantages of licensing. First, licensing can restrict a licensor’s future activities. Second, licensing might reduce the global consistency of the quality and marketing of a licensor’s product in different national markets. Third, licensing might amount to a company “lending” strategically important property to its future competitors.

Q: Describe how franchising differs from licensing. What are its main benefits and drawbacks? A: Franchising is a contractual entry mode in which one company (the franchiser) supplies another (the franchisee) with intangible property and other assistance over an extended period of time. Franchising differs from licensing in at least three important ways. First, franchising gives a company greater control over the sale of its product in a target market. Second, although licensing is fairly common in manufacturing industries, franchising is primarily used in the service sector. Third, although licensing normally involves a one-time transfer of property, franchising requires ongoing assistance from the franchiser. Advantages of franchising include: (1) low-cost, low-risk market entry mode; (2) maintains consistency of products and theme; (3) allows for rapid geographic expansion; (4) franchisers can benefit from cultural knowledge and know-how of local managers. Disadvantages include: (1) possible control problems with many locations; and (2) franchisees can experience loss of strategic and tactical flexibility.

Q: When is a management contract useful? Identify two types of knowledge it is used to transfer. A: A management contract is the practice by which one company supplies another with managerial expertise for a specific period of time. Management contracts are useful when the need for expert service is not met by local employees. The two types of knowledge that can be transferred through management contracts are 1) the specialized knowledge of technical managers and 2) the business-management skills of general managers.

Q: What is a turnkey project? Describe its main advantages and disadvantages. A: A turnkey project is the practice by which one company designs, constructs, and tests a production facility for a client firm. Advantages include: (1) allows firms to focus on core competencies; and (2) allows governments to attain projects from world-class companies. Disadvantages include: (1) contracts may not be awarded on the basis of merit, but rather politics; and (2) a future competitor may be created. .

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Quick Study 4 (p. ???) 1.

Q: What is a wholly owned subsidiary? Identify its advantages and disadvantages. A: A wholly owned subsidiary is a facility entirely owned and controlled by a single parent company. Companies can establish a wholly owned subsidiary by purchasing an existing company or by forming a new company from the ground up. There are several advantages: (1) managers have complete control over day-to-day operations in the target market and over access to valuable technologies, processes, and other intangible properties within the subsidiary; and (2) a wholly owned subsidiary is a good mode of entry when a company wants to coordinate the activities of all its national subsidiaries. Disadvantages include: (1) they can be expensive undertakings—making it difficult for many small and medium-size firms; and (2) risk exposure is high because a wholly owned subsidiary requires substantial company resources.

Q: What is meant by the term joint venture? Identify four joint venture configurations. A: A joint venture is a separate company that is created and jointly owned by two or more independent entities to achieve a common business objective. In the forward integration joint venture, the parties choose to invest together in downstream business activities. In the backward integration joint venture, the parties choose to invest together in upstream business activities. In the buyback joint venture, its input is provided by and output is absorbed by each of its partners. In the multistage joint venture, one partner integrates into downstream activities and one partner integrates into upstream activities. Advantages of joint ventures include: (1) exposure of fewer company assets, (2) penetrate international markets that otherwise are off-limits, (3) gain access to another company’s distribution channel, and (4) having a partner who also has a stake in the venture’s success. Disadvantages include: (1) possible partner conflict and (2) possible loss of operational control.

Q: How does a strategic alliance differ from a joint venture? Explain the pluses and minuses of such alliances. A: A strategic alliance is a relationship whereby two or more entities cooperate (but do not form a separate company) to achieve the strategic goals of each. The single most important difference is that a joint venture involves the establishment of a separate entity whereas a strategic alliance normally does not. Advantages of strategic alliances include: (1) sharing the cost of international projects, (2) tapping a competitor’s specific strengths, and (3) access to channels of distribution. Disadvantages include: (1) possibly creating a future competitor and (2) strategic partner conflict.

Q: Discuss the strategic factors to consider when selecting an entry mode. A: Because entering a new market requires an enormous investment of time and money and because of the strategic implications of the entry mode choice, entry mode selection must be done carefully. The importance of cultural differences diminishes when managers are knowledgeable about the culture of the target market. Political instability in a target market increases the risk exposure of investments. Certain import regulations such as high tariffs or low quota limits can encourage investment: A company producing locally avoids tariffs that increase product cost and does not have to worry about making it into the market below quota. Rising incomes in a market encourages investment entry modes because investment allows a firm to prepare for expanding market demand and increase its understanding of the target market. By helping to control total costs, low-cost production .

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and shipping can give a company an advantage. Companies producing products with high shipping costs typically prefer local production. Exporting is feasible when products have relatively lower shipping costs. As companies gain international experience, they will tend to select entry modes that require deeper involvement. But this means that they must accept greater risk in return for greater control over operations and strategy. Advances in technology and transportation are allowing more small companies to undertake entry modes requiring a great deal of commitment to the local market. Talk It Over 1.

Q: Not all companies “go international” by first exporting, then using contracts, and then investing in other markets. How does a company’s product influence the process of going international? How (if at all) does technology, such as the Internet, affect the process of going international? A: As we saw in this chapter, some products (intangible products) cannot be imported, exported, or exchanged using countertrade. Companies with intangible products must instead explore contractual or investment entry modes. The Internet and World Wide Web are allowing companies to be global and access markets worldwide right from their inception. In fact, online retailer Amazon.com allows small retailers to list their wares on a subsidiary site of Amazon.com for a small monthly fee plus a small commission on sales.

Q: “Companies should use investment entry modes whenever possible because they offer the greatest control over business operations.” Do you agree or disagree with this statement? Are there times when other types of market entry offer greater control? When is investment entry a poor option? A: Even if the investment entry mode is a wholly owned subsidiary, the local government may exercise a great deal of control over its activities. Thus, even 100 percent ownership does not “guarantee” control. In such situations, a joint venture might give a company greater control if the company supplies a good or service that is absolutely essential for the continuation of operations. Investment entry is a poor option in markets characterized by a great deal of instability.

Q: In earlier chapters, we learned how governments get involved in the international flow of trade and foreign direct investment. We also learned how regional economic integration is influencing international business. Identify two market entry modes and describe how each might be affected by the actions of governments and by increasing regional integration. A: Students should have little trouble explaining how two of the many entry modes discussed in this chapter are affected by government intervention and increasing regional integration. If they get stumped for an example, business periodicals such as the Wall Street Journal and Bloomberg Business Week are teeming with current examples.

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Practicing International Management Case Telecom Ventures Unite the World 1.

Q: What strengths did AT&T bring to its joint venture with Unisource? A: AT&T offered a globally recognized brand name and a presence in practically every major market worldwide except Latin America. AT&T also had significant experience in developing international relationships as well as the firm’s association with WorldPartners.

Q: Can you think of any potential complications that could arise in the AT&T–Unisource joint venture? A: Perhaps the greatest potential danger is the potential for complications caused by the fact that there are so many partners involved in the venture. Not only can there be conflicts over the direction and goals of the venture, but also partners exiting and entering can cause a loss of strategic focus and intent. Just as things begin going well, one partner may leave or another one may join with different motivations.

Q: Assess the formation of Global One, Unisource, and other partnerships discussed in this case in terms of the strategic factors for selecting entry modes identified in the chapter. A: Students should be sure to cover at least the main points listed near the end of the chapter. They should also be encouraged to present other factors that they consider potentially important. Specifically, cultural, legal, regulatory, and technological competencies in each scenario should be assessed and evaluated.

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CHAPTER 12 DEVELOPING AND MARKETING PRODUCTS LEARNING OBJECTIVES: 1. Explain the impact globalization is having on international marketing activities. 2. Describe the types of things managers must consider when developing international product strategies. 3. Discuss the factors that influence international promotional strategies and the blending of product and promotional strategies. 4. Explain the elements that managers must take into account when designing international distribution strategies. 5. Discuss the elements that influence international pricing strategies.

CHAPTER OUTLINE: Introduction Globalization and Marketing Standardization versus Adaptation Influence of National Business Environments Developing Product Strategies Laws and Regulations Cultural Differences Brand and Product Names Selecting International Brand and Product Names Best Global Brands National Image Counterfeit Goods and Black Markets Shortened Product Life Cycles Creating Promotional Strategies Push and Pull Strategies International Advertising Standardizing or Adapting Advertisements Case: The Elusive Euro-Consumer Blending Product and Promotional Strategies Communicating Promotional Messages Product/Communications Extension (Dual Extension) Product Extension/Communications Adaptation Product Adaptation/Communications Extension Product/Communications Adaptation (Dual Adaptation) Product Invention Designing Distribution Strategies Designing Distribution Channels Degree of Exposure Channel Length and Cost Influence of Product Characteristics Special Distribution Problems Lack of Market Understanding Theft and Corruption .

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Developing Pricing Strategies Worldwide Pricing Dual Pricing Factors That Affect Pricing Decisions Transfer Prices Arm’s-Length Pricing Price Controls Dumping Bottom Line for Business

A comprehensive set of specially designed PowerPoint slides is available for use with Chapter 12. These slides and the lecture outline below form a completely integrated package that simplifies the teaching of this chapter’s material. Lecture Outline 1.

INTRODUCTION Globalization affects international business activities, industries, and products differently. Some companies market an identical product worldwide, whereas others must adjust marketing strategies across national markets.

GLOBALIZATION AND MARKETING Globalization is transforming the way some products are marketed internationally. How do managers decide when strategies need modifying? A.

Standardization versus Adaptation 1. U.S. researcher Theodore Levitt argued that because the world is becoming standardized and homogeneous, companies should market the same products in the same way in all countries. Technology, he claimed, causes needs and preferences to converge throughout the world. Companies reduce production and marketing costs by standardizing the 2. physical features of their products and marketing strategies. Other researchers say that standardization is just one strategy for going 3. international successfully. They say standardization is not always the best strategy and advise smaller companies to adapt to local cultures while exploiting their unique images to gain local market share. 4. Influence of National Business Environments a. Consumers in different national markets want products that reflect their tastes; business environments affect consumer preferences and industrial buyers. Certain products do appeal to practically all cultures. b. c. Product standardization is more likely when nations share the same level of economic development.

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DEVELOPING PRODUCT STRATEGIES A.

Laws and Regulations 1. Companies must adapt their products to satisfy laws and regulations in a target market. 2. The fact that many developing countries have fewer consumer-protection laws creates an ethical issue; lower levels of education and experience mean that consumers need protection. 3. Many governments impose fewer regulations to hold down production costs and consumer prices.

Cultural Differences 1. Companies sometimes must adapt their products to suit local buyers’ preferences rooted in culture. 2. Not all companies modify products but find a different cultural need that it satisfies.

Brand and Product Names 1. Brand name is the name of one or more items in a product line that identifies the source or character of the items. Consumers assign products a certain value based on experiences with a brand. 2. Brand names help consumers select, recommend, or reject products; they also function as legal property that owners can protect from competitors. 3. A consistent worldwide brand image is important as more consumers and businesspeople travel internationally. 4. Companies must review its brand image and update it if needed. 5. Selecting International Brand and Product Names a. Products in international markets need carefully selected names whether standardized or localized. b. Company and product names are made up of morphemes— semantic elements, or language building blocks. c. Brand names seldom offend people in international markets, but product names do. 6. Best Global Brands The top 10 brands in 2013 were Apple, Google, Coca Cola, IBM, Microsoft, General Electric (GE), MacDonald’s, Samsung, Intel, and Toyota. Thomson Reuters ( www.thomsonreuters.com ), ranked 47, is the only Canadian brand included in the 2013 Global Brands report. Specializing in media and intellectual information including financial, tax, and accounting information, Thomson Reuters is valued at $8444 million dollars.

Think – Pair – Share Slide 8 D.

National Image 1. Value customers obtain from a product is influenced by the image of the country in which it is designed, manufactured, or assembled. Image can be positive for some products but negative for others. 2.

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Because it affects buyers’ perceptions of quality and reliability, national image is an important element of product policy. National image can and does change over time.

Counterfeit Goods and Black Markets 1. Counterfeit goods are imitation products passed off as legitimate trademarks, patents, or copyrighted works. 2. Counterfeit brand name consumer goods, such as watches, perfumes, clothing, movies, music, and computer software are sold to consumers on the black market. 3. Topping the list for counterfeits: China, India, Russia, Thailand, and Turkey. Counterfeiting is worth tens of billions globally each year. 4. Counterfeit goods can damage buyers’ images of a brand when the counterfeits are of inferior quality to the original. Buyers who purchase a brand expect a level of craftsmanship and satisfaction; when the product fails to deliver on expectations, the buyer is dissatisfied and the company’s reputation is tarnished.

Shortened Product Life Cycles 1. Companies traditionally managed to extend a product’s life by introducing it into different markets consecutively; products were first in industrialized countries and later in developing markets. 2. Advances in telecommunications have alerted consumers around the world to the latest product introductions; consumers in developing and emerging markets demand the latest products. 3. Companies now undertake new product development at a rapid pace and shorten product life cycles.

CREATING PROMOTIONAL STRATEGIES Efforts by companies to reach distribution channels and target customers through communications such as personal selling, advertising, public relations, and direct marketing are called its promotion mix. A.

Push and Pull Strategies 1. Pull strategy: Create buyer demand that will encourage channel members to stock a company’s product. Buyer demand is generated in order to “pull” products through distribution channels to end-users. 2. Push strategy: Pressure channel members to carry a product and promote it to final users. Manufacturers of products sold in department and grocery stores often use a push strategy. 3. The strategy to use depends on the type of distribution system, access to mass media, and the type of product. a. Distribution system. Implementing a push strategy is difficult when channel members wield a great deal of power relative to that of producers. It can be ineffective when distribution channels are lengthy: It might be easier to use a pull strategy. b. Access to mass media. Developing and emerging markets have fewer forms of mass media, making it difficult to increase consumer awareness and generate product demand. Many consumers cannot afford cable or satellite television, or glossy magazines, so advertisers use billboards and radio.

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Type of product. A pull strategy is appropriate when buyers display brand loyalty; brand-loyal buyers know what they want before they buy it. Push strategies are appropriate for inexpensive consumer goods for buyers who are not brand loyal; low brand loyalty means that a buyer purchases one of the brands carried by the retailer.

International Advertising International advertising differs from domestic advertising. Cultural similarities mean that ads are only slightly modified in different nations. Cultural differences may mean that entirely new ads must be created. 1.

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Standardizing or Adapting Advertisements a. Most advertising in any one nation is produced solely for that domestic audience. Companies that advertise in multiple markets must determine the aspects of the advertising campaign that can be standardized and those that cannot. b. To pursue a global marketing strategy, a company tries to get the most for its advertising expenditure. An increasingly popular method is marketing over the World Wide Web. Companies that use direct marketing (such as telemarketing or leaflets through the mail) have had mixed results with Web ads. c. Companies reach a global audience by sponsoring global sporting events, such as the Olympics, World Cup Soccer, and Formula One automobile racing. Case: The Elusive Euro-Consumer a. The integration of EU nations causes marketers to think they can standardize advertising to appeal to the Euro-consumer. b. Advertising agencies have tried a pan-European advertising approach only to fail due to national differences; Europe’s many languages create translation issues for marketers. c. Successful pan-European ads contain visuals, few words, and a focus on the product.

Blending Product and Promotional Policies When companies extend marketing to international markets, they develop communication strategies that blend product and promotional policies. A company’s communication strategy for a market considers the nature of the product and the promotion mix. There are five product/promotional methods. 1. Communicating Promotional Messages a. Marketing communication is the process of sending promotional messages about products to target markets. b. Marketing internationally often means translating promotional messages from one language to another. Marketers must also be knowledgeable of cultural nuances that affect how buyers interpret a promotional message. c. Laws that govern promotion in another country can force changes in marketing communication. d. Marketing communication is typically considered a circular process (Figure 12.1): i. The company with an idea to communicate is the source.

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The idea is encoded (translated into images, words, and symbols) into a promotional message. iii. The promotional message is sent to the audience (potential buyers) through various media—radio, television, newspapers, magazines, billboards, and direct mailings. The audience receives the message, decodes the message, and interprets its meaning. iv. Information in the form of feedback (purchase or nonpurchase) flows to the source of the message. v. The decoding process can be disrupted by the presence of noise—anything that disrupts the audience’s ability to receive and interpret the promotional message. Language barriers between the company and potential buyers create noise if a company’s promotional message is incorrectly translated into the local language. Product/Communications Extension (Dual Extension) a. Extends the same home-market product and marketing promotion into target markets. Under certain conditions, it can be the simplest and most profitable strategy. b. May grow more popular as the information age ties the world together. Best suited for companies that use a global strategy; upscale personal items with global brand names. c. Useful to companies who are low-cost leaders in their industries; one product and one promotional message keep costs down. Product Extension, Communications Adaptation a. Extends the same product into new target markets, but alters its promotion. Communications require adaptation because the product satisfies a different need, serves a different function, or appeals to a different type of buyer. b. Contains costs because the product does not undergo any alterations; developing new promotional campaigns is expensive. c. Low economic development can demand that communications be adapted to local conditions. In developing countries, television and radio coverage are limited and the Web is years behind; marketers use door-to-door personal selling and regional product shows or fairs. Product Adaptation, Communications Extension a. Requires a company to adapt its product to the international market yet retain the original marketing communication. b. Company may adapt its product for reasons such as legal requirements in the local market. Governments can require certain local materials, labor, or other resources in local production process; if the same materials are not available locally, the product may be modified. c. Can be costly, especially if a company invests in production facilities to remain close to changing buyer preferences. It can be successful if a firm sells a differentiated product and charges a higher price to offset production costs. Product/Communications Adaptation (Dual Adaptation) a. Adapts a product and its marketing communication to suit the target market. The product itself is adapted to match the needs or

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preferences of local buyers. The promotional message is adapted to explain how the product meets those needs and preferences. b. High cost means few companies employ this strategy; it can be implemented successfully if a large and profitable market segment exists. Product Invention a. Requires that an entirely new product be developed for the target market. Product invention is necessary when many differences exist between the domestic and target markets. b. One reason for invention is that local buyers cannot afford a product because of low purchasing power. c. Product inventions can arise due to lack of infrastructure.

DESIGNING DISTRIBUTION STRATEGIES Planning, implementing, and controlling the physical flow of a product from its point of origin to its point of consumption is called distribution. The physical path that a product follows on its way to customers is called a distribution channel. Companies along this channel that work together in delivering products to customers are called channel members or intermediaries. Manufacturers of goods are not the only producers who need distribution channels; service providers such as consulting companies, health-care organizations, and news services need distribution. Companies develop their international distribution strategies based on two related decisions: (1) how to get the goods into a country and (2) how to distribute goods within a country. A.

Designing Distribution Channels When managers establish distribution policies, they consider the market exposure needed and the cost of distribution. 1. Degree of Exposure a. Exclusive channel: Manufacturer grants the right to sell its product to one or a limited number of resellers. Gives control over sales to channel members such as wholesalers and retailers; this helps constrain distributors from selling competing brands. b. An exclusive channel creates a barrier that makes it difficult or impossible for outsiders to penetrate the channel. c. Intensive channel: Producer grants the right to sell its product to many resellers. Provides convenience because of the many outlets through which a product is sold. It does not create strong barriers to channel entry, nor provide control over reseller decisions such as what competing brands to sell. d. Obstacle for small companies that choose intensive channels is gaining shelf space. This is exacerbated by the increasing global trend toward retailers developing their own private label brands—brands created by retailers themselves. 2. Channel Length and Cost a. Channel length refers to the number of intermediaries between the producer and the buyer. b. Zero-level channel (called direct marketing): producers sell directly to final buyers.

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One-level channel: One intermediary between producer and buyer. Two intermediaries make up a two-level channel, and so on. The more intermediaries, the more costly it becomes because each one adds a fee for services.

Influence of Product Characteristics 1. Value density: Value of a product relative to its weight and volume; an important variable in formulating distribution policies. 2. As a rule, the lower a product’s value density, the more localized the distribution system. Commodities have low value-density ratios—value is low relative to their cost of shipping. 3. Products with high value-density ratios include emeralds, semiconductors, and premium perfumes. Because the cost of transporting these products is small relative to their values, they can be processed or manufactured and then shipped.

Special Distribution Problems A country’s distribution system develops over time and reflects its unique cultural, political, legal, and economic traditions. The distribution system of each nation has its own unique pros and cons. 1. Lack of Marketing Understanding This can create frustration and financial loss for companies. 2. Theft and Corruption This can present major obstacles to distribution.

DEVELOPING PRICING STRATEGIES The pricing policy must match a company’s overall international strategy.

Worldwide Pricing 1. Establishes one selling price for all international markets. 2. Difficult to achieve for four reasons: a. Production costs differ from one nation to another. b. Producing in just one location cannot guarantee the same selling price in international markets because of the different cost of reaching different markets. c. Purchasing power of local buyers must be considered. d. Fluctuating currency values can affect a product’s price abroad.

Dual Pricing 1. Product has a different selling price (typically higher) in export markets than it has in the home market. 2. When a product has a higher selling price in the target market than it does in the home market, it is called price escalation, which results from exporting costs and currency fluctuations. 3. Product’s export price may be lower than the price in the home market. 4. Some companies decide that domestic sales are to cover expenses for R&D, administration, and overhead; exports cover only additional costs associated with exporting and selling in a target market (e.g., tariffs). 5. To apply dual pricing in international marketing, a company must keep domestic and international buyers separate. If a company cannot keep its

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buyers separate, they could undermine the policy through arbitrage— buying products at lower prices and reselling them at higher prices. C.

Factors That Affect Pricing Decisions Several key factors affect pricing decisions. 1. Transfer Prices a. Price of products between a company and a subsidiary. b. Companies enjoyed freedom in setting transfer prices; subsidiaries in countries with high taxes charged a low price for outputs to subsidiaries. The subsidiary lowered the parent company’s taxes by reducing profits in the high-tax country. c. Large firms used transfer pricing to manage their global taxes and become more price-competitive. 2. Arm’s-Length Pricing a. Free-market price that unrelated parties charge one another. b. Although companies had great latitude in assigning transfer prices, many governments are assigning them arm’s-length prices to clamp down on tax evasion. There is also pressure on companies to be good corporate citizens in target markets. c. Developing and emerging markets are hurt by lost revenue when international companies manipulate prices to reduce tariffs and corporate taxes. Need revenue for schools, hospitals, and infrastructure. These, in turn, benefit companies by improving the productivity and efficiency of the local business environment. 3. Price Controls a. Upper or lower limits placed on the prices within a country. b. Upper-limit price controls provide price stability in an inflationary economy (when prices are rising). Companies that want to raise prices must apply to government authorities. c. Lower-limit price controls prohibit the lowering of prices below a certain level. d. Governments impose lower-limit prices to help local companies compete against the less expensive imports of international companies or to ward off price wars. 4. Dumping a. Price of a good is lower in export markets than in the domestic market. b. Accusations of dumping are often made against foreign competitors when inexpensive imports flood a domestic market. c. Although charges of dumping normally result from deliberate efforts to undercut the prices of competitors in the domestic market, changes in exchange rates can cause unintentional dumping. d. Antidumping tariffs punish producers in the offending nation by increasing the price of their products.

Think – Pair – Share Slide 36

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Bottom Line For Business. Despite the academic debate over globalization and the extent to which companies should standardize their international marketing activities, many companies continue to adapt to local conditions. Sometimes this takes the form of only slightly modifying promotional campaigns and at other times it can require the creation of an entirely new product. The causes of alterations in promotional aspects of marketing strategy can be cultural, such as language differences. They can also be legal such as requirements to produce locally so as to help ease local unemployment. Some companies benefit from standardization and centralized production obtained by selling one product worldwide.

Quick Study Questions Quick Study 1 (p. ???) 1.

Q: How is globalization affecting international marketing activities? A: U.S. researcher Theodore Levitt argued that because the world is becoming standardized and homogeneous, companies should market the same products in the same way in all countries. Technology, he claimed, causes needs and preferences to converge throughout the world. Others say that standardization is just one of many strategies to enter the international marketplace successfully. They argue that standardization is not always the best strategy and advise smaller companies to adapt to local cultures while exploiting their unique images to gain local market share. Globalization is transforming the way some products are marketed internationally. Some companies implement a global strategy that uses similar promotional messages and themes to market the same product around the world. Those companies can reduce production and marketing costs by standardizing the physical features of their products and marketing strategies. Others find that their products require physical changes to suit the tastes of consumers abroad. Consumers in different national markets demand products that reflect their tastes; cultural, political, legal, and economic environments affect consumer preferences and industrial buyers worldwide. Certain products do appeal to practically all cultures. Product standardization is more likely when nations share the same level of economic development.

Q: List elements of the national business environment that influence the standardizationversus-adaptation decision. A: Many factors influence a company’s product policies. First, laws and regulations of the target market can force product alteration. Cultural differences between the home and host markets can force adaptations in products to suit local buyers’ product preferences. National image of the country in which a product is designed, manufactured, or assembled can have a strong influence on the value that customers obtain from a product. It affects buyers’ perceptions of quality and reliability. Counterfeit goods can damage buyers’ images of a brand because counterfeits are often of inferior quality to the original product. Companies historically entered international markets on a sequential basis and could therefore greatly extend their products’ life cycles. But new product development at an increasingly rapid pace is shortening the life cycles of products.

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Q: What is the link between brand names and competitive advantage? A: There is a strong link between brand name and competitive advantage. A strong brand can become a company’s most valuable asset and primary source of competitive advantage. A consistent worldwide brand image is increasingly important as more consumers and businesspeople travel internationally than ever before. Any inconsistency in brand name can confuse existing and potential customers. Although companies keep their brand names consistent across markets, they often do create new product names or modify existing ones to suit local preferences.

Q: Explain the potential impact of national image and counterfeit products on international product strategy. A: Because it affects buyers’ perceptions of quality and reliability, national image is an important element of product policy. We consider the influence of a country’s name when thinking of Italian shoes, German luxury cars, and Japanese electronics. This image can be positive for some products but negative for others. However, national image can and does change over time—although slowly. Decades ago, Japanese products were considered to be of poor quality and rather unreliable. But a national effort toward quality improvement and the installation of quality-control procedures by companies earned Japan a national image for precision and quality products.

Quick Study 2 (p. ???) 1.

Q: Identify several factors that influence the choice between a push and a pull strategy. A: A pull strategy is a promotional strategy designed to create buyer demand that will encourage channel members to stock a company’s product. A push strategy is a promotional strategy designed to pressure channel members to carry a product and promote it to final users. Push and pull strategies in a given marketing environment depend on such things as the characteristics of the distribution system itself, degree of access to mass media, and the type of product.

Q: What issues affect the decision of whether to standardize or adapt international advertising? A: Cultural differences are the main reason advertising must be adapted for target markets abroad. However, companies that advertise in multiple markets must determine those aspects of the advertising campaign that can be standardized across the markets and those that cannot. Firms that standardize their advertising tend to control campaigns from the home office.

Q: Identify each element in the marketing communications process and describe how they interact. A: The process of sending promotional messages about products to target markets is called marketing communication. Communicating the benefits of a product can be more difficult in international business than domestic business for at least several reasons. Marketing internationally usually means translating promotional messages from one language into another. Marketers must also be knowledgeable of many cultural nuances that can affect how buyers interpret a promotional message. A nation’s laws that govern the promotion of products in another country can also force changes in marketing communication. Marketing communication is typically considered as a circular process. The company that has an idea it wishes to communicate is the source of the communication. The idea is encoded (translated into images, words, and symbols) into a promotional .

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message that the company is trying to get across. The promotional message is then sent to the audience (potential buyers) through various media. Media commonly used by companies to communicate their promotional messages include radio, television, newspapers, magazines, billboards, and direct mailings. Once the audience receives the message, they decode the message and interpret its meaning. Information in the form of feedback (purchase or nonpurchase) then flows back to the source of the message. The decoding process by the audience can be disrupted by the presence of noise—anything disrupting the audience’s ability to receive and interpret the promotional message. By ignoring important cultural nuances, companies can inadvertently increase the potential for noise that can cloud the audience’s understanding of their promotional message. Language barriers between the company and potential buyers can, for instance, create noise if a company’s promotional message is incorrectly translated into the local language. 4.

Q: What five generic methods are used to blend product and promotional strategies for international markets? Describe each briefly. A: Product Communications Extension (Dual Extension): This method extends the same home-market product and marketing promotion into target markets. Under certain conditions, it can be the simplest and least costly strategy. It may grow more popular as the information age continues to knit the world more closely together. Product Extension, Communications Adaptation: Under this method, a company extends the same product into new target markets, but alters its promotion. Communications require adaptation because the product satisfies a different need, serves a different function, or appeals to a different type of buyer. This approach can help contain costs because the product does not undergo any alterations whatsoever. However, developing new promotional campaigns for international markets can be expensive. Product Adaptation, Communications Extension: Using this method, a company adapts its product to the requirements of the international market while retaining the product’s original marketing communication. This method can be costly—especially if the company invests in production facilities in each market to remain close to changing buyer preferences. Product/Communications Adaptation (Dual Adaptation): This method adapts both the product and its marketing communication to suit the target market. Few companies employ this strategy because it can be very costly. Product Invention: This method requires that an entirely new product be developed for the target market. Product invention is often necessary when a great number of differences exist between the domestic and international markets.

Quick Study 3 (p. ???) 1.

Q: How do exclusive and intensive channels of distribution differ? Give an example of each. A: An exclusive channel is one in which a manufacturer grants the right to sell its product to only one or a limited number of resellers. An example of a product sold through this type of channel is automobiles. An intensive channel is one in which a producer grants the right to sell its product to many resellers. An example of a product sold through this type of channel is highlighters.

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Q: Explain the importance of value density to distribution strategy. A: The value of a product relative to its weight and volume is called its value density. Value density is an important variable in formulating distribution policies. As a rule, the lower a product’s value density, the more localized the distribution system.

Q: How might a lack of market understanding, theft, and corruption affect international distribution? A: Companies can experience a great deal of frustration and financial loss by not understanding a local market. A high incidence of theft and corruption can present obstacles to distribution. The chapter refers to the Russian distribution system, which reflects its roughly 75-year experiment with communism. When Acer Computers (www.acer.com) decided to sell its computers in Russia, it built production facilities in Russia’s stable neighbor Finland yet in three years’ time, a highway that serves as a main route to get goods overland from Finland to Russia saw 50 Finnish truckers hijacked, 2 drivers killed, and another 2 missing. Acer solved its distribution problem by selling its computers to Russian distributors outside its factory in Finland.

Quick Study 4 (p. ???) 1.

Q: What is the difference between worldwide pricing and dual pricing? A: Worldwide pricing sets one selling price for all international markets. Dual pricing is a pricing policy in which a product has a different selling price (typically higher) in export markets than it has in the home market. It is typically the result of price escalation resulting from exporting costs and currency fluctuations.

Q: Explain what is meant by the terms transfer pricing and arm’s-length pricing. A: A transfer price is the price charged for products transferred among a company and its subsidiaries. Companies can sometimes adjust transfer prices to minimize their tax burden in high-tax countries. Arm’s-length pricing is the free market price that unrelated parties charge one another for a specific product. Although companies used to have great latitude in assigning transfer prices to their products, many governments are assigning them arm’s-length prices to clamp down on tax evasion.

Q: How might price controls and dumping affect the pricing decisions of international companies? A: Price controls are upper or lower limits placed on the prices of products sold within a country. Upper-limit price controls restrict companies from raising prices above a certain level. Lower-limit price controls are often designed to help local companies compete against multinationals that may be inclined to start a price war to drive out competition.

Talk It Over 1.

Q: Suppose that the product preferences of cultures and people around the world continue to converge. Identify two products that will likely be affected and two products that will likely not be affected by this convergence. For each product, how will the changes influence the marketing manager’s job? A: Students should be sure to address how the Internet might impact product policies, promotional policies, distribution policies, and pricing policies. They should also

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speculate as to whether it will influence the combination of product and promotional policies (discussed in the chapter) that the company uses in international markets. 2.

Q: Price escalation can present serious problems for companies wishing to export their products to other markets under a worldwide pricing policy. How might companies combat the effects of price escalation? List as many possibilities as you can. A: Students should review the section of the chapter on worldwide and dual pricing to see the causes of price escalation. They should be encouraged to be creative in their thinking, not concerned with constraints the firm may face, but the wealth of possibilities.

Practicing International Management Case Psychology of Global Marketing 1.

Q: Put yourself in the position of Stephan Loerke of the World Federation of Advertisers. First, make an argument for why the EU should not enact more strict advertising laws. Second, make a case for why advertisers operating in the EU should initiate “voluntary” limits. Third, make a case for why current laws need no modification whatsoever. Which case do you agree with? Which case do you think is the strongest? A: Students should recognize the highly political debate that will arise within the EU. Some may feel that it is foolish to enact new laws if they cannot be enforced. Sweden cannot currently control the broadcasts of other nations that are accessed by satellite. If members of the EU could agree on “voluntary” limits just the way that members agreed to institute the euro or accept certain standards for products, then the problem could be controlled. However, agreement on advertising in the EU would be difficult.

Q: Certain organizations regularly attack advertisers for their promotional methods. What could the advertising industry do to make themselves a smaller target for such criticisms? Be specific. A: The advertising agencies such as the Ad Council curry favorable public opinion when they produce ads that speak out against social problems. Ads that suggest “Talk to your kids about drugs” are socially responsible. The resulting image of the industry can help counteract the ads that market something harmful, such as alcohol and cigarettes.

Q: Some critics charge advertisers with creating wants among consumers rather than helping them satisfy needs. Select a product and describe how, if it were marketed in a developing economy, it can create wants and not satisfy needs. Explain the ethical issues surrounding the decision of whether to market the product in developing nations. A: Ads can indeed create wants. The cell phone is a good example. Before cell phones were available, the telephone sufficed. In developing countries, there are fewer telephones per person, but telephone access was generally possible. Now, it seems that every young person around the world wants a cell phone with all the bells and whistles and personalized, designer outer shells. The ethical issue is whether companies are creating wants in some countries that should instead be focusing young people’s wants and needs on more basic things such as education and health.

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TEAMING UP Part One Q: With a group of classmates, select two countries other than Canada that you are interested in comparing. Next, choose an industry and product or service, and assume you and your teammates own a Canadian company in this area. Your company has to choose between your two selected countries for making a $150 million investment. Both investments promise the same long-run return, so your choice is driven by challenges in international business. Assess the various challenges—economic, political, legal, ethical, and cultural—of doing business in each of these countries. By the end of the course, you should be able to determine which country you would select for your investment and why. Start your research by answering the following questions: Can you obtain a benefit from the globalization of production in the countries you selected? Which one(s) and why? What is the KOF index for the two countries that you selected? A: This project gets students to begin pondering the types of elements that must be considered when selecting a country for investment. At a minimum, students’ responses should consider: (1) the presence of investment barriers in the country; (2) resources needed to carry out production, as well as their availability and cost; (3) availability of modern telecommunications to facilitate communication with the home office; and (4) how the expansion might be financed.

Part Two Q: For the countries you are studying, list several of their peoples’ manners and customs. What values do people hold dear? Describe their attitude toward time, work, and cultural change. What religions are practised there? What language(s) are spoken? What ethnicities reside in the nation, and do they form distinct subcultures? Describe the nation’s social structure and its education system. Turn to Figures 2.2 and 2.3, and either: a. explain why you think the nation appears where it does, or b. identify where you think it belongs on the figure and explain why. Politics and Law For the countries you are studying, what type of political and legal systems do they have? Do free elections take place? Is the government heavily involved in the economy? Is the legal system effective and impartial? Do political and legal conditions suggest the country could be a potential market? If so, for what kinds of goods or services might the market be appealing? What is the level of corruption in the nation? Is legislation pending that may be relevant to international companies? International Ethics For each of the countries your team is researching, answer the following questions: What is the corruption perception index score? What ethical dilemmas or challenges might you encounter in the country? Are there examples of CSR being applied by local companies? Copyright © 2015 Pearson Canada Inc.

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Economics and Emerging Markets For each of the countries your team is researching, answer the following questions: What type of economic system does it have? Has it always had this type of economic system? Is it a developed, newly industrializing, emerging, or developing country? How does it rank on the various measures of economic development? Has it undergone any form of economic transition within the past 20 years? If so, how has that transition affected the culture and the country’s political, legal, and economic systems? A: This exercise gets students to learn more about a country and to generate interest in countries other than their own. These questions focus on important aspects of each country and the process can begin to develop teamwork in the course Part Three Q: For the countries you are studying, what trade patterns can you observe? Is there evidence of your product being imported? Exported? List the methods each government uses to promote and restrict trade. Foreign Direct Investment For each of the countries your team is researching, answer the following questions: Does it attract large amounts of FDI? Is it a major source of FDI for other nations? What is the nation’s balance-of-payments position? What is its current account balance? List some possible causes for its surplus or deficit. How is this surplus or deficit affecting the nation’s economic performance? What is its capital account balance? How does the government encourage or restrict trade with other nations? Regional Economic Integration For the countries your team is researching, identify any regional integration efforts in which the nation may be participating. What other nations are members? What economic, political, and social objectives drive integration? So far, what have been the positive and negative results of integration? How are international companies (domestic and nondomestic) coping? Explain why companies’ coping strategies are, or are not, succeeding. International Financial Markets and Foreign Exchange For each of the countries your team is researching, answer the following questions: Does it have a city that is an important financial centre? How has its stock market(s) performed over the past year? What is the exchange rate between its currency and that of your own country? What factors are responsible for the stability or volatility of that exchange rate? Are there any restrictions on the exchange of the nation’s currency? How is the forecast for the country’s currency likely to influence business activity in its major industries? How have inflation and interest rates affected the nation’s exchange rate with other currencies? What impact has the country’s exchange rate had on its imports and exports? A: This exercise gets students to learn more about a country and to generate interest in countries other than their own. These questions focus on important aspects of each country and the process can begin to develop teamwork in the course

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Part Four Q: What are the corporate- and business-level strategies that you could apply for your product or service in the two countries selected? In which nations do you currently produce and market your products? Are the production facilities centralized or decentralized? Does your company standardize its products/ services or adapt them for different markets? What type of organizational structure does it have? Which of the two types of international strategy does it follow? Does the company make use of work teams? Selecting and Managing Entry Modes What method are you going to use to go international? How are you planning to receive payment for the goods or services you offer abroad? Is your company going to use different entry modes in different markets? What factors are influencing your choice of entry mode? Developing and Marketing Products For the countries and product or service you selected, determine which of the five types of product and promotion policies is being used: dual extension, product extension/communications adaptation, product adaptation/communication extension, dual adaptation, or product invention. What type is more suitable for your product or service in the two countries you selected? A: This exercise gets students to learn more about a country and to generate interest in countries other than their own. These questions focus on important aspects of each country and the process can begin to develop teamwork in the course. Students could be asked to present the results from this project to the class in a brief, tenminute presentation so that all the students can benefit from each team’s research. Students might need to do some further research into various companies’ business activities before fully answering the question on promotions.