INSTRUCTOR MANUAL for International Business The Challenges of Globalization 7e John Wild Kenneth Wi by StudyGuide

INSTRUCTOR MANUAL for International Business The Challenges of Globalization 7e John Wild Kenneth Wild

Contents INSTRUCTOR’S MANUAL Market Entry Strategy Project Guide ........................................................... 1 Chapter 1

Globalization .............................................................................................. 23

Chapter 2

Cross-Cultural Business ............................................................................. 40

Chapter 3

Politics, Law, and Business Ethics............................................................. 58

Chapter 4

Economics and Emerging Markets ............................................................ 75

Chapter 5

International Trade ..................................................................................... 89

Chapter 6

Business-Government Trade Relations .................................................... 103

Chapter 7

Foreign Direct Investment........................................................................ 117

Chapter 8

Regional Economic Integration................................................................ 132

Chapter 9

International Financial Markets ............................................................... 150

Chapter 10

International Monetary System ................................................................ 167

Chapter 11

International Strategy and Organization................................................... 185

Chapter 12

Analyzing International Opportunities ..................................................... 200

Chapter 13

Selecting and Managing Entry Modes ..................................................... 216

Chapter 14

Developing and Marketing Products ........................................................ 234

Chapter 15

Managing International Operations .......................................................... 249

Chapter 16

Hiring and Managing Employees............................................................. 264

CHAPTER 1 GLOBALIZATION LEARNING OBJECTIVES: 1. Identify the types of companies that participate in international business. 2. Describe the process of globalization and how it affects markets and production. 3. Describe the two forces causing globalization to increase. 4. Summarize the evidence for each main argument in the globalization debate. 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 Key Players in International Business Multinational Corporations Entrepreneurs and Small Businesses Globalization Globalization of Markets Reduces Marketing Costs Creates New Market Opportunities Levels Uneven Income Streams Local Buyers’ Needs Global Sustainability Globalization of Production Access Lower-Cost Workers Access Technical Expertise Access Production Inputs Forces Driving Globalization Falling Barriers to Trade and Investment The World Trade Organization Regional Trade Agreements Trade and National Output Technological Innovation E-mail and Videoconferencing The Internet 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

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Exploits Workers in Developing Nations For Globalization Increases Wealth and Efficiency in All Nations Generates Labor Market Flexibility in Developed Nations Advances the 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’s Influence on Cultures Globalization and National Sovereignty Globalization: Menace to Democracy? Globalization: Guardian of Democracy? 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 1. Each of us encounters the result of international business transactions 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 1. Technology is a remarkable facilitator of international business and change.

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E-business (e-commerce) is the use of computer networks to purchase, sell, or exchange products; service customers; and collaborate with partners. 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.

KEY PLAYERS IN INTERNATIONAL BUSINESS ** This section now appears earlier than in previous editions. ** 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. A.

Multinational Corporations A multinational corporation (MNC) 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. Some MNCs have more employees than small nations have citizens (e.g., Walmart has 2.2 million employees globally). b. If Walmart were a country, it would rank third behind Norway in terms of economic power (Figure 1.1).

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. 3. Some small Internet companies reach customers solely through the Web (e.g., Vellus Products, Weekend in Italy).

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.” 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 e. Need for global sustainability—development that meets the needs of the present without compromising the ability of future generations to meet their own needs. 2. The world’s 7 billion people live in three types of markets, yet all require companies to act in a sustainable manner: a. Developed markets are solidly middle class and people can consume almost any product desired. A firm may use the latest

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technologies to develop sustainable products in a sustainable manner. b. Emerging markets are racing to catch up to rich nations and are overloading infrastructures. Resource constraints can force companies to develop sustainable production methods. c. Traditional markets have mostly rural populations for whom poverty and corruption prevail. Here, sustainability means teaching safe farming practices, environmental stewardship, and disease awareness. 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

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). b. Trade growth has been faster than world output. c. 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.

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b. 2.

Driving growth in videoconferencing are lower-cost bandwidth and equipment, and decreased travel for cost or safety reasons. The Internet 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 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. Advancements in Transportation Technologies a. Make global shipping more efficient and dependable (e.g., GPS)

Measuring Globalization ** This edition introduces a new Globalization Index not in prior editions. ** 1. The KOF Swiss Economic Institute’s Globalization Index ranks nations on their economic, social, and political engagement. 2. Richest nations are the most global, with many in Europe. The United States ranked 35th (see Table 1.1). 3. The least global nations are found in Africa, East Asia, South Asia, Latin America, and the Middle East. Low technological connectivity slows global integration.

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. A 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.

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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 the economies of developing nations by injecting capital that creates higher-paying jobs, which expands the middle class and raises standards of living. 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

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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. 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 whereas closed ones are not. 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.

Globalization’s Influence on Cultures ** This section now appears earlier than in previous editions. ** 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.

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

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

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The Road Ahead for International Business Part 1 (Chapter 1): Globalization Part 2 (Chapters 2–4): National Business Environments Parts 3 and 4 (Chapters 5–8 and 9–10): International Business Environment Part 5 (Chapters 11–16): International Business 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 1.

Q: Define the term international business, and explain how it involves us all. 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 that originate outside our borders or that contain components made abroad. We also

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consume services, such as a news broadcast or music entertainment, that are sent to us from abroad. 2.

Q: Explain how e-business (e-commerce) affects 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.

Q: What types of companies are involved in international business? A: Large, global firms and multinational corporations (MNCs) dominate international business activity. These companies generate significant jobs, investment, and tax revenue for the regions and nations they enter. It is common for the incomes and deals of these large businesses to be valued in the billions. Also, small firms are increasingly active internationally 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 have knowledge-based organizational capabilities. They often rise to the level of international competition in a very short period of time.

Quick Study 2 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 among 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 1.

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

Ch 1: Globalization WTO are: (1) to help the free flow of trade, (2) help negotiate further opening of markets, 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.

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 globalized than others? A: Factors that make a country more global are high levels of economic globalization (high trade and investment volumes, low trade and capital restrictions), social globalization (dissemination of information and ideas), and political globalization (political cooperation with other countries).

Quick Study 4 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.

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

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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 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 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 1.

Q: What does the evidence suggest for each aspect 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

Ch 1: Globalization them into the global economy. Second, in the debate over inequality among 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: 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.

Q: What are the arguments of each side 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.

Quick Study 7 1.

Q: Identify the four main components of the global business environment. A: It is helpful to view international business as occurring within an integrated global business environment consisting of four main elements: (1) Globalization is a potent force transforming our societies and commercial activities. (2) Separate national business environments, including culture and systems of politics, law, and economics. (3) The international business environment, which is where the actions of consumers, workers, companies, financial institutions, and governments from different nations converge. (4) International business management which involves all the duties of management in a domestic setting, but which are complicated by a multitude of differences.

Q: How does globalization influence other elements in the global business environment?

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A: Globalization is a potent force transforming our societies and commercial activities. Globalization increases competition and produces significant changes in how societies operate. The effects of globalization are felt in the cultures and systems of politics, law, and economics of nations. Companies riding on the back of globalization must acknowledge differences in business environments and adapt products and processes as needed. As globalization continues, flows of trade, investment, and capital are becoming more entwined. This often causes firms to look simultaneously for production bases and markets. Globalization causes the management of an international firm different from the management of a domestic firm in nearly all respects. 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 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.

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 and contain 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.

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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 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.

This item can be assigned as a Discussion Question in MyManagementLab. Student responses will vary. 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? 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. Teaming Up 1.

Q: Research Project. Imagine that you and a group of your fellow classmates own a company that manufactures cheap sunglasses. To lower production costs, you want to move your factory from your developed country to a more cost-effective nation. Choose a prospective country to which you will move production. What elements of the national business environment might affect your move? Are there obstacles to overcome in the international business environment? How will managing your company be different when

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you undertake international activities? What challenges will you face in managing your new employees? 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. 2.

Q: Market Entry Strategy Project. This exercise corresponds to the MESP online simulation. With a group of classmates, select a country that interests you. Describe its national flag: what do its colors and any symbols represent? Identify neighbors with which it shares borders. Give some important facts about the country, including its population, population density, land area, topography, climate, natural resources, and the locations of main industries. What does the nation produce? Do any aspects of the natural environment help explain why it produces what it does? Integrate your findings into your completed MESP report. A: This may be a good time to get students working on their Market Entry Strategy Project. This exercise gets students to learn more about a country, and to generate interest in countries other than their own. The project focuses on important aspects of each country and the process can begin to develop teamwork in the course.

Take It to the Web We invite you to visit MyManagementLab.com, an innovative set of course-management tools for delivering all or part of your course online. MyManagementLab makes it easier for you to add meaningful assessment to your course. Whether you’re interested in testing your students’ recall of concepts and theories or in asking them to apply their new knowledge to real-world scenarios, MyManagementLab offers a variety of assessment questions to fit your needs. Ethical Challenges 1.

Q: You are a U.S. citizen recently assigned as the manager of distribution in a European country where bribery is relatively acceptable. Your job description includes responsibility for accepting shipments as they enter the local port authority. On your first trip down to the docks to sign for a shipment, the customs agent in charge asks for a “tip” to clear the goods for pickup. The value of the incoming shipment is around $150,000. Knowing that the government has recently launched an initiative to reduce corruption, how do you react? If additional information would be helpful to you, what would it be? A: This question forces an examination of both personal ethical principles as well as company ethical guidelines. The situation also has a legal issue that must be addressed. U.S. citizens are covered by the Foreign Corrupt Practices Act, which prohibits paying bribes to foreign officials. The “tip” may be legal under the FCPA if it is a small amount and paid to the official to do what he or she would already be doing. The fact that the local government began a campaign to reduce corruption must also be considered. Additional information that would be helpful includes the amount of the “tip,” company

Ch 1: Globalization policy on such matters, and the potential of the local government in helping to reduce corruption.

Q: You are the CEO of a major U.S. apparel company that contracts work to garment manufacturers abroad. Employees of the contractors report 20-hour workdays, pay lower than the minimum wage, overcrowded living conditions, physically abusive supervisors, and confiscation of their passports. Contractors and government officials say local labor laws are adhered to and enforced, though abuses appear widespread. You send inspectors to the factories abroad but they uncover no labor violations. A labor-advocacy group claims that supervisors coached workers to lie to your inspectors about conditions and threatened workers with time in makeshift jails without food if they talked. How do you handle this situation? Do you help the factories improve conditions, withdraw your business, or do nothing? How might your actions affect your relations with the factory owners and your ability to do business in the country? A: It’s extremely important that your company be thorough and transparent throughout the monitoring process. The monitoring process could seem more impartial by contracting an independent organization to conduct the investigation, rather than employ someone with whom the company might be suspected as having social or political connections. You could also have the report made public to all parties simultaneously to eliminate the perception of the report being adjusted. To implement and maintain rapid, sustainable improvements: monitor and verify codes of conduct regarding labor practices, disseminate information to workers explaining their rights, appeal to government agencies on effective ways to raise labor standards, explain how their reputation as being “good guys” in the labor standards arena can create a useful marketing tool and opportunities for firms and countries by differentiating themselves when competing in the apparel export market.

Q: You are the mayor of a midsize U.S. town on the Colorado River between Mexico and Arizona. Pollution from factories on both sides of the U.S.–Mexico border has contaminated your community and the Colorado River. The North American Free Trade Agreement (NAFTA) requires the U.S. government to pay for environmental cleanup in the United States. Yet critics accuse both the U.S. and Mexican governments of not doing enough to safeguard the environment along the border. As mayor, what can you do to persuade business leaders and governmental officials to adhere to environmental standards? Which body do you think presents your biggest challenge: the Arizona state legislature, the U.S. government, or the Mexican government? What can business leaders do if governments ignore their environmental responsibilities? A: As mayor, you must fight for your local community. Dealing with the Arizona and U.S. governments should be easier than negotiating with Mexican officials. Another strategy would be to get the media involved in order to put pressure on business. Because this dilemma involves ethical and social responsibilities regarding the environment, this question might quickly polarize the discussion. Students should delineate between legal and ethical responsibilities in their answers, and consider the environment’s impact on the living standards of a company’s workforce. They should also explore briefly the impact of regulation on business performance and the issue of having the right amount of regulation versus over-regulation.

Ch 1: Globalization

Practicing International Management Case MTV Goes Global with a Local Beat 1.

Q: Some people outside the United States say teens exposed to large doses of U.S. youth culture on MTV will identify less with their own societies and teens in developing countries will want Western goods they cannot afford. MTV’s response: “It’s just fun, it’s only TV,” says one executive. What do you think? Are there dangers in broadcasting U.S.-style programs and ads to developing countries? A: The debate over the impact of U.S. programming beamed to other developed and developing cultures will likely never cease. The U.S. television program The Simpsons, which depicts a rather unflattering U.S. family, is seen in more than 90 countries. Such a program is unlikely to want young people outside the United States to grow up to be like Homer Simpson. Generally, this program and others, such as Married with Children, the Jerry Springer Show, and Baywatch, are watched around the world for a glimpse into the humorous or darker aspects of U.S. culture. On the other hand, local programming can lose out to the U.S. programming if it is not as entertaining. As regards desires among young people for more “Western” goods, this is a sensitive issue involving elements of economic development and materialism. It could be argued that it is not ethical to show U.S. programs that depict wealthy lifestyles in developing countries because they promote discontent in those markets and promote materialism. However, there are wealthy and poor people in every nation and, following this line of reasoning, one could argue that such programs should not be aired in the U.S. market either—incidentally, some groups do make this argument.

Q: Digital compression technology made it possible for MTV to program over a global network. Can you think of other technological innovations that have helped companies to think globally and act locally? A: Internet retailers such as Amazon make online books in English available globally. However, Amazon also has online service to accommodate those in French- and Spanishspeaking countries. This is a localized approach. The French version of Amazon can further localize its selections by offering books tailored to specific Francophone regions such as Africa and Canada, not just France. Clearly, Amazon can continue to localize by selecting other languages where significant numbers of readers are.

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 other. 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.

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 Custom of Gift Giving Social Structure Social Group Associations Family Gender Social Status Social Mobility Caste System Class System Religion Christianity Islam Hinduism Buddhism Confucianism Judaism

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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 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. 2. Ethnocentricity can undermine business projects when employees are insensitive to cultural nuances.

Developing Cultural Literacy

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Managers working directly in international business should develop 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 improves competitiveness.

National Culture and Subcultures National culture generalizes (e.g., British culture: English, Scottish, and Welsh). 1. National Culture a. Nation-states support and promote the concept of a national culture by building museums and monuments to preserve the legacies of important events and people. b. Nation-states intervene to help preserve their national cultures. 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. b. Companies must be mindful of subcultures when formulating business strategies (e.g., China has 50 ethnic groups). c. Decisions regarding product design, packaging, and advertising must consider distinct cultures. d. Subcultures also can extend beyond national borders.

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. A.

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 colors. 2. Appropriate colors for advertising, product packaging, and even work uniforms can enhance success (e.g., Green in Islam). 3. Blunders can result from selecting inappropriate colors and symbols for advertising, product packaging, and architecture. 4. Music is deeply cultural and must be considered in promotions. 5. It is also an important consideration in marketing over the Internet.

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 a. Latin American and Mediterranean cultures are casual about time; people in Japan and the United States arrive promptly for meetings and keep tight schedules.

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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. Attitudes toward Work a. Some cultures have a strong work ethic, others stress a balanced 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. Attitudes toward Cultural Change A cultural trait is anything that represents a culture’s way of life including gestures, material objects, traditions, and concepts. a. 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. b. Cultural imperialism is the replacement of one culture’s traditions, folk heroes, and artifacts with substitutes from another. c. Culture can force companies to adjust business policies and practices, such as using situational management. d. 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 the United States). 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., dragon boat festival in China). 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. The U.S. Foreign Corrupt Practices Act prohibits companies from giving large gifts to win business favors, applies to U.S. firms operating at home and abroad.

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

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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. ii. Extended family includes grandparents, aunts and uncles, cousins, and relatives through marriage. More important in Asia, Middle East, North Africa, and Latin America. b. 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.” Copyright © 2014 Pearson Education, Inc.

Ch 2: Cross-Cultural Business b. 3.

Religion strongly affects the goods and services acceptable to Muslim consumers (e.g., alcohol, pork, interest on loans). Hinduism a. Founded 4,000 years ago in present-day India, where more than 90 percent of its nearly 900 million adherents live. b. 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 the first religion to teach belief 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.

Ch 2: Cross-Cultural Business 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. Japanese competitiveness in world markets has benefited from loyal workforces, low employee turnover, and good labor– 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.

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. 2. The “Brain Drain” Phenomenon 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 a. Topography: all physical features that characterize the surface of a geographic region. Cultures isolated by impassable mountains

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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. A.

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 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.

Ch 2: Cross-Cultural Business 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. 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). 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. Masculinity versus Femininity: Identifies the extent to which a culture emphasizes masculinity versus femininity. a. Cultures scoring high are characterized by personal assertiveness, accumulation of wealth, and entrepreneurial drive. b. Cultures scoring low have relaxed lifestyles, with more of a concern for others than material gain. 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. a. Cultures scoring high (strong long-term orientation) value respect for tradition, thrift, perseverance, and a sense of personal shame.

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Cultures scoring low are characterized by individual stability and reputation, fulfilling social obligations, and reciprocation of greetings and gifts.

BOTTOM LINE FOR BUSINESS 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 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 people’s overall 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 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 colors. 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

Ch 2: Cross-Cultural Business blowing. An example of good taste with respect to dance is the ritualistic dancing of the native Australian Aborigines.

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 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 to consider when doing business abroad. A: Several tips include respecting formalities, adapting to personal space, respecting religious values, giving and receiving business cards respectfully, using comedy sparingly, and maintaining 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 labor–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 1.

Q: What are the main beliefs of each of the seven religions presented in the previous sections? 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 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 importance of a lingua franca to 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 influential for international business? Give several examples. 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 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 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.

Ch 2: Cross-Cultural Business

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 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? • 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

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•

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.

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.”

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 one-

Ch 2: Cross-Cultural Business

half 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. Teaming Up 1.

Q: Research Project. Select a company in your city or town that does business internationally and make an appointment to interview the owner or a senior manager. Your team’s goal is to learn how cultural differences affect the decisions of this business as it pursues international opportunities. How does the company balance the need for global efficiency and local responsiveness in a cultural sense? Has local culture ever required the company to alter its personnel or corporate practices? Be sure to ask your interviewee for specific examples. Present a brief talk or paper on your group’s interview findings. A: Students may want to use the content of this chapter as a guide to create the questions they will ask the interviewee. Students should include in their report a full account of the cultural elements their interview uncovers. Student teams may also enjoy comparing their findings to look for similarities and differences among companies.

Q: Market Entry Strategy Project. This exercise corresponds to the MESP online simulation. For the nation you are studying, list several of its people’s manners and customs. What values do people hold dear? Describe their attitude toward time, work, and cultural change. What religions are practiced 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. Integrate your findings into your completed MESP report. A: This may be a good time to get students working on their Market Entry Strategy Project. This exercise gets students to learn more about a country, and to generate interest in countries other than their own. The project focuses on important aspects of each country and the process can begin to develop teamwork in the course.

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Ethical Challenges 1.

This item can be assigned as a Discussion Question in MyManagementLab. Student responses will vary. Q: You are the vice president of operations for a U.S.-based software

firm. Your firm’s board of directors wants you to explore building a software-design operation in India. Typically, when international firms enter the Indian market, they quickly learn about the various ways in which a rigid caste system can affect business activities. Do you think it will be possible to uphold a U.S. management style in India? Or should your company be prepared to adjust to the local Indian managerial style and human resource practices? A: Students must understand that understanding cultural differences is crucial to developing strong relationships. The question in this vignette poses a real dilemma for international companies operating in India. Local management practices can be very different from the company’s practices in its home country. The response by most companies is to implement the home country policies but to adapt them to the local market. This is probably best accomplished by placing as head of the Indian operation an Indian-born employee that has worked for the company in the home country who understands the corporate culture. This manager would know what policies can or cannot be implemented in the Indian subsidiary. 2.

Q: You are the public relations director for a company that recently announced its decision to close its factory in the United States and outsource the work to manufacturers in Asia and Latin America. Your firm is doing just what many other companies have already done, reducing labor costs by shifting work to low-wage countries such as China, India, Mexico, and Central American nations. Yet the media and disgruntled workers are lambasting your firm’s decision. Is there a reasonable response to charges that the companies you will hire frequently exploit child labor, force women to work 75-hour weeks, and destroy family units? A: As the head of Public Relations, this will be a challenging ordeal. Emphasis must be placed on the many positive outcomes of the outsourcing decision. Issues such as keeping retail prices low, increasing shareholder wealth, adhering to local laws abroad, and creating foreign jobs can be discussed. Moreover, students should first of all recognize the bias in this statement. Many companies relocate labor-intensive operations to lowwage countries. But they also involve themselves in the local community to better people’s lives, not exploit workers at the expense of education and family. They do this because human rights groups are active in every country and closely monitor the activities of multinational firms. If they abuse the rights of local workers, they receive a great deal of bad publicity in the home country—hurting their reputation and, perhaps, sales. Firms also do it because they recognize how important an educated, healthy, and happy workforce is to productivity.

Practicing International Management Case A Tale of Two Cultures

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Q: If your international firm were doing business in Asia, would you feel partly responsible for these social trends? Is there anything that your company could do to ease the tensions these cultures are experiencing? Be specific. A: This question presents students with an ethical dilemma. Some students will say that their company is in business to earn a profit and that Asian consumers are not being forced to buy Western goods—they make a conscious decision when they make a purchase. Other students will feel a sense of responsibility to those societies in which they market their products. These students will want to suggest ways to lessen tensions in those societies. Some possibilities for this include doing charity work to help people suffering economic difficulties, financially supporting and giving employees time off to do volunteer work for cultural fairs and festivals, and making counselors available in the company to help employees with their troubles.

Q: In your opinion, is globalization among the causes of the increasing incidence of divorce, crime, and drug abuse in Asia? Why or why not? A: Many students will agree that the forces of globalization are exposing people in all countries to new ways of thinking and behaving. However, many social ills are not a direct result of globalization, but of other forces causing social change. Drug use is certainly not a new problem in most countries—opium has been used across Asia for centuries. Also, many women in Asian cultures are no longer financially dependent on their spouses because of the growing employment of women in the workforce. Thus when marital problems arise, divorce can be a viable option unlike in the past. This is not a Western phenomenon being spread by globalization, but one tied to economic development and industrialization more generally.

Q: Broadly defined, Asia comprises more than 60 percent of the world’s population—a population that practices Buddhism, Confucianism, Hinduism, Islam, and numerous other religions. Thus, do you think it is possible to carry on a valid discussion of “Asian” values? Why or why not? A: Clearly, there are important and significant differences between Asian societies. But some values tend to be Pan-Asian, including the extended family concept—in contrast to the nuclear family concept in Western cultures. Also, respect for community elders is deeply ingrained throughout Asia—unlike the Western emphasis on youth and vitality (most pronounced in the United States). Thus, certain cultural elements can be discussed as “Asian” just as we identify certain concepts and behaviors as “Western.” But the validity of generalizing about “Asian values” depends on the depth of the discussion. The deeper we explore Asian cultures, the more differences we uncover.

Q: Consider the following statement: “Economic development and capitalism require a certain style of doing business in the twenty-first century. The sooner Asian cultures adapt the better.” Do you agree or disagree? Explain. A: The statement is clearly biased toward Western management practices. But it is true that many companies worldwide are learning Western business principles. Companies are trying to instill a drive toward greater efficiency and are showing a greater appetite for trying new management techniques. The shift toward Western management principles in Asia was seen during the Asian economic crisis: Governments passed laws forcing greater transparency among companies and banks, and U.S. and other Western companies bought bankrupt Asian companies and radically altered how they were run. But no matter how rapid the pace of change, Asian companies will always retain practices that make them unique.

CHAPTER 3 POLITICS, LAW, AND BUSINESS ETHICS 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 some important global legal issues. 4. Explain ethics and social responsibility and key issues facing international companies. 5. 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 Global Legal Issues Standardization Intellectual Property Industrial Property Copyrights Product Safety and Liability Taxation Antitrust Regulations

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Ethics and Social Responsibility Philosophies of Ethics and Social Responsibility CSR Issues Bribery and Corruption Labor Conditions and Human Rights Fair Trade Practices Environment Business and International Relations The United Nations Bottom Line for Business

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. A.

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. 2. Wide participation occurs when people who are capable of influencing 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

Ch 3: Politics, Law, and Business Ethics

governments share three features: imposed authority, lack of constitutional guarantees, and restricted participation. a. Theocratic totalitarianism: political system under the control of 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. 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

Ch 3: Politics, Law, and Business Ethics

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. 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. 3. 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. 4. 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. 5. 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. B.

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.

Ch 3: Politics, Law, and Business Ethics d. 2.

Insurance can be used to protect companies against losses and can provide project financing. 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. b. 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.

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.

Common Law • Tradition: Country’s legal history • Precedent: Past cases that have come before the courts • Usage: How laws are applied in specific situations 1. Originated in England in the eleventh century and adopted in its territories worldwide. 2. 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. 3. Practiced in Australia, Britain, Canada, Ireland, New Zealand, the United States, and some nations in Asia and Africa.

Civil Law 1. 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. 2. 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.

Ch 3: Politics, Law, and Business Ethics 3.

Practiced in Cuba, Puerto Rico, Quebec, Central and South America, most of Western Europe, and parts of Asia and Africa.

Theocratic Law 1. Legal tradition based on religious teachings (e.g., Islamic, Hindu, and Jewish law). 2. 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. 3. Firms operating in countries with theocratic legal systems must be sensitive to local values and beliefs. They must evaluate business activities, including hiring practices and investment policies, to ensure compliance with the law, local values, and beliefs.

GLOBAL LEGAL ISSUES Companies must adapt to dissimilar legal systems in global markets because there is no clearly defined body of international law that all nations accept. A.

Standardization 1. Standardization is uniformity in interpreting and applying laws across countries, not to the standardizing of entire legal systems. 2. Treaties and agreements already exist in intellectual property rights, antitrust (antimonopoly) regulation, taxation, contract arbitration, and general matters of trade. 3. Organizations that promote standardization: the UN, OECD, and International Institute for the Unification of Private Law.

Intellectual Property 1. Results from intellectual talent and abilities such as graphic designs, novels, computer software, machine-tool designs, and secret formulas. 2. 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. a. 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). b. 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.

Ch 3: Politics, Law, and Business Ethics •

Protected under the Berne Convention and the 1954 Universal Copyright Convention.

Product Safety and Liability 1. Product liability holds manufacturers, sellers, and others, including individual company officers, responsible for damage, injury, or death caused by defective products. 2. Developed nations have the toughest product liability laws. Lessdeveloped and emerging countries have weaker laws.

Taxation 1. Tax revenues needed to pay government salaries, build military capacity, and shift earnings from people with high incomes to the poor. 2. Consumption taxes: indirect taxes that help pay for consequences of using a particular product and to make imports more expensive. 3. Value added tax (VAT): levied on each party that adds value to a product throughout its production and distribution.

Antitrust Regulations 1. 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. 2. 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. 3. 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.

ETHICS AND SOCIAL RESPONSIBILITY International managers are exposed to different conceptions of ethical behavior and guidelines for socially responsible behavior. Child labor, human rights, the environment, and plant closings are the heart of debates over impact of multinationals. • Ethical Behavior: personal behavior in accordance with guidelines for good conduct or morality. No right or wrong decisions, but alternatives, each of which may be equally valid depending on one’s perspective. • Corporate Social Responsibility: practice of companies going beyond legal obligations to actively balance commitments to investors, customers, other companies, and communities. • Three layers of CSR activity: (1) company works toward a specific social cause; (2) company follows a code of conduct and operates with greater transparency; and (3) company builds social responsibility into its core operations to create value and build competitive advantage. A.

Philosophies of Ethics and Social Responsibility 1. Friedman View: company’s sole responsibility is to maximize profits for its owners (or shareholders) while operating within the law. a. Example: managers would applaud a company moving pollution-generating operations from a strict country to a lax country.

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Many disagree with this argument against socially responsible activities. Today the discussion is not whether a company has CSR obligations, but how it will fulfill them. Cultural Relativist View: company should adopt local ethics wherever it operates because all belief systems are determined within a cultural context. a. Sees truth, itself, as relative and argues that right and wrong are determined within a specific situation. b. “When in Rome, do as the Romans do” captures the essence of cultural relativism. Righteous Moralist View: 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. a. Example: company headquarters instructs subsidiary managers to refrain from bribing local officials and, thereby, imposes its righteous moralist view on local managers. Utilitarian View: company should behave in a way that maximizes “good” outcomes and minimizes “bad” outcomes wherever it operates. a. A utilitarian manager asks the question “What outcome should I aim for?” and answers, “That which produces the best outcome for all affected parties.” b. Example: manager pays a bribe based on calculations that more people will benefit than will be harmed by the outcome.

CSR Issues Business leaders realize that the future rests on healthy workforces and environments. Still, international managers face dilemmas on a daily basis. 1. Bribery and Corruption a. Corruption leads to the misallocation of resources, hurts economic development, distorts public policy, and damages the integrity of “the system.” b. Enron’s failure sent a shockwave around the world. Energy trading markets were in chaos and many lost jobs worldwide. c. In 2002, Congress passed the Sarbanes-Oxley Act, which set more stringent accounting standards and reporting practices. 2. Labor Conditions and Human Rights a. Managers must monitor behavior of themselves, employees, and business partners. b. Governments, labor unions, consumer groups, and human rights activists force apparel companies to implement codes of conduct and monitoring principles in international production. 3. Fair Trade Practices a. Fair trade products: involve companies working with suppliers in more equitable, meaningful, and sustainable ways. b. TransFair USA certifies that a product embodies fair prices, fair labor conditions, direct trade, democratic community development, and environmental sustainability. 4. Environment a. Companies pursue “green” initiatives to reduce their toll on the environment and to reduce operating costs and boost profit margins.

Ch 3: Politics, Law, and Business Ethics b.

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. A.

Carbon footprint: environmental impact of greenhouse gases (measured in units of carbon dioxide) that results from human activity.

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. 2. Receives funding from member contributions based on gross national 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.

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 1.

Q: What is a political system? Explain the relationship 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.

Ch 3: Politics, Law, and Business Ethics

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. 3.

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.

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 1.

Q: What is democracy? Explain the differences 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?

Ch 3: Politics, Law, and Business Ethics 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.

Quick Study 3 1.

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

Q: Distinguish among 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 1.

Q: What is meant by the term legal system?

Ch 3: Politics, Law, and Business Ethics

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. 2.

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 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. 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.

Ch 3: Politics, Law, and Business Ethics 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. 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 1.

Q: Define ethical behavior and corporate social responsibility. A: Ethical behavior is personal behavior in accordance with guidelines for good conduct or morality. Corporate social responsibility is the practice of companies going beyond legal obligations to actively balance commitments to investors, customers, other companies, and communities.

Q: What are four commonly cited philosophies of business ethics and social responsibility? A: The Friedman view says that a company’s sole responsibility is to maximize profits for its owners (or shareholders) while operating within the law. Today, many people disagree with this argument and assume a company has CSR obligations and the issue is how it will fulfill them. 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. It sees truth, itself, as relative and argues that right and wrong are determined within a specific situation. “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 homecountry 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. A utilitarian manager asks the question, “What outcome should I aim for?” and answers, “That which produces the best outcome for all affected parties.”

Q: List several issues of ethics and social responsibility relevant to international managers. A: Business leaders realize that the future rests on healthy workforces and environments. Still, international managers face dilemmas on a daily basis. (1) Bribery and corruption lead to the misallocation of resources, hurt economic development, distort public policy, and damage the integrity of “the system.” In 2002, Congress passed the Sarbanes-Oxley Act, which set more stringent accounting standards and reporting practices. (2) Managers must monitor behavior of themselves, employees, and business partners. Governments, labor unions, consumer groups, and human rights activists force apparel companies to implement codes of conduct and monitoring principles in international production. (3) Fair trade products involve companies working with suppliers in more equitable, meaningful, and sustainable ways. TransFair USA certifies that a product embodies fair

Ch 3: Politics, Law, and Business Ethics

prices, fair labor conditions, direct trade, democratic community development, and environmental sustainability. (4) Companies pursue “green” initiatives to reduce their toll on the environment and to reduce operating costs and boost profit margins. Carbon footprint refers to the environmental impact of greenhouse gases (measured in units of carbon dioxide) that results from human activity. 4.

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.

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 its 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 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.

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

Ch 3: Politics, Law, and Business Ethics 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.

Teaming Up 1.

Q: Debate Project. Two groups of four students each will debate the ethics of doing business in countries with totalitarian governments. After the first student from each side has spoken, the second student will question the opposing side’s arguments, looking for holes and inconsistencies. The third student will attempt to answer these arguments. A fourth student will present a summary of each side’s arguments. Finally, the class will vote to determine which team has offered the more compelling argument. A: Students arguing in favor of entering countries with totalitarian governments should consider the perspective of companies based in like countries, not just democratic ones. Many students will overlook the fact that many companies based in totalitarian countries do business in other like countries. Trying to view business from this perspective might challenge students not coming from such a country. For this reason, it can be interesting for international students in the class to be divided into different groups so that each group has a variety of opinions and perspectives. Likewise, students arguing against entering totalitarian countries must grapple with whether their not investing will create political change—it oftentimes does not. These students will also need to accept the fact that not investing might actually mean a lower standard of living for people in the totalitarian country and perhaps less work at home for the multinational that would undertake the investment.

This item can be assigned as a Discussion Question in MyManagementLab. Student responses will vary. Q: Market Entry Strategy Project. This exercise corresponds to the

MESP online simulation. For the nation you are studying, what type of political and legal systems does it 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? Integrate your findings into your completed MESP report. A: This may be a good time to get students working on their Market Entry Strategy Project. This exercise gets students to learn more about a country and to generate interest in countries other than their own. The project focuses on important aspects of each country and the process can begin to develop teamwork in the course.

Ch 3: Politics, Law, and Business Ethics

Q: You are the president of a firm that publishes textbooks for medical students in more than 30 languages. On a recent trip to a university in a developing country (with a GDP per capita of less than $1,000 per year), you discover that many of the students are using bound photocopies of your best-selling medical textbook. Speaking with several students, they inform you that if they were required to pay for the actual books, they could not afford medical school. Witnessing the clear copyright violation firsthand, how do you react? What possible courses of action might you take? If additional information would be helpful to you, what would it be? A: We first need to know how many students and how many books are involved. If the financial impact is minimal, and this is a large firm, we could perhaps donate the books and benefit from goodwill. Yet if the financial impact is significant, a different alternative must be selected. Producing a low-cost version in the local country is another option. The firm could also attempt to sponsor a local scholar that could develop a textbook. An analysis of the theory of justice is relevant to this discussion.

Q: You are the proprietor of a fledgling computer graphics company in Shanghai, China. The sophisticated business application software you need for your business normally sells for 2,900 renminbi (around $350) at computer stores in Shanghai. But with an income of a little more than $5,000 a year, you cannot afford to buy the original graphics software for your business. A friend has told you she can get you all the software you need, and more, at a nearby street market for only $40. Because very few people buy official software, you know the authorities will not punish you if you are caught. Is it unethical for you to purchase the pirated software? Do you believe you are justified in doing so? A: This question forces students to consider the piracy issue from the perspective of a budding entrepreneur who cannot possibly afford the legal version of the software. One option that students often suggest is for companies to offer their products at reduced prices in markets where piracy is rampant. However, the company must be able to ensure that products are not then re-exported to other wealthier markets and sold at the official price—earning pirates a huge profit. Another is the precedent that is set for other markets—all people need to do to have companies reduce their prices would be to start an underground market. The position most students might arrive at is for multinationals to fight piracy but to be less forceful in the poorest markets.

Q: You are the CEO of a major pharmaceutical firm that holds worldwide patents on several highly successful drugs. Your company invests heavily to develop its drugs because patents allow it to recoup its investment. But your firm has come under pressure

Ch 3: Politics, Law, and Business Ethics from competitors selling cheaper alternatives, and from politicians and nongovernmental groups to supply drugs to people in poor nations at reduced prices. Several senior executives in your company feel the firm is unfairly being asked to discount its drugs that treat diseases afflicting people of poor nations. Some executives suggested that the firm focus on drugs to treat diseases (such as heart disease and cancer) that occur mostly in wealthy nations, but you are uneasy with such a move. Would such a course of action be ethical? Diseases such as AIDS, cancer, and heart disease all kill their victims. Should drugs for only certain diseases be exempt from patent protection? A: To answer this question, students should read a few articles for more background information. This will help them understand the economics of the drug business. Companies must often sell their products for years in order to recoup their investment and earn a fair return. Students might also suggest government subsidies for makers of drugs that prevent death from certain diseases.

Practicing International Management Case Pirates of Globalization 1.

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: Locate information on the Tiffany vs. eBay lawsuit mentioned in the case. Identify the arguments of the plaintiff and the defendant and who prevailed. What are the implications of that lawsuit for the sale of counterfeits in online auctions? A: Tiffany’s allegation that eBay contributed directly to infringement of the Tiffany trademark due to the sale of counterfeit Tiffany jewelry is a strong warning to online auction houses. The policy of eBay has been to monitor its own site for fraud, yet that has been insufficient according to Tiffany executives. Defendant eBay was victorious in the lawsuit, though Tiffany is appealing the case. The ongoing saga can be tracked online through newspapers and search engines.

CHAPTER 4 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 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 National Production Uncounted Transactions Question of Growth Problem of Averages Pitfalls of Comparison Purchasing Power Parity Human Development

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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 4. 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. c. By the 1970s, central planning was found in Eastern Europe, Asia, Africa, and Latin America. 2. Decline of Central Planning a. In the late 1980s, nations dismantled central planning in favor of market-based economics for several reasons.

Ch 4: Economics and Emerging Markets

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, labor, 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. a. 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.

Ch 4: Economics and Emerging Markets

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. 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. 4. 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. Copyright © 2014 Pearson Education, Inc.

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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 a. Per capita figures are averages. Urban areas can be more developed than rural areas and have higher per capita income. 4. 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. Using purchasing power parity to compare the wealth of nations (e.g., Swiss GDP per capita is $47,900 but only $34,700 at PPP compared to U.S. GDP at PPP of $39,700).

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. b. Examples are Australia, Canada, Japan, New Zealand, the United States, all western European nations, and Greece.

Ch 4: Economics and Emerging Markets 2.

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 cuts are in welfare, unemployment benefits, and guaranteed government jobs. 4. Environmental Degradation a. Economic and social policies of former communist governments in Central and Eastern Europe were disastrous for the natural environment.

Ch 4: Economics and Emerging Markets 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 labor, 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).

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 1.

Q: Define economic system. What is the relationship 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 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.

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

Ch 4: Economics and Emerging Markets 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. By 2012, China is growing more slowly due to slow growth in the developed economies. China’s growth is solid, but it is dependant on exports. Domestic consumption cannot make up for lost export sales. Higher unemployment resulting from slower growth may bring domestic unrest to China. Wages need to rise further to increase the average Chinese family’s purchasing power to make up for lost export sales.

Quick Study 2 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 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.

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Q: What is the role of government in a market economy? 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.

Quick Study 3 1.

Q: What is meant by the term economic development? Explain the relationship 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 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.

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 parity can be used to compare the relative wealth of nations. For example, unadjusted Swiss GDP per capita is $47,900. But, at PPP it falls to

Ch 4: Economics and Emerging Markets $34,700 and is actually lower than the comparable figure for the U.S. GDP at PPP— $39,700. Thus, it costs more to buy the same basket of goods in Switzerland than in the United States.

Quick Study 4 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: 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 1.

Q: What are several reform measures 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

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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. 3.

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 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 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,

Ch 4: Economics and Emerging Markets 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.

Teaming Up 1.

Q: Debate Project. In this project, two groups of four students each will debate the benefits and drawbacks of both market and mixed economies. After the first student from each side has spoken, the second student will question the opposing side’s arguments, looking for holes and inconsistencies. The third student will attempt to answer these arguments. A fourth student will present a summary of each side’s arguments. Finally, the class will vote on which team has offered the more compelling argument. A: In this debate, assign one team to the side of market economies and the other to mixed economies. Note that students will often fully develop arguments for why their economic system is better than the other system. But they often fail to develop clear and defined arguments that diminish the drawbacks of their system. For example, students arguing for mixed economies should be able to explain why the social welfare system is worth (perhaps) higher taxes on citizens.

This item can be assigned as a Discussion Question in MyManagementLab. Student responses will vary. Q: Market Entry Strategy Project. This exercise corresponds to the

MESP online simulation. For the country your team is researching, 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? Integrate your findings into your completed MESP report. A: This may be a good time to get students working on their Market Entry Strategy Project. This exercise gets students to learn more about a country, and to generate interest in countries other than their own. The project focuses on important aspects of each country and the process can begin to develop teamwork in the course. Take It to the Web We invite you to visit MyManagementLab.com, an innovative set of course-management tools for delivering all or part of your course online. MyManagementLab makes it easier for you to add meaningful assessment to your course. Whether you’re interested in testing your students’ recall of concepts and theories or in asking them to apply their new knowledge to real-world scenarios, MyManagementLab offers a variety of assessment questions to fit your needs.

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Ethical Challenges 1.

Q: You are the CEO of a Canadian–Chinese joint venture that operates in China. Your Chinese partner is the People’s Liberation Army (PLA). The PLA has built a sprawling network of businesses that do everything from raise pigs to run airlines and hospitals, mine coal, manage hotels, and operate paging and cellular networks. As a business conglomerate, the PLA does business with international investors. Some argue that a large portion of foreign investment going to China is with companies and cartels controlled by the Chinese military. Others argue that it’s easy to read too much into the PLA’s foray into business. They point out that there is little centralized coordination among the thousands of businesses with military affiliations. Some companies are run by retired officers, others by civilians. As the CEO of the joint organization, do you have any ethical concerns about partnering with the PLA? If so, what are they? Suppose a clash between pro-democracy demonstrators and the PLA turns bloody. How would this turn of events affect business relations with your PLA partner? Are the ethical issues of partnering with the Chinese military any different from those that arise from exporting to China? Why or why not? A: Students’ responses to the questions posed here hinge on past actions of the PLA. Because we know the history of the PLA in putting down demonstrations (Tiananmen Square, 1989) many students will take an ethical stance against partnering with the PLA or officers it employs. Students should also be able to distinguish between partnering with a PLA entity and exporting to China or investing in a wholly owned subsidiary there. If the PLA is not involved, students often say it is unethical to deny Chinese citizens access to the company’s product. Nevertheless, individual political ideas and personal moral compasses will color students’ responses to this ethical dilemma.

Q: You are the managing director of your U.S. firm’s subsidiary in southern France. The social-welfare states of Western Europe were founded after the Second World War with specific ethical considerations in mind: reduce social and economic inequality, improve living standards for the poor, and provide nearly free health care for all. Now many of these countries have trimmed social-welfare provisions and increased their reliance on market forces. Do you think that the ethical concerns of half a century ago are a thing of the past? Or do you feel that market reforms will simply re-create the conditions that motivated the development of the welfare state in the first place? What can you do as a manager to alleviate workers’ fears that a more open economy will reduce their social safety net? A: As a manager, you must convey to your workers that there are risks involved with capitalism, yet the potential rewards are great. Ethical issues never become dated. The dilemma of the role of the state in providing for its people was argued two thousand years ago by the great philosophers of the time. The issues remain the same, only the context is different. The reason many Western European nations are cutting back on corporate welfare is because they believe market forces are more efficient at allocating resources in most situations. They are also imposing austerity programs to reduce rising government debt levels since the global recession began in 2008–2009. The extent to which these nations cut back on social-welfare benefits for individuals is difficult to estimate. However, it is highly unlikely that we will anytime soon see the kinds of conditions that existed in Europe immediately following the Second World War.

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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.

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: 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. Why does the United States maintain such a hard line against doing business with Cuba? Do you think this embargo is in the United States’ best interests? Why or why not? A: Implementation and enforcement of this law, called the Helms-Burton 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). As far as whether it is in the best interest of the United States, there are again political and economic arguments involved. Obviously, there is no easy answer to such a question. Although U.S. companies cannot invest now, they will likely have little trouble catching up to others as soon as political and economic reforms occur. In discussing whether it is in the United States’ best interest, students might want to consider the perspective of many Cuban-Americans who themselves engage in debate over whether the embargo should continue because of the impact on ordinary citizens.

CHAPTER 5 INTERNATIONAL TRADE LEARNING OBJECTIVES: 1. Describe the relationship between international trade volume and world output, and identify overall trade patterns. 2. Describe mercantilism and explain its impact on world powers and their colonies. 3. Explain the theories of absolute advantage and comparative advantage. 4. Explain the factor proportions and international product life cycle theories. 5. 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 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

Ch 5: International Trade

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

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 5.1). A.

Benefits of International Trade Creates new entrepreneurial opportunities, expands the choice of goods and services, and creates jobs. The U.S. Department of Commerce estimates that for every $1 billion increase in exports, 22,800 U.S. jobs are created.

Volume of International Trade World merchandise exports are worth more than $14 trillion and service exports are valued at more than $3 trillion (see Table 5.1). Trade in merchandise is around 80 percent of total trade; services account for 20 percent of total trade. 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. 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.

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Intra-regional trade accounts for around 71 percent of Europe’s exports, 52 percent of Asia’s exports, and more than 48 percent of North America’s exports (see Table 5.2). 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. c.

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 characterized by a certain degree of interdependency, which often reflects trade between a company’s subsidiaries.

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). A.

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 practiced from around 1500 to the late 1700s by European nations, including Britain, France, the Netherlands, Portugal, and Spain. 1. How Mercantilism Worked Trade was to benefit mother countries; colonies (in Africa, Asia, and North, South, and Central America) were exploitable resources. a. 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. b. 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. c. 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. 2. Flaws of Mercantilism

Ch 5: International Trade 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. B.

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. 1. 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. a. Gains from Specialization and Trade i. 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. ii. 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 5.2). iii. 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. iv. 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.

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 goods. 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. 1. Gains from Specialization and Trade a. 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

Ch 5: International Trade

are still needed to produce a ton of tea. Thus, Riceland has absolute advantages in producing both goods. b. 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. c. 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. 1. 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). 2. 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

Ch 5: International Trade 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. d. 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. e. Yet the theory retains explanatory power when applied to technology-based products that are eventually mass-produced. F.

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.

Ch 5: International Trade 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 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. 4. Firm Strategy, Structure, and Rivalry a. Strategic decisions of firms have lasting effects on future competitiveness, but equally important is industry structure and rivalry among companies. b. The more intense the struggle to survive among 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. 5. 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.

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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.

Quick Study Questions Quick Study 1 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 relationship 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.

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 71 percent of Europe’s exports, 52 percent of Asia’s exports, and 48 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 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 the three pillars: (1) trade surpluses, (2) active government intervention, and (3) practicing colonization.

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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 3 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. 139–141) 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. 141– 142) 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.

Quick Study 4 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

Ch 5: International Trade 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 5 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 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.

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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.

Teaming Up 1.

Q: Debate Project. In this project, two groups of four students will debate the advantages and disadvantages of completely free international trade. After the first student from each side has spoken, the second student will question the opponent’s arguments, looking for holes and inconsistencies. The third student will attempt to answer these arguments. A fourth student will present a summary of each side’s arguments. Finally, the class will vote on which team has offered the more compelling argument. A: Students should be sure to support their arguments with aspects of the theories discussed in this chapter. They should also be prepared to defend their positions, after the debate, if they are called on to give a synopsis of their position in class. It may also be useful to give students some time to do outside research to prepare for the debate.

This item can be assigned as a Discussion Question in MyManagementLab. Student responses will vary. Q: Market Entry Strategy Project. This exercise corresponds to the

MESP online simulation. For the country your team is researching, how important is trade (trade as a share of GDP)? What products and services does it export and import? Is there a concerted effort to promote exports to stimulate the economy? With whom does the nation trade? Is it dependent on any particular nation for trade, or does another nation depend on it? Is outsourcing affecting its trade patterns? Does the nation trade only with high-income countries or with low- and middle-income countries as well? Integrate your findings into your completed MESP report. A: This may be a good time to get students working on their Market Entry Strategy Project. This exercise gets students to learn more about a country, and to generate interest in countries other than their own. The project focuses on important aspects of each country and the process can begin to develop teamwork in the course. Take It to the Web We invite you to visit MyManagementLab.com, an innovative set of course-management tools for delivering all or part of your course online. MyManagementLab makes it easier for you to add meaningful assessment to your course. Whether you’re interested in testing

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Ethical Challenges

Q: You are a research fellow for a Washington, D.C.-based research institute investigating the ethics of restrictions on the international movement of labor. In the practice of international trade, both physical resources and capital cross international borders rather freely, whereas labor is heavily restricted. In fact, it can be extremely difficult for individuals to obtain a permit that allows them to be gainfully employed within many countries. Thus, although companies are free to set up production in markets where labor is cheap, labor cannot move to markets where wages are higher. Some argue that this locks poor people to their poor geographies and gives them little hope for advancement. Why do you think this situation prevails? Is it ethical that of all the components of production, labor is the one most subject to restrictions on its international mobility? Explain. A: In responding to this ethical question, students should not forget the legal and political issues involved. Many nations restrict entrance to their nation by people who have criminal backgrounds or whose political views do not match that of the government in power. But putting aside these arguments, labor is clearly restricted in its international mobility and students will likely take a wide range of positions on this issue.

Q: You are the production manager for a European-based firm that is considering outsourcing its manufacturing to a producer in China. You are asked by your firm’s CEO to prepare a report that outlines the benefits and drawbacks of this potential change. During your research, you find international trade theories that say protectionist actions restrict imports and harm a nation’s standard of living—an argument for free trade. Yet you know that free trade and global competition are driving firms such as your own to move production to cheaper locations abroad, thereby eliminating jobs in their home countries. Clearly, the gains and losses of free trade are not always distributed evenly across the population. As part of your report to the CEO, argue either for or against the need for measures that protect domestic production and, therefore, jobs at home. A: Free trade without domestic protection is still the best way. However, job loss is painful and must be handled in an ethical way. When NAFTA was enacted, Americans feared seeing their jobs flee to Mexico. In fact, these fears were justified because of the low wages in Mexico. The U.S. government provided some retraining programs to help individuals reenter the workforce. Now China is the investment darling. For the past two decades, China has seen rising investment from companies around the world, producing everything from refrigerators, calculators, laptop computers, and mobile phones for export. But regions inside China are now experiencing rising wages as investment pours in to take advantage of low-cost labor. But as China’s wages rise, production is moving further inland and to lower-cost Asian nations.

Q: You are a member of a World Trade Organization task force that is reviewing the recent banana conflict between the United States and the European Union. The European Union and the United States recently ended a nine-year battle over trade in bananas. The European Union was giving preferential treatment to banana exporters from Africa, the Caribbean, and the Pacific island nations. But the United States challenged what it saw

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as unfair trading practices, and the World Trade Organization agreed. Large global fruit companies such as Dole, Chiquita, and Del Monte—which alone account for nearly twothirds of the fruit traded worldwide—supported the U.S. action. The European Union argued it was trying to support struggling economies, for which bananas make up a large portion of their income. Discuss the ethics of managing trade in the interests of countries vulnerable in the global economy. Would you have argued on behalf of the United States or the European Union? Why? What are the pros and cons of each side’s arguments? A: Here is some background on the matter. The United States (backed by Mexico, Guatemala, Ecuador, and Honduras) complained about the EU policy to the WTO, which awarded victory to the plaintiffs in 1997. The EU made amendments to its banana policy, which the EU said brings the policy in line with WTO specifications. However, the United States and its backers said that the amended policy was no better than the old one. The U.S. government notified U.S. importers that they are liable for hefty tariffs on $520 million worth of European luxury goods in retaliation for European barriers on banana imports. Washington said $520 million is the sum that U.S. companies such as Chiquita and Dole lost because of the EU banana quota system. The tariffs affected a range of EU goods, from Belgian biscuits and Scottish cashmere sweaters to Italian cheese and Spanish leather goods. The British Trade Minister Brian Wilson called the U.S. action “potentially catastrophic” for the British cashmere industry concentrated in Scotland. The French Foreign Ministry also called on the United States to halt what Paris considered an illegal action by Washington. “We strongly deplore that the U.S. has once again acted unilaterally,” the ministry said in a statement. “We are asking them to show good faith and to reconsider this unacceptable decision.” The World Trade Organization ruled in April 1999 that the European Union’s banana import program violated international trade law and would have to change. Caribbean leaders reacted to the ruling with anger and concern, saying it posed a dire threat to tiny island nations that rely on bananas for their foreign exchange. The Caribbean accounts for 10 percent of the world’s banana trade. Much of the remaining 90 percent is dominated by Latin America’s so-called “dollar banana” producers. Finally, other issues that could be discussed are job creation, setting an international trade precedent, political strategy, and the environment. Practicing International Management Case First in Asia and the World 1.

This item can be assigned as a Discussion Question in MyManagementLab. Student responses will vary. Q: As the first to set up an international air express business in 1969,

DHL had the first-mover advantage over other companies. Is being a first mover as advantageous for a service company such as DHL, as it is for a manufacturing company such as Boeing? Explain. A: In theory, the principle of first-mover advantage is the same for a service firm and a manufacturer. The first-mover advantage is based on economies of scale and strategic benefits of being first. There are economies of scale in services as there are economies of scale in production and the strategic benefits of being first apply to services as well. Expedia is a prime example of this in Internet travel services. 2.

Q: When it comes to global expansion and setting up affiliates abroad, how is a service company’s focus different from that of a manufacturing company? What elements are

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Ch 5: International Trade necessary for a service company to achieve global success? What are the obstacles to global expansion? A: Key to a service company’s success in markets abroad is the people that represent the company. Because services are provided and consumed simultaneously, a buyer’s impression of the provider is largely based on the experience it has during its interaction with the company. In contrast, a buyer can have an unpleasant purchase experience of a physical product but be so pleased with the product’s performance that repeat purchase is assured. Thus, the most important element or obstacle to a service firm operating internationally is the training of employees to supply the highest quality service experience as possible to buyers.

Q: DHL prides itself on having its own staff of more than 300,000 people spread across the globe, instead of relying on local agents. Discuss the merits and drawbacks of this international staffing approach. A: The potential problems of using this approach rest in effective training and management of employees in markets abroad. This approach can also increase the cost of providing a service, although it is believed that special employee training and oversight allows the company to provide higher quality service.

Q: Why do you think DHL faltered in the United States? What do you think are the dangers, if any, of being a first mover? A: DHL largely overreached in its expansion throughout the United States. It underestimated its competition and faced a global recession after launching its expansion strategy. Perhaps the biggest danger of being a first mover is complacency. Companies can easily develop hubris at their rapid growth and dominance of the industry. New, more agile companies may come along and knock them off their pedestal by being more attuned to customers’ needs. Start-ups might also employ a new business model (approach to doing business in the industry) and take market share away from the leader.

CHAPTER 6 BUSINESS-GOVERNMENT TRADE RELATIONS LEARNING OBJECTIVES: 1. Describe the political, economic, and cultural motives behind governmental intervention in trade. 2. List and explain the methods governments use to promote international trade. 3. List and explain the methods governments use to restrict international trade. 4. Discuss the importance of the World Trade Organization in promoting free trade.

CHAPTER OUTLINE: Introduction Why Do Governments Intervene in Trade? Political Motives Protect Jobs Preserve National Security National Security and Imports National Security and Exports Respond To “Unfair” Trade Gain Influence Economic Motives Protect Infant Industries Pursue Strategic Trade Policy Benefits of Strategic Trade Policy Drawbacks of Strategic Trade Policy Cultural Motives Cultural Influence of the United States 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 Reasons for Export Quotas Voluntary Export Restraints Tariff-Quotas Embargoes Local Content Requirements Administrative Delays Currency Controls Global Trading System

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General Agreement on Tariffs and Trade (GATT) Uruguay Round of Negotiations Agreement on Services Agreement on Intellectual Property Agreement on Agricultural Subsidies World Trade Organization (WTO) Dispute Settlement in the WTO Dumping and the WTO Subsidies and the WTO Doha Round of Negotiations WTO and the Environment Bottom Line for Business

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 business-government trade relations, considers why nations erect barriers to trade, and explores the cultural, political, and economic motives for such barriers. It also examines the instruments countries use to restrict imports and exports, and how the global trading system promotes trade.

WHY DO GOVERNMENTS INTERVENE IN TRADE? Free trade is the pattern of imports and exports that would result in the absence of trade barriers. Governments impose restrictions on free trade for political, economic, and cultural reasons. A.

Political Motives 1. Protect Jobs Short of an unpopular war, nothing will oust a government faster than high unemployment. All governments become involved when trade threatens jobs at home. 2. Preserve National Security Industries essential to national security receive government-sponsored protection for both imports and exports. a. Imports Governments restrict imports to guarantee domestic supply, which preserves national security. Many countries fiercely protect their agricultural sector for national security reasons because a nation that imports its food supplies could face starvation in times of war. b. Exports Governments have national security motives for banning certain defense-related goods from export to other nations. Agencies

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review requests to export technologies or products that have dual uses—meaning they have both industrial and military applications. Respond to “Unfair” Trade Many argue that it makes no sense for one nation to allow free trade if others do not. Governments threaten to close their ports or to impose high tariffs if another nation does not concede on a certain trade issue. Gain Influence Governments of the largest nations may become involved in trade to gain influence over smaller nations. The United States wishes to maintain control over Central, North, and South America and the Caribbean basin.

Economic Motives 1. Protect Infant Industries The infant industry argument says that emerging industries need protection from international competition during development until they become competitive internationally. Protection can be removed after it gains the knowledge to become innovative, efficient, and competitive. a. Drawbacks Governments may make errors in distinguishing between industries worth protecting and those that are not. Protection can cause domestic firms to grow complacent toward innovation and limit their competitiveness and increase consumer prices. Small promising ventures today can get private funding. 2. Pursue Strategic Trade Policy New trade theorists believe government intervention helps firms take advantage of economies of scale and enjoy first-mover advantages. Firstmover advantages result because economies of scale limit the number of companies in an industry. a. Benefits Companies earn profits if they obtain first-mover advantages and solidified market positions. The chaebol helped companies survive poor economic times because of the wide range of industries in which they competed; policies had spin-off effects on industries such as transportation. b. Drawbacks Government assistance to domestic companies caused inefficiency and high costs for South Korean and Japanese companies in the late 1990s. Government support is subject to political lobbying and special-interest groups could capture gains with no benefit for consumers.

Cultural Motives Exposure to people and products of other countries slowly alters cultures. 1. Unwanted cultural influence causes great distress and can force governments to block imports. 2. Many countries have laws that protect their media programming for cultural reasons. 3. The United States is seen as a threat to national cultures because of its global strength in consumer goods, entertainment, and media.

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METHODS OF PROMOTING TRADE

Subsidies A subsidy is financial assistance to domestic producers in the form of cash payments, low-interest loans, tax breaks, product price supports, or some other form intended to help domestic companies fend off international competitors. 1. Drawbacks of Subsidies Some say subsidies cover costs that competitive industries should absorb, thus encouraging inefficiency and complacency. Because governments pay for subsidies with tax income, it is felt that subsidies benefit companies but harm consumers. Although subsidies provide short-term relief, the idea that subsidies are helpful in the long term is questionable.

Export Financing 1. Governments promote exports by helping companies finance their export activities through loans or loan guarantees. 2. Two agencies help U.S. companies to obtain export financing: ExportImport Bank and the Overseas Private Insurance Corporation (OPIC). OPIC insures against losses due to: (1) expropriation, (2) currency inconvertibility, and (3) war, revolution, and insurrection. 3. Financing is often crucial to small businesses just beginning to export. 4. Critics say subsidizing large multinational companies at taxpayer expense is corporate welfare.

Foreign Trade Zones 1. A foreign trade zone (FTZ) is a designated geographic region in which merchandise is allowed to pass through with lower customs duties (taxes) or fewer customs procedures. Goals are jobs and trade. 2. Customs duties increase production costs and the time it takes to get a product to market. Companies can reduce such costs and time by establishing a facility inside a foreign trade zone. 3. A common purpose of such zones is final product assembly. Lower customs duties are offset by the jobs created in the United States. 4. China established very large foreign trade zones to reap the benefits. 5. Mexico’s maquiladora zone: import materials from the United States without duties, process them, and re-export them to the United States, which charges duties only on the value added in Mexico.

Special Government Agencies 1. Governments have special agencies responsible for promoting exports. Such agencies organize trips for trade officials and businesspeople to visit other countries and open trade offices in other countries. 3. Governments not only promote exports but also may encourage imports. 4. Although finding out about government regulations in other countries can be daunting, information access is now easier on the Web.

METHODS OF RESTRICTING TRADE A.

Tariffs 1. A tariff is a government tax levied on a product as it enters or leaves a country: (1) export tariff, (2) transit tariff, and (3) import tariff.

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Types of Import Tariff: An ad valorem tariff is levied as a percentage of the stated price of an imported product. A specific tariff is levied as a specific fee for each unit (by number or weight) of an imported product. A compound tariff is calculated partly as a percentage of the stated price of an imported product, and partly as a specific fee for each unit. Protect Domestic Producers Because import tariffs raise the cost of an imported good, domestically produced goods appear more attractive to buyers. But protection may cause domestic producers to become lax in increasing efficiency. Generate Revenue Tariffs are a source of government revenue. Less-developed nations have less formal domestic economies that lack the capability to record domestic transactions accurately. Because this makes collection of sales taxes difficult, nations raise needed revenue through import and export tariffs. As countries develop, they generate a greater portion of their revenues from taxes on income, capital gains, and other economic activities. Tariffs exact a cost on countries because they lessen the gains from trade.

Quotas A quota is 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. Governments administer quota systems by granting quota licenses to other nations’ companies or governments (import quotas) and domestic producers (export quotas). 1. Reason for Import Quotas a. Protects domestic producers by placing a limit on the amount of goods entering the country. This helps domestic producers maintain market shares and prices by retraining competition. b. Domestic producers win because of market protection, but consumers lose because of higher prices and limited selection. Other losers include domestic producers whose production requires the import subjected to a quota; companies relying on imported intermediate goods find the final cost of their own products increase. 2. Reasons for Export Quotas a. A country may wish to maintain supplies in the home market. This is common for countries that export natural resources that are needed in the domestic market. b. A country may restrict supply on world markets to increase the international price. c. A voluntary export restraint (VER) is a unique version of export quota that a nation imposes on its exports, usually at the request of an importing nation. If domestic producers do not curtail production, consumers benefit from lower prices due to a greater supply. Export quotas hurt consumers in the importing nation because of reduced selection and higher prices. Export quotas might retain jobs if imports threaten to put domestic producers out of business. 3. Tariff-Quotas A tariff-quota is a lower tariff rate for a certain quantity of imports and a higher rate for quantities that exceed the quota (e.g., agricultural trade).

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Embargoes a. An embargo is a complete ban on trade (imports and exports) in one or more products with a particular country. It may be placed on one or a few goods or completely ban trade in all goods. It is the most restrictive nontariff trade barrier and often has political goals. b. Embargoes can be decreed by individual nations or by supranational organizations such as the UN.

Local Content Requirements a. Local content requirements are laws stipulating that producers in the domestic market must supply a specified amount of a good or service. Designed to force companies from other nations to employ local resources in their production processes—particularly labor. b. May help protect domestic producers from the price advantage of companies based in other, low-wage countries. Developing countries use them to boost industrialization.

Administrative Delays a. Administrative delays are regulatory controls or bureaucratic rules designed to impair the rapid flow of imports into a country. b. Can include government actions such as requiring international air carriers to land at inconvenient airports, requiring inspections that damage the product, understaffing customs offices to cause delays, and requiring special licenses that take time to obtain. c. Objective is protectionism.

Currency Controls a. Currency controls are restrictions on the convertibility of a currency into other currencies. b. Governments reduce imports by stipulating an exchange rate that is unfavorable to potential importers. Also can give exporters favorable rates to encourage exports.

GLOBAL TRADING SYSTEM World trade volume peaked in the late 1800s. U.S. Smoot-Hawley Act in 1930 shifted nation from free trade to protectionism. Smoot-Hawley, and the global trade wars it ushered in, crippled industrialized nations and helped spark the Great Depression. A.

General Agreement on Tariffs and Trade (GATT) The GATT was a 1947 treaty designed to promote free trade by reducing both tariff and nontariff barriers to international trade. Success in GATT’s early years began to wane in the 1980s. 1. Uruguay Round of Negotiations The Uruguay Round made significant progress in reducing trade barriers by revising and updating GATT. a. Services The General Agreement on Trade in Services (GATS) extended the principle of nondiscrimination to cover international trade in all services. The GATS identifies four forms of services.

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Cross-border supply: Services supplied from one country to another (e.g., international phone calls). • Consumption abroad: Consumers or companies using a service while in another country (e.g., tourism). • Commercial presence: Company’s subsidiary in another country provides a service (e.g., banking operations). • Presence of natural persons: Individuals traveling to another country to supply a service (e.g., business consultants). Intellectual Property i. Intellectual property refers to property that results from people’s intellectual talent and abilities and is legally protected by copyrights, patents, and trademarks. ii. Uruguay Round took a step toward getting intellectual property under control; it created the Agreement on Trade-Related Aspects of Intellectual Property (TRIPS) to standardize intellectual-property rules. Agricultural Subsidies i. Popular barriers to protect agricultural sectors include import quotas and subsidies paid to farmers. ii. Uruguay Round increased exposure of national agricultural sectors to market forces and increased predictability in international agricultural trade. iii. Forces countries to convert nontariff barriers to tariffs and calls for cutting of agricultural tariffs significantly.

World Trade Organization The World Trade Organization (WTO) is the international organization that regulates trade among nations. Three main goals of the WTO are to: (1) help free trade; (2) negotiate opening of markets; and (3) settle trade disputes. Key component of the WTO is normal trade relations: WTO members must extend the same favorable terms of trade to all members that they extend to any single members. WTO absorbs the GATT agreements into its own agreements. 1. Dispute Settlement in the WTO a. WTO’s power to settle trade disputes sets it apart from the GATT. WTO agreements are contracts among member nations that commit them to maintaining fair and open trade policies. b. When a member files a complaint, the Dispute Settlement Body of the WTO renders a decision in less than one year. Offenders must realign policies according to WTO guidelines or suffer financial penalties and perhaps trade sanctions. 2. Dumping and the WTO a. WTO gets involved in settling disputes that involve “dumping” and the granting of subsidies. Dumping occurs when a company exports a product at a price that is either lower than the price normally charged in its domestic market, or lower than the cost of production. b. Because dumping is an act by a company, not a country, the WTO cannot punish the country in which dumping is based. c. WTO allows a nation to retaliate against dumping if it proves dumping charges, calculates the damage, and can show the

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damage is significant. Nations retaliate by imposing an antidumping duty—an additional tariff placed on an imported product that a nation believes is being dumped on its market. Subsidies and the WTO a. Governments retaliate when the competitiveness is threatened by a subsidy that another country pays domestic producers. A countervailing duty is an additional tariff placed on an imported product that a nation believes is receiving an unfair subsidy. b. WTO regulates the actions of the government that reacts to the subsidy and the one that imposes the subsidy. New Round of Negotiations a. Negotiations began in Doha, Qatar, in late 2001. The new round was expected to bring particular benefits for developing nations. b. Negotiations in this round are ongoing but disappointingly slow. WTO and the Environment a. Rapid industrialization in many developing and emerging economies has generated environmental concerns among governments and special-interest groups. b. WTO has no separate agreement for environmental issues, but works with international agreements on the environment. c. But the WTO has a Committee on Trade and Environment to study the relationship between trade and the environment and to recommend changes in the WTO trade agreements. d. WTO also takes explicit positions on some environmental issues related to trade. It states that labeling requirements or policies cannot discriminate against the products of other WTO members. It also supports policies of the least-developed countries that require full disclosure of potentially hazardous products for reasons of public health and environmental damage.

BOTTOM LINE FOR BUSINESS Despite the theoretical benefits of trade, nations do not simply throw open their doors to free trade and force all their domestic businesses to sink or swim. This chapter has discussed reasons why national governments continue to protect all or some of their industries and how they go about it. The global trading system through the World Trade Organization tries to strike a balance between national desires for protection and international desires for free trade.

Quick Study Questions Quick Study 1 1.

Q: What are some political reasons why governments intervene in trade? Explain the role of national security concerns. A: (1) Practically every government restricts imports that threaten jobs in the domestic economy. (2) Governments restrict certain imports for national security reasons because the nation must have access to a domestic supply of certain items in the event of war. Agriculture is often protected for national security because a nation importing food could face starvation in war. (3) A government often threatens to restrict imports coming from a

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nation that restricts its own imports. (4) The largest nations may get involved in trade to gain influence over smaller nations. For example, Japan has influence among many Asian nations because they rely on Japan for a large amount of their imports and exports. (5) Nations restrict exports containing high technology and those with “dual uses.” They also restrict imports to protect domestic sources in case of war. 2.

Q: Identify the main economic motives for government trade intervention. What are the drawbacks of each method of intervention? A: One economic motive for a nation to intervene in trade is protection of young (infant) industries from competition. According to the infant industry argument, a country’s emerging industries need protection from international competition during their development phase until they become sufficiently internationally competitive. However, drawbacks of this policy include: (1) Governments may not identify industries worth protecting and those not to protect. (2) Protection from international competition can cause domestic companies to become complacent. (3) It can be political suicide to remove protection once it has been given. (4) Consumers can wind up paying more if domestic companies are protected and do not become highly competitive. (5) A main argument of this policy is that small businesses often cannot obtain financing is less true today than in the past. Another economic motive for intervention is pursuit of a strategic trade policy. The new trade theorists believe government intervention can help companies take advantage of economies of scale and be first movers in their industries. First-mover advantages result because economies of scale limit the number of companies that an industry can sustain. Supporters of strategic trade policy argue that strategic trade policies result in increased national income. However, drawbacks of this strategy are: (1) because it fosters inefficiencies and high costs, following a strategic trade policy can be very damaging to a nation’s economy in hard times; (2) those industries with the best political connections might benefit most from such a policy; and (3) strategic trade policies can spark destructive competition and even trade wars among nations.

Q: What cultural motives do nations have for intervening in free trade? A: The main cultural motive for government intervention in trade is protection of national identity. For example, France has laws that guarantee French artists a minimum amount of airtime on French radio programs and Canada is considering doing something similar. Governments also block imports of products they think might be harmful to the nation’s culture. They also restrict the importation of certain services such as media and entertainment in order to protect budding artists and others in these industries.

Quick Study 2 1.

Q: How do governments use subsidies to promote trade? Identify the drawbacks of subsidies. A: Governments employ the use of subsidies to assist domestic companies in fending off international competitors. One drawback of subsidies is that they can cause companies to become complacent about increasing efficiency and cutting costs. This can cause companies to overuse resources—an especially difficult problem in developing and emerging countries. Because subsidies are generally funded through tax revenues earned from sales and income taxes, critics charge that they amount to corporate welfare on behalf of consumers.

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Q: How does export financing promote trade? Explain its importance to small and medium-size firms. A: Export financing can help a nation increase exports. A government can offer its companies financing to expand their export activities—financing that they would otherwise be unable to obtain. Governments can also offer to guarantee the loans of its domestic companies that will use the money to expand their exports. Such loans and loan guarantees are often crucial to the export success of small and midsize companies because they often have a far greater need for cash than large, established exporters.

Q: Define the term foreign trade zone. How can it be used to promote trade? A: A foreign trade zone (FTZ) is a designated geographic region in which merchandise is allowed to pass through with lower customs duties (taxes) or fewer customs procedures. FTZs promote the most trade when they are established as low-cost assembly points for companies manufacturing products that will then be shipped out to other international markets. An example of an FTZ is the location of Japanese car plants in U.S. states that are administered by the U.S. Department of Commerce.

Q: How can special government agencies help promote trade? A: Special government agencies are often created for the purpose of promoting a nation’s exports. They organize trade missions to promising markets for the country’s products to generate contracts for new export business. They may have trade offices in other countries that are designed to promote the home country’s exports and introduce businesses to potential local partners. Such agencies can also identify products abroad that fulfill a current need in the home country.

Quick Study 3 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 quota is 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. An export tariff is levied by the government of an exporting country. A transit tariff is levied by the government of a country that a product passes through. An import tariff is levied by an importing government. The import tariff can be further subcategorized. (1) An ad valorem tariff is levied as a percentage of the stated price of an imported product. (2) A specific tariff is levied as a specific fee for each unit (by number or weight) of an imported product. (3) A compound tariff is calculated partly as a percentage of the stated price of an imported product, and partly as a specific fee for each unit. Quotas come in two forms: import quotas and export quotas. There is also a combined tariff-quota.

Q: Describe how a voluntary export restraint works and how it differs from a quota. A: A voluntary export restraint (VER) is a unique version of export quota that a nation imposes on its exports usually at the request of an importing nation. It differs from a typical quota because a country normally self-imposes a VER in response to a threat of an import quota or total ban on a product by an importing nation.

Q: What is an embargo? Explain why it is seldom used today.

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A: An embargo is a complete ban on trade (imports and exports) in one or more products with a particular country. It may be placed on one or a few goods or completely ban trade on all goods. Embargoes can be decreed by individual nations or by supranational organizations such as the United Nations. Embargoes are used less frequently today because they are difficult to enforce—some nations will always continue to trade with an embargoed nation. 4.

Q: Explain how local content requirements, administrative delays, and currency controls restrict trade. A: A local content requirement is a law that stipulates a specified amount of a good or service be supplied by producers in the domestic market. It’s designed to force foreign companies to employ local resources in production processes—particularly labor. Administrative delays are regulatory controls or bureaucratic rules designed to impair the flow of imports into a country. It can include a range of government actions such as requiring: international air carriers to land at inconvenient airports, product inspections that damage the product, understaffing customs offices to cause delays, and special licenses that take a long time to obtain. The central aim is protectionism. Currency controls are restrictions on the convertibility of a currency into other currencies. A country can restrict who is allowed to convert the home country currency into others or stipulate an exchange rate that is unfavorable to potential importers. It can be an effective tool for governments because conversion into one of several internationally acceptable currencies is often required for most trade deals.

Quick Study 4 1.

Q: What was the General Agreement on Tariffs and Trade (GATT)? List its main accomplishments. A: The GATT was designed to promote free trade by reducing both tariff and nontariff barriers to trade. The GATT was formed in 1947 and early success began to wane in the 1980s. Between 1947 and 1988, it helped to reduce average tariffs from 40 percent to 5 percent and multiply the volume of international trade by 20 times. But by the middle to late 1980s, rising nationalism worldwide and trade conflicts led to a nearly 50 percent increase in nontariff barriers to trade. Also, services (not covered by the original GATT) had become increasingly important—accounting for between 25 and 30 percent of total world trade. It was clear that a revision of the treaty was necessary, and in 1994 a new round of trade talks were concluded. A more recent round of talks begun in 2001 has been disappointing and appears deadlocked.

Q: What is the World Trade Organization (WTO)? Describe how the WTO settles trade disputes. A: The WTO is the international organization regulating trade among nations. WTO agreements are essentially contracts between member nations that commit them to maintaining fair and open trade policies. The Dispute Settlement Body goes to work as soon as a member nation files a complaint. The rulings of the Body cannot be ignored or blocked by members. Offenders must realign their trade policies according to WTO guidelines or suffer financial penalties and perhaps trade sanctions. Dumping occurs when a company exports its product at a lower price than it normally charges in its domestic market. The WTO cannot punish the country in which the company accused of dumping is based. The WTO can rule only on the retaliatory actions of other nations. The WTO allows a country to retaliate if it can show that dumping is actually occurring, calculate the damage to its own companies, and show that

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Q: Explain the difference between an antidumping duty and a countervailing duty. A: An antidumping duty is an additional tariff placed on an imported product that a nation believes is being dumped on its market. A countervailing duty is an additional tariff placed on an imported product that a nation believes is receiving an unfair subsidy.

Talk It Over 1.

Q: Most countries create a list of “hostile” countries that require special permission before an exporter will be allowed to proceed. Which countries and products would you place on such a list for your nation, and why? A: This question forces students to consider the inseparable link between trade and international relations among countries. Students should explain the historical reasons for the state of the relations and identify current events that are inflaming or subduing tensions. For each product they identify as one about which they are concerned, students should explain the reasons for their concern in the context of the cultural, political, and economic motives described in this chapter.

Q: Two students are discussing efforts within the global trading system to reduce trade’s negative effects on the environment. One student says, “Sure, there may be pollution effects, but they’re a small price to pay for a higher standard of living.” The other student agrees saying, “Yeah, those ‘tree-huggers’ are always exaggerating those effects anyway. Who cares if some little toad in the Amazon goes extinct? I sure don’t.” What counterarguments can you offer to these students? A: Students should support any counterargument with facts and data. They should realize that protection of the environment does come with a financial burden in terms of monitoring abidance by regulations, and added costs to companies that must install special pollution-control equipment. They must provide reasons for why environmental protection is worth these added costs, which will ultimately be passed on to consumers.

Teaming Up 1.

Q: Research Project. As a group, select a company in your city or town that is involved in importing or exporting, and interview the owner or a top manager. Your goal is to understand how government involvement in international trade has helped or harmed the company’s business activities. Prepare for your appointment by researching the topic of government trade intervention in a business periodical, in print or online, and follow up the interview with additional research. Ask for specific past examples and specific potential impacts of government intervention on the business. A: Students should be encouraged to find out as many specific examples as possible from their interview. They can also arrange to visit two or more companies to see how intervention can affect companies in different industries differently.

This item can be assigned as a Discussion Question in MyManagementLab. Student responses will vary. Q: Market Entry Strategy Project. This exercise corresponds to the

MESP online simulation. For the country your team is researching, to what extent does

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its government intervene in trade? What are its political, economic, or cultural motives for intervention? What methods, if any, does the government use to: (a) promote exports and (b) restrict imports? Does the nation maintain a free trade zone within its borders? Has the country filed a complaint with the WTO against another member nation? Has it been reported by another nation for unfair trade practices? Integrate your findings into your completed MESP report. A: This may be a good time to get students working on their Market Entry Strategy Project. This exercise gets students to learn more about a country, and to generate interest in countries other than their own. The project focuses on important aspects of each country and the process can begin to develop teamwork in the course. Take It to the Web We invite you to visit MyManagementLab.com, an innovative set of course-management tools for delivering all or part of your course online. MyManagementLab makes it easier for you to add meaningful assessment to your course. Whether you’re interested in testing your students’ recall of concepts and theories or in asking them to apply their new knowledge to real-world scenarios, MyManagementLab offers a variety of assessment questions to fit your needs. Ethical Challenges 1.

Q: You are a consultant advising the World Trade Organization (WTO) on the U.S. Supreme Court decision regarding the State of Massachusetts and the country of Myanmar. A nonprofit trade and industry group, the National Foreign Trade Council (NFTC), based in Washington, D.C., won a court battle recently against the State of Massachusetts. In a unanimous decision, the U.S. Supreme Court sided with the NFTC and struck down a Massachusetts law that was designed to deny state contracts to any company doing business in Myanmar. The Court ruled that the Massachusetts law intruded on the federal government’s authority and was preempted by federal law regarding Myanmar. In fact, the U.S. Constitution states that, “foreign policy is exclusively reserved for the federal government.” The NFTC says it shares concern over human rights abuses occurring in Myanmar, but believes that a coordinated, multinational effort would be most effective at instilling change in the nation. Do you think companies should be penalized in their domestic business dealings because of where they do business abroad? Should the World Trade Organization get involved in these types of political matters? Why or why not? How might domestic firms be affected if each state were allowed to punish firms based on its individual foreign policy ideals? A: Students will likely have strong opinions on this question because of the human rights issue. Probably the biggest problem with such a policy is the cost of monitoring the activities of companies around the world and making sure that deals are not just restructured so as to hide their involvement. Even then, companies could create holding companies in offshore locations that have strict secrecy laws so that home governments would be unable to find out whether they are dealing with countries having questionable human rights records. Finally, if the WTO were to involve itself in such political issues of nations, charges of political favoritism for powerful industrialized countries would likely increase.

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Practicing International Management Case Down with Dumping 1.

Q: “You can’t tell consumers that the low price they are paying on that video game console 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: Many people would agree with the sentiment expressed in this statement. The attitude would likely change dramatically, however, if the person were to suddenly find his or her own job threatened by a cheap import being dumped on the domestic market. People from individual-oriented cultures would probably be more likely to agree with the statement than would people from very group-oriented cultures. For example, many Japanese would probably disagree with the statement because they would see the dumping as a threat to many people in their nation with whom they are inextricably linked and with whom they feel obligated to assist if possible.

This item can be assigned as a Discussion Question in MyManagementLab. Student responses will vary. 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 task of investigating the actions of individual companies would no doubt overwhelm the resources of an organization the size of the WTO even. Investigating each company against which a complaint was brought would be very time consuming and expensive. Besides, the members of the WTO are not individual companies but the governments of nations in which companies are based. Also, if the WTO had authority to charge individual companies with offenses, charges of political favoritism would probably increase over that which already occurs at the governmental level. 3.

Q: Identify a recent antidumping case that was brought before the WTO. 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 favor of the measures taken by the retaliating nation? Why or why not? A: Students should probably be advised to stay with large countries and prominent cases so that enough information is available to complete the assignment. Students might also be asked to work in small groups so that they can do more in-depth analysis in an expedient manner. Presenting their findings in front of the class would also benefit students in the audience by exposing them to a wide array of cases and the reasoning of students rendering decisions on the cases.

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

CHAPTER OUTLINE: Introduction Patterns of Foreign Direct Investment Ups and Downs of FDI Globalization Mergers and Acquisitions Worldwide 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 and Foreign Direct Investment 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 Reasons for Intervention by the Home Country

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Government Policy Instruments and Foreign Direct Investment 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—the U.S. Commerce Department sets it at 10 percent.

PATTERNS OF FOREIGN DIRECT INVESTMENT A.

Ups and Downs of FDI FDI inflows grew around 30 percent through the 1990s. FDI peaked at $1.4 trillion in 2000, and then slowed. It rebounded in 2004, 2005, 2006, and reached an all-time high of more than $1.9 trillion in 2007. Slower growth again restricted FDI flows in 2008 and 2009. FDI climbed in 2010 and 2011 and are expected to increase slowly but steadily in coming years (see Figure 7.1). 1. Globalization a. Companies got around trade barriers in the 1980s through FDI. b. Uruguay Round of GATT further cut trade barriers, letting firms 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. b. Power of largest multinationals seems to multiply each year. c. 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

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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 49 percent, and developing countries account for about 45 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.

EXPLANATIONS FOR FOREIGN DIRECT INVESTMENT A.

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) 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 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

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make a location appealing for investment. When each advantage is present, a company will undertake FDI. 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. 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.

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 AND FOREIGN DIRECT INVESTMENT 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. 2. 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

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firm. The purchase of an existing business also may allow for alternative methods of financing, such as an exchange of stock ownership. Factors that reduce the appeal of purchasing existing facilities are obsolete equipment, poor labor relations, and an unsuitable location. 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. b. The components are brought together at one central location for assembly into the final product. c. 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.

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

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FDI decisions resemble a “follow the leader” scenario in industries with a limited number of large firms. 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.

GOVERNMENT INTERVENTION IN FOREIGN DIRECT INVESTMENT 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. A.

Balance of Payments 1. National accounting system that records all payments to entities in other countries and all receipts coming into the nation. 2. 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 7.1). 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. 4. 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. 5. Capital Account a. National account that records transactions involving the purchase or sale of assets. b. 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

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manufacturing facilities. This improves the competitiveness of local producers and boosts a host nation’s exports—improving its balance-of-payments position. 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 FOREIGN DIRECT INVESTMENT A.

Host Countries: Promotion 1. Financial Incentives a. Host governments commonly offer tax incentives or low-interest loans to attract investment. b. 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. 2. 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.

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.

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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.

Quick Study Questions Quick Study 1 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 FDI? 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 FDI. 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 49 percent of global FDI inflows and developing countries account for about 45 percent of global FDI inflows. For developing nations, China attracts the most FDI in Asia and India attracts the most on the subcontinent.

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Yes, the pattern is shifting as emerging markets attract an increasingly greater amount of worldwide FDI flows. Also, newly industrialized and emerging markets (particularly in Asia) are becoming a growing source of FDI. Quick Study 2 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.

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.

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Quick Study 3 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 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 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.

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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 plant 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. 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 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.

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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 offshoring service work to lower-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 automaker 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 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. 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.

Q: This chapter presented several theories that attempt to explain why firms undertake FDI. 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.

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Teaming Up 1.

Q: Research Project. In a small group, locate an article in the business press that discusses a cross-border merger or acquisition within the past year. Gather additional information on the deal from any sources available. What reasons did each company give for the merger or acquisition? Was it a marriage of equals or did a larger partner absorb a far smaller one? Do the articles identify any internal issues managers had to deal with following the merger or acquisition? What is the current performance of the new company? Write a two- to three-page report of your group’s findings. A: As with many projects that require outside research of articles in the business press, it is probably best to stick with companies that are fairly large and covered regularly in the media. This way, the students will have far less difficulty locating two or more articles covering the merger or acquisition.

This item can be assigned as a Discussion Question in MyManagementLab. Student responses will vary. Q: Market Entry Strategy Project. This exercise corresponds to the

MESP online simulation. For the country your team is researching, 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? Integrate your findings into your completed MESP report. A: This may be a good time to get students working on their Market Entry Strategy Project. This exercise gets students to learn more about a country, and to generate interest in countries other than their own. The project focuses on important aspects of each country and the process can begin to develop teamwork in the course. Take It to the Web We invite you to visit MyManagementLab.com, an innovative set of course-management tools for delivering all or part of your course online. MyManagementLab makes it easier for you to add meaningful assessment to your course. Whether you’re interested in testing your students’ recall of concepts and theories or in asking them to apply their new knowledge to real-world scenarios, MyManagementLab offers a variety of assessment questions to fit your needs. Ethical Challenges 1.

Q: You are a sales manager working in international sales for a major U.S. beef distributor. Your firm is attempting to sell a large quantity of beef to a developing market in northern Africa where U.S. beef is a rarity. The vice president for new business development has instructed you to sell the beef well below the market price quickly. Standing at the coffee machine, you overhear two quality assurance managers discussing “the potentially tainted beef heading for Africa.” You are aware that, in the past, your firm has come across small traces of typhoid in some of its products. What do you do? Do you go through with the northern Africa deal? Do you first contact someone inside or

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Q: You are the U.S. senator deciding whether to vote yes or no on a new piece of legislation. The potential new law places restrictions on the practice of outsourcing work to low-wage countries and is designed to protect U.S. workers’ jobs. These days it is increasingly common for companies to promise manufacturing contracts to overseas suppliers in exchange for entry into that country’s market. Labor union representatives argue that these kinds of deals are made at the expense of jobs at home. After all, if a company can have parts made in China at lower wages, why keep factories going at home? They also are concerned that the transfer of technology will breed strong competitors in other nations and thereby threaten even more domestic jobs in the future. But others argue that increased sales abroad actually help create more jobs at home. Discuss the ethics of companies contracting out production to factories abroad in exchange for sales contracts. How would you vote on the pending legislation? What other issues must you consider? A: Students approach this issue from a variety of perspectives ranging from a total freemarket ideology to a protectionist one. Students must balance the short-term gains of new business and greater profits against the short-term loss of jobs and potential long-term loss of creating future competitors. One key issue here is whether companies are transferring cutting-edge technologies or those that are a generation or more old. Students must also consider social issues of lost jobs due to manufacturing going abroad and the strong competitors arising from transferring technologies abroad.

Q: You are the U.S. Ambassador to Malaysia. In order to become a major export platform for the semiconductor industry, Malaysia’s government not only offered tax breaks but also guaranteed that electronics workers would be prohibited from organizing independent labor unions. The government decreed that the goal of national development required a “union-free” environment for the “pioneers” of semiconductors. Under pressure from U.S. labor unions, the Malaysian government offered a weak alternative to industry unions—company-by-company “in-house” unions. Yet as soon as workers organized one at a Harris Electronics plant, the 21 union leaders were fired and the new union disbanded. In another instance, when French-owned Thomson Electronics inherited a Malaysian factory with a union of 3,000, it closed the plant and moved the work to Vietnam. Newly industrialized nations such as Malaysia feel that their futures depend on investment by multinationals. Yet their governments are acutely aware that in the absence of incentives such as a “union-free” workforce, international companies can easily take their investment elsewhere. Discuss the problems that these governments face in balancing the needs of their citizens with the long-term quest for economic development. As the ambassador, what advice do you give Malaysian business and government leaders? Can you think of examples from other nations that can help you make the case for local unions?

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A: As ambassador, you must wear many hats. More trade with Malaysian firms would be a positive development for the United States. Because the United States tends to honor the rights of workers to unionize, Malaysian work standards must be acceptable to U.S. firms, especially because they are image conscious when operating abroad. Ethical issues include a fear of lost jobs, MNCs causing small firms to fail, worker exploitation, lost control over the domestic economy, and consumer and environmental protection. Most students will agree that MNCs should not have completely free rein in FDI activities. Perhaps phase policies in over time with individual governments retaining a say over the types of allowable FDI and their circumstances. An organization similar to the WTO for international trade could be created to monitor the FDI activity of nations. All nations industrialized by exploiting workers to some degree. European workers lived in squalid conditions, which laid the foundation for communist ideas. U.S. companies exploited new immigrants who could not form unions (slavery represented the nation’s most immoral practice). Thus, poor nations should not be viewed as immoral or unenlightened. Developing nations that allow or promote unions may see international companies invest elsewhere, where labor is abundant and unions nonexistent. Practicing International Management Case World Class in Dixieland 1.

Q: What do you think were the chief factors involved in Mercedes’ decision to undertake FDI in the United States rather than build the M-class in Germany? A: First, Mercedes undertook FDI to learn about the U.S. market. They needed to fully understand consumers to produce cars that they would want. Second, Mercedes chose the U.S. south over Germany because U.S. labor costs were lower. Third, Alabama offered attractive tax refunds and other incentives to gain jobs that the plant would create in and around Vance, Alabama. Fourth, the company chose the U.S. market to develop an ultramodern plant that would be a model for its future international facilities.

Q: Why do you think Mercedes decided to build the plant from the ground up in Alabama rather than buying an existing plant in, say, Detroit? List as many reasons as you can and explain your answers. A: First, Mercedes probably chose to build from the ground up because existing facilities would not supply the cutting-edge environment it wanted for its latest efforts in carmanufacturing technology, organizational design, and HRM techniques. Second, it probably chose Alabama because of the mix of economic factors, including low wages, a rural setting with a strong work ethic, and financial incentives. Third, it wanted to create a unique work setting and environment that reflected the firm’s values.

This item can be assigned as a Discussion Question in MyManagementLab. Student responses will vary. Q: Do you think Mercedes risks diluting its “Made in Germany”

reputation for engineering quality by building its M-class outside Germany? Why or why not? A: “Made in Germany” transcends individual products and applies to all products made in Germany that therefore incorporate German expertise in engineering. If Mercedes can successfully implement its effort in changing “Made in Germany” to “Made by Mercedes,” they will not dilute the value of its brand. However, in doing so, it will need

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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. 3. Describe regional integration in Europe and its pattern of enlargement. 4. Discuss regional integration in the Americas and analyze its future prospects. 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 EU European Parliament Council of the EU European Commission Court of Justice Court of Auditors European Free Trade Association (EFTA) Integration in the Americas North American Free Trade Agreement (NAFTA)

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Local Content Requirements and Rules of Origin Effects of NAFTA Expansion of NAFTA Central American Free Trade Area (CAFTA-DR) 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 (CER) Agreement 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. A.

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.

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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 among members. 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. 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. 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. 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 among 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 higher demand for goods because people have more money after a purchase to buy other products. 2. 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.

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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 such as 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 among 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. b. 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.

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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, Turkey, and the Former Yugoslav Republic of Macedonia. c. New members must meet the Copenhagen Criteria. Structure of the EU 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 EU 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. c. 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.

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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.

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 a. 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. b. 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. 2. Effects of NAFTA a. Trade among Canada, Mexico, and the United States has grown from $297 billion in 1993 to around $1.6 trillion.

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Ch 8: Regional Economic Integration Mexico’s exports to the United States rose to about $230 billion, and U.S. exports to Mexico grew to more than $163 billion. c. Canada’s exports to the United States more than doubled to approximately $277 billion, and U.S. exports to Canada grew to $248 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 AFLCIO group of unions debate NAFTA’s effect on jobs. Expansion of NAFTA a. Continued ambivalence about NAFTA delays its expansion. b. A boost would be if the U.S. Congress grants trade promotion authority to successive U.S. presidents. c. The Americas will experience further integration and North American economies could even adopt a single currency. b.

Central American Free Trade Agreement (CAFTA-DR) 1. Established in 2006 between the United States and Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, and the Dominican Republic. 2. CAFTA nations represent a U.S. export market larger than India, Indonesia, and Russia combined. And nearly 80 percent of exports from the Central American nations and the Dominican Republic already enter the United States tariff-free. 3. Central American nations have already cut average tariffs from 45 percent in 1985 to around 7 percent today. 4. Combined value of goods traded among the United States and the six CAFTA countries is around $32 billion. 5. Benefits to the United States: (1) lower tariff and nontariff barriers; (2) ensures U.S. companies are not disadvantaged by Central American nations’ trade agreements with other countries; (3) requires Central American nations and Dominican Republic to encourage competition and investment, protect intellectual property rights, and promote transparency and the rule of law; (4) supports U.S. national security interests by advancing regional integration, peace, and stability.

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. 3. But each member is given exceptions in the common tariff structure for 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.

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Southern Common Market (MERCOSUR) 1. MERCOSUR members: Argentina, Brazil, Paraguay, Uruguay, and 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. 3. May incorporate all of South America into a South American Free Trade Agreement and link up with NAFTA. 4. Different trade agendas, various macroeconomic policy frameworks, and economic problems of Argentina and Brazil hamper integration.

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. b. In 2000, CARICOM members called for the establishment of a single market, but the problem is that members trade more with nonmembers than with one another. 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.

INTEGRATION IN ASIA A.

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.

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3. 4.

Comprise more than 40 percent of world trade and a GDP of more than $19 trillion. Aims to strengthen the multilateral trading system and expand the global economy by simplifying and liberalizing trade and investment procedures. Hopes to have completely free trade and investment throughout the region by 2020. Record of APEC a. Succeeded in halving members’ tariff rates from an average of 15 to 7.5 percent. Less progress more recently. b. 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. c. Grants region-wide business visas without requiring multiple visas, and recommends regional recognition of national qualifications for professionals.

Closer Economic Relations (CER) Agreement 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 A.

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.

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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).

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 among nations and among existing trading blocs of nations.

Quick Study Questions Quick Study 1 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 among 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 among 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,

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Ch 8: Regional Economic Integration 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 economic and political systems. A political union requires member nations to accept a common stance on economic and political policies regarding nonmember nations.

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 whereas 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 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.

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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 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 EU 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.

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.

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Quick Study 3 1.

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

Q: What effect has NAFTA had on trade among its member nations? A: Trade among Canada, Mexico, and the United States has grown from $297 billion in 1993 to about $1.6 trillion. Mexico’s exports to the United States rose to $230 billion. Meanwhile, U.S. exports to Mexico grew to more than $163 billion. Canada’s exports to the United States more than doubled to around $277 billion, whereas U.S. exports to Canada grew to $248 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.

Q: List the main benefits the United States obtains from the Central American Free Trade Agreement. A: The agreement benefits the United States in several ways. CAFTA-DR aims to reduce tariff and nontariff barriers against U.S. exports to the region. It also ensures that U.S. companies are not disadvantaged by Central American nations’ trade agreements with Mexico, Canada, and other countries. The agreement also requires the Central American nations and the Dominican Republic to reform their legal and business environments to encourage competition and investment, protect intellectual property rights, and promote transparency and the rule of law. CAFTA-DR is also designed to support U.S. national security interests by advancing regional integration, peace, and stability.

Quick Study 4 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.

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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 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.

Q: What is the objective of the Free Trade Area of the Americas? What are its current prospects for success? 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.

Quick Study 5 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: 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.

Teaming Up 1.

Q: Debate Project. In this project, two groups of four students each will debate the merits of extending NAFTA to more advanced levels of economic (and political) integration. After the first student from each side has spoken, the second student will question the opponent’s arguments, looking for holes and inconsistencies. The third student will attempt to answer these arguments. A fourth student will present a summary of each side’s arguments. Finally, the class will vote to determine which team offered the more compelling argument. A: There would be many economic and political obstacles in expanding NAFTA to more advanced levels of integration and to include other countries. First, there is the problem of unequal levels of development of the three existing members’ economies. It will be

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quite a long time before Canada and the United States will allow Mexican workers to travel freely to their countries to find work. The disparity in wages between those countries and Mexico would literally cause a flood of workers to flee northward. Second, each subsequent country entering NAFTA would need to be given time and exceptions to ensure the smooth transitions of their economies. This would be a very long-term affair taking many years. Third, the problem that political integration faces is the fear among many countries that this would mean surrendering their national sovereignty to the United States—which through its enormous economic and political muscle could dictate what the bloc’s political position should be. One need only look at the difficulties facing political integration in the EU to see how problematic this can be. Not that it is impossible, but that it would take a very long time if it could ever be accomplished. At any rate, students should be prepared to defend their positions with conceptual information and facts from countries and companies affected by regional integration. 2.

This item can be assigned as a Discussion Question in MyManagementLab. Student responses will vary. Q: Market Entry Strategy Project. This exercise corresponds to the

MESP online simulation. For the country 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. Integrate your findings into your completed MESP report. A: This may be a good time to get students working on their Market Entry Strategy Project. This exercise gets students to learn more about a country, and to generate interest in countries other than their own. The project focuses on important aspects of each country and the process can begin to develop teamwork in the course. Take It to the Web We invite you to visit MyManagementLab.com, an innovative set of course-management tools for delivering all or part of your course online. MyManagementLab makes it easier for you to add meaningful assessment to your course. Whether you’re interested in testing your students’ recall of concepts and theories or in asking them to apply their new knowledge to real-world scenarios, MyManagementLab offers a variety of assessment questions to fit your needs. Ethical Challenges 1.

Q: You are a member of the United States Congress from the state of Florida. Many constituents in your district have complained that NAFTA and CAFTA-DR are unfair to their extended families living on the Caribbean islands. Some experts argue that the term “free trade agreement” is misleading. They say these agreements are really “preferential trade agreements” that offer free trade only to members and relative protection against nonmembers. You worry that this is the case for Caribbean nations excluded from NAFTA and CAFTA-DR. Some argue that from apparel factories in Jamaica to sugar cane fields in Trinidad, these trade agreements have cost jobs, market share, and income for the vulnerable island nations as jobs moved to Mexico. Given the impact on

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This item can be assigned as a Discussion Question in MyManagementLab. Student responses will vary. Q: You are a world-renowned economist hired by Ecuador’s

government to advise it on its current involvement with the Andean Community. The Andean Community is a customs union that consists of four nations in South America: Bolivia, Colombia, Ecuador, and Peru. Member nations are permitted free access to one another’s markets, with nonmember nations required to negotiate tariffs with community members. Because Ecuador recently adopted the U.S. dollar as its currency, some believe the other Andean members are perhaps holding Ecuador back from more rapid development. As the consultant, what pros and cons do you present to the Ecuadorian government for breaking free from the Andean Community? A: Ecuador is in a precarious position now that it has dollarized. On the positive side of the ledger, potential foreign investors will have less fear of currency devaluation with the U.S. dollar in place. The country’s relationship with the United States, a major trade partner, should also improve. Further, local real wages are bound to increase, which helps the work force. Negatives include the higher labor costs for employers, less autonomy in financial planning at the top government level, and an economy that is tied to U.S. economic decision making. Cultural issues, such as the historical significance of replacing a currency with that of a different nation, can also be explored. 3.

Q: You are the economic advisor to the President of Mexico. Labor unions and environmentalists in the United States aren’t the only ones speaking out against NAFTA. There continues to be opposition in Mexico by those complaining of a loss of national sovereignty and who feel that the income gap between the two countries will never be narrowed. Average hourly wages on the U.S. side of the border can be six times that on the Mexican side. Mexican critics fear that their entire country will be subsumed by companies from the United States that do not contribute to Mexico’s higher standard of living, but who instead use Mexico as a low-cost assembly site while keeping highpaying, high-skilled jobs at home. Do you think there is a way for trade agreements to help close the economic gap between poor and wealthy partners? Or will the interests of poorer nations always be subordinate to wealthier countries within regional trading blocs? As economic advisor, how do you suggest the president protect Mexico’s workforce? A: NAFTA has had many implications, some positive and some negative, for Mexico. Trade agreements can help poorer nations close the economic development gap (witness what the EU is doing—having wealthier EU nations provide poorer EU ones with funding for economic development projects). Only if poorer nations place themselves firmly on the path of economic development for the long term, will they be able to have power in promoting their interests. However, any nation that is subordinate to another

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will have difficulty getting its way on important matters unless it can hold the dominant nation hostage to something it badly desires that the subordinate possesses. Mexico must stay the course and continue with investment in potential high-growth sectors. Also, Mexico must now reconsider its position as a low-wage nation with the competition from China and other parts of Asia. Practicing International Management Case Global Trade Deficit in Food Safety 1.

Q: How do you think countries with a high volume of exports to the United States, such as Mexico, would respond to stricter food-safety rules? Do you think such measures are a good way to stem the tide of food-related illnesses? Why or why not? A: They will clearly be opposed to it. How would the U.S. government react if Mexico wanted to send its federal investigators around the United States to inspect its farming methods and safety systems? It would rightly say that the Mexican government is meddling in its domestic affairs. Education of farmers in the safe handling and shipping of agricultural products and closer inspections at U.S. borders would seem to be a better approach that would not smack of heavy-handedness and arrogance.

Q: Sue Doneth of Marshall, Michigan, is a mother of one of the schoolchildren who was exposed to the Hepatitis A virus after eating tainted frozen strawberry desserts. Speaking before Congress she said, “We are forcing consumers to trade the health and safety of their families for free trade. That is not fair trade. NAFTA is not a trade issue: it is a safety issue.” Do you think food-safety regulations should be built into an extension of NAFTA? Why or why not? What are the benefits and drawbacks of putting food-safety regulations into international trade pacts? A: It is probably not necessary to place food-safety regulations within the free trade agreement itself. Free trade means that goods can enter other member nations tariff-free, not inspection free. All that governments need to do is enforce the food-safety regulations on the books, or pass more stringent ones if current ones are unacceptable. It would be a far better approach than exploiting food contamination for political purposes.

This item can be assigned as a Discussion Question in MyManagementLab. Student responses will vary. Q: The lack of harmonized food-safety practices and standards is just

one of the challenges faced by the food industry as it becomes more global. What other challenges face the food industry in an era of economic integration and opening markets? A: Perhaps the most important issue is whether relatively less efficient farmers will be able to compete with the large farming operations existing in developed nations. Throwing the doors to trade wide open without protection for small family-operated farms can spell disaster for the rural farming communities of relatively less developed countries.

CHAPTER 9 INTERNATIONAL FINANCIAL MARKETS 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. Explain how currencies are quoted and the different rates that are given. 5. Identify the main instruments and institutions of the foreign exchange market. 6. 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 Direct and Indirect Rate Quotes Cross Rates Spot Rates

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Buy and Sell Rates Forward Rates Forward Contracts Swaps, Options, and Futures Currency Swaps Currency Options Currency Futures Contracts Foreign Exchange Market Today Trading Centers Important Currencies Institutions of the Foreign Exchange Market Interbank Market Clearing Mechanisms Securities Exchanges Over-the-Counter Market Currency Convertibility Goals of Currency Restriction Policies for Restricting Currencies Countertrade Bottom Line for Business Appendix: Calculating Percent Change

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. 1. 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.

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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.

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. Deregulation Increases competition, lowers cost of financial transactions, and opens many national markets to global investing and borrowing. Yet greater

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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 certain regulatory requirements and disclose details about company activities, owners, and upper management. 2. 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.

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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. c. 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.

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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.

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.

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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. 3. Currency Arbitrage 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. a. Interest arbitrage is the profit-motivated purchase and sale of 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 A.

Quoting Currencies Two components to every quoted exchange rate: the quoted currency and the base currency. In (¥/$), the yen is the quoted currency, the dollar is the base currency. The quoted currency is always the numerator, and the base currency is always the denominator. 1. Direct and Indirect Rate Quotes a. In ¥ 90/$, the yen is the quoted currency; this is called a direct quote on the yen and an indirect quote on the dollar. b. In $0.0111/¥, the dollar is the quoted currency; this is called a direct quote on the dollar and an indirect quote on the yen. c. This formula derives a direct quote from an indirect quote: Direct Quote = ____1_____ Indirect Quote

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Ch 9: International Financial Markets And, for deriving an indirect quote from a direct quote, use: Indirect Quote = ____1____ Direct Quote 2.

Cross Rates 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 Rates 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 Rates 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. 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. 3. 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.

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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. A.

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.

Institutions of the Foreign Exchange Market 1. Interbank Market Market where the world’s largest banks exchange currencies at spot and forward rates. Banks act as agents for clients and turn to foreign exchange brokers, who can obtain seldom traded currencies. a. Clearing mechanisms aggregate currencies that one bank owes another and then carry out that transaction. b. Today, clearing is a mostly digital, computerized affair, whereas in the past it meant physically delivering currencies from one bank to another. 2. Securities Exchanges Specialize in currency futures and options transactions. Securities brokers facilitate currency transactions on securities exchanges. Transactions on securities exchanges are much smaller than those in the interbank market and vary with each currency. 3. 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. A.

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.

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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 a. The exchange of goods or services between two parties without the use of money. International companies can circumvent currency convertibility restrictions and yet conduct business.

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.

APPENDIX: Calculating Percent Change 1. Exchange rate risk can jeopardize profits from current and future international transactions. Managers minimize this risk by tracking percent changes in exchange rates. 2. Take Pn as the exchange rate at the end of a period (a currency’s new price), and Po as the exchange rate at the beginning of that period (a currency’s old price). Percent change in the value of the currency is calculated with the following formula: Percent change (%) = Pn - Po x 100 Po 3.

Suppose on February 1, the exchange rate between the Norwegian krone (NOK) and the U.S. dollar was NOK 5/$. On March 1, the exchange rate stood at NOK 4/$. What is the change in the value of the base currency—the dollar? Percent change (%) = 4 - 5 x 100 = –20% 5

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Quick Study Questions Quick Study 1 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. 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 has been accomplished through securitization—unbundling and repackaging hard-to-trade financial assets into more liquid, negotiable, and marketable securities.

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 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

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Ch 9: International Financial Markets 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 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.

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. It is common among experienced foreign

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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 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? Explain how it is useful to businesses. 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 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.

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 specified amount of a currency on a specified date at a specified rate. A currency futures contract is a contract requiring the exchange of a specified amount of currency on a specified date at a specified exchange rate, with all conditions fixed and not adjustable.

Quick Study 4 1.

Q: What are the world’s main foreign exchange trading centers? Identify the currencies most used in the foreign exchange market. A: The world’s main foreign exchange trading centers are located in the United Kingdom (London), the United States (New York), and Japan (Tokyo)—together accounting for slightly more than one-half of all global currency trading. London dominates the foreign exchange market for historic and geographic reasons. The U.S. dollar, the British pound, the Japanese yen, and the European euro are the currencies most used in the foreign exchange market.

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Ch 9: International Financial Markets A: The interbank market is a market in which the world’s largest banks exchange currencies at spot and forward rates. Banks act as agents for client companies and can provide many services in addition to currency conversion. A securities exchange is an exchange that specializes in currency futures and options transactions. Buying and selling currencies on securities exchanges entails the use of securities brokers, who facilitate transactions by transmitting and executing clients’ orders. Transactions on securities exchanges are much smaller than those in the interbank market and vary with each currency. The over-the-counter market is an exchange consisting of a global computer network of foreign exchange traders and other market participants, but with no central trading location. The major players in the OTC market are large financial institutions and investment banks.

Q: What are the reasons for restrictions on currency conversion? Identify policies governments use to restrict currency conversion. A: Reasons nations restrict currency conversion: 1. Preserve a country’s reserve of hard currencies with which to repay debts owned to other nations. 2. Preserve hard currencies to pay for imports and finance trade deficits. 3. Protect a currency from speculators. 4. Keep resident individuals and businesses from investing in other nations. Policies nations use to restrict currency conversion: 1. Require all foreign exchange transactions to go through the nation’s central bank. 2. Require importers to obtain import licenses—allowing governments to control the amount of foreign currency leaving the country. 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.

Talk It Over 1.

This item can be assigned as a Discussion Question in MyManagementLab. Student responses will vary. 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.

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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.

This item can be assigned as a Discussion Question in MyManagementLab. Student responses will vary. 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. 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. Teaming Up 1.

Q: Research Project. Form a team with several of your classmates. Suppose you work for a firm that has $10 million in excess cash to invest for one month. Your group’s task is to invest this money in the foreign exchange market to earn a profit—holding dollars is not an option. Select the currencies you wish to buy at today’s spot rate, but do not buy less than $2.5 million of any single currency. Track the spot rate for each of your currencies over the next month in the business press. On the last day of the month, exchange your currencies at the day’s spot rate. Calculate your team’s gain or loss over the one-month period. (Your instructor will determine whether, and how often, currencies may be traded throughout the month.) A: This project is excellent for instructors who want their students to acquire a better grasp of the foreign exchange market and the reasons for currency fluctuations. Students should be asked to research each of the currencies they purchase and pass these reasons on to the instructor at the time of their initial purchase. Students should also follow the business press to learn the reasons for daily fluctuations in the value of each currency.

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This item can be assigned as a Discussion Question in MyManagementLab. Student responses will vary. Q: Market Entry Strategy Project. This exercise corresponds to the

MESP online simulation. For the country your team is researching, does it have a city that is an important financial center? What volume of bonds is traded on the country’s bond market? How has its stock market 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 in 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? Integrate your findings into your completed MESP report. (Hint: Good sources are the monthly International Financial Statistics and the annual Exchange Arrangements and Exchange Restrictions, both published by the IMF.) A: This may be a good time to get students working on their Market Entry Strategy Project. This exercise gets students to learn more about a country, and to generate interest in countries other than their own. The project focuses on important aspects of each country and the process can begin to develop teamwork in the course. Take It to the Web We invite you to visit MyManagementLab.com, an innovative set of course-management tools for delivering all or part of your course online. MyManagementLab makes it easier for you to add meaningful assessment to your course. Whether you’re interested in testing your students’ recall of concepts and theories or in asking them to apply their new knowledge to real-world scenarios, MyManagementLab offers a variety of assessment questions to fit your needs. Ethical Challenges 1.

Q: You are a U.S. senator serving on a subcommittee with the task of developing new regulations for U.S. firms doing business through offshore financial centers (OFCs). Bank deposits in offshore financial centers grew from the tens of billions of dollars a few decades ago to more than $1 trillion today. “Dirty money” obtained through drug trafficking, gambling, and other illicit activities use offshore financial centers to escape the same thing as respectable “clean capital”—national taxation and government regulations. Some experts argue that institutions such as international currency markets and offshore tax havens reduce stability and are hostile to the public interest. They say people use such institutions to get beyond the reach of the law and undermine what they consider to be inefficient and bureaucratic attempts to impose a certain morality on people. As senator, what type of regulations do you support? What rationale do you give business leaders in your constituency who do business with OFCs? Do you think corporate use of OFCs to avoid home-country bureaucracies and taxes is ethical? Why or why not? A: This is a good opportunity to discuss extraterritoriality. On the one hand, should the U.S. government have the right to control and legislate U.S. business activity abroad? And on the other hand, should U.S. firms be allowed to exploit a loophole and avoid paying their fair share of taxes? Students supporting the use of an OFC to avoid taxation in national markets must explain why it is okay for some (usually large) companies to evade national taxation but not others (usually small companies with fewer resources).

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They must also justify letting a company using an OFC off the hook in terms of contributing to the national infrastructure, health care, education, and general welfare of the people of that nation. Students supporting a clampdown on the OFC system must explain why it is unethical to use an OFC to shelter income and avoid regulations. 2.

Q: You are a member of the board of directors for one of the nation’s largest banks. Although recent banking deregulation is fostering greater competition in the industry, you are concerned about the direction in which banking is headed. The top management team of your bank is to meet soon with government officials to discuss the situation. The goal of government regulation of financial-services industries is to maintain the integrity and stability of financial systems, thereby protecting both depositors and investors. Regulations include prohibitions against insider trading, against lending by management to itself or to closely related entities (a practice called “self-dealing”), and against other transactions in which there is a conflict of interest. Yet in less than two decades, deregulation has transformed the world’s financial markets. It spurred competition and growth in financial sectors and allowed capital to flow freely across borders, which boosted the economies of developing countries. What advice do you give your bank’s executives prior to meeting with the government? What do you see as the “dark side” of deregulation, in terms of business ethics? What do you think Adam Smith, one of the first philosophers of capitalism, meant when he warned against the dangers of “colluding producers”? Do you think this warning applies to the financial-services sector today? A: The dark side of deregulation is the potential for the occurrence of those very things that are mentioned in the question itself. However, deregulation does not mean the total dismantling of all regulations, but a reduction in those that are overly burdensome and that create market inefficiencies. Countries retain the most important regulatory aspects of their legal systems and continue to support their agencies responsible for oversight of financial services industries. The “colluding producers” argument may apply today to the recent surge in merger and acquisition activity. However, as long as regulators scrutinize proposed mergers and acquisitions for anticompetitive consequences, it is likely that the trend toward greater concentration will continue in many industries.

Practicing International Management Case Should We Cry for Argentina? 1.

Q: Update the economic situation in Argentina to reflect recent events. How is the value of the peso faring? Do you think it was wise to cut the ties between the peso and the dollar? Why did Argentina peg its currency to the dollar in the first place? Do you think that the link between the peso and dollar contributed to Argentina’s problems? Explain. A: Students can consult business and financial Web sites to update the situation and get background information on the peso’s link to the dollar. The peso–dollar link contributed to Argentina’s problems. For 10 years the Argentine peso was fixed at parity to the dollar through a currency board. Argentina initially pegged the peso to the dollar to reduce inflation. Early on, the currency board worked and stabilized the peso and eliminated the inflation problem. But the peg caused problems after Brazil devalued its currency, raising the relative price of Argentina’s goods on global markets.

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Q: How did local and international companies adapt to the business environment at the height of Argentina’s crisis? Did they pursue similar courses of action or design distinct strategies to deal with its effects? Be specific in your answer and give examples. A: The Argentine units of U.S. companies, which collect revenues in pesos, had a difficult time repaying dollar-denominated debts as the peso’s value fell. Parent firms did not rescue their ailing subsidiaries in Argentina because most were independent entities. AES Corp. of Arlington, VA reported that most of its Argentine businesses were in default on their project-financing arrangements but that AES was not required to support the potential cash flow or debt service obligations of the businesses. Local companies blamed their defaults on the need to get authorization from the central bank to send money abroad. Stiff restrictions on foreign-currency exchange forced importers to wait several months or more while the government authorized payments in dollars. Companies also struggled with new rules that raised taxes on exporters and other cash-rich firms to help the government pay for social services. Local firms also had a hard time obtaining funds to pay their debts to foreign suppliers. (Students could be asked to research the experiences of several Argentine companies to learn how they endured the economic crisis, loss of markets abroad, and so on.)

Q: What was the impact on ordinary citizens immediately after the default and later as the economy recovered? What do the aftereffects of the crisis mean long term for ordinary citizens’ spending power? What has it done to the value of their savings? In your opinion, has international aid helped or hurt the ordinary people of Argentina? Explain your answer. A: Strapped for cash, the government seized the savings accounts of its citizens and restricted how much they could withdraw at a time. When street protesters turned violent, they beat up several politicians and attacked dozens of banks. Many citizens have lost everything because of the value of the currency and chose to leave Argentina. For example, the World Jewish Congress financially assisted Argentine Jews to relocate to Israel. Students should locate recent articles in the business press for reports on how international aid is perceived by the Argentines themselves (paying attention to the people’s differing economic status) and the international community. There will no doubt be disparity in their views.

CHAPTER 10 INTERNATIONAL MONETARY SYSTEM LEARNING OBJECTIVES: 1. Explain how exchange rates influence the activities of domestic and international companies. 2. Identify the factors that help determine exchange rates and their impact on business. 3. Describe the primary methods of forecasting exchange rates. 4. Discuss the evolution of the current international monetary system and explain how it operates.

CHAPTER OUTLINE: Introduction How Exchange Rates Influence Business Activities Desire for Stability and Predictability What Factors Determine Exchange Rates? Law of One Price McCurrency Purchasing Power Parity Role of Inflation Impact of Money-Supply Decisions Impact of Unemployment and Interest Rates How Exchange Rates Adjust to Inflation Role of Interest Rates Fisher Effect Evaluating PPP Impact of Added Costs Impact of Trade Barriers Impact of Business Confidence and Psychology Forecasting Exchange Rates Efficient Market View Inefficient Market View Forecasting Techniques Fundamental Analysis Technical Analysis Difficulties of Forecasting Evolution of the International Monetary System Early Years: The Gold Standard Par Value Advantages of the Gold Standard Collapse of the Gold Standard Bretton Woods Agreement Fixed Exchange Rates Built-In Flexibility World Bank International Monetary Fund Special Drawing Right (SDR) Collapse of the Bretton Woods Agreement

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Smithsonian Agreement Final Days A Managed Float System Emerges Jamaica Agreement Later Accords Today’s Exchange-Rate Arrangements Pegged Exchange-Rate Arrangement Currency Board European Monetary System How the System Worked Recent Financial Crises Developing Nations’ Debt Crisis Mexico’s Peso Crisis Southeast Asia’s Currency Crisis Russia’s Ruble Crisis Argentina’s Peso Crisis Future of the International Monetary System Bottom Line for Business

A comprehensive set of specially designed PowerPoint slides is available for use with Chapter 10. 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 factors that determine exchange rates and various international attempts to manage them. It also presents different methods of forecasting exchange rates, and the functioning of the international monetary system.

HOW EXCHANGE RATES INFLUENCE BUSINESS ACTIVITIES Exchange rates affect demand for products. When a country’s currency is weak, the price of its exports declines, making the exports more appealing on world markets. Devaluation is the intentional lowering of the value of a currency by the nation’s government. Gives domestic producers an edge on world markets, but also reduces citizens’ buying power. Revaluation is the intentional raising of the value of a nation’s currency. Increases the price of exports and reduces the price of imports. Exchange rates affect profits earned abroad when repatriated by the parent company into the home currency. Translating subsidiary earnings from a weak host country currency into a strong home currency reduces earnings, and vice versa. A.

Desire for Stability and Predictability 1. Stability makes for accurate financial planning and cash flow forecasts. 2. Predictability reduces odds that a company will be caught off-guard by unexpected rate changes. Reduces the need for costly insurance (currency hedging) against possible adverse exchange rates.

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WHAT FACTORS DETERMINE EXCHANGE RATES? To understand what determines rates, must know: (1) the law of one price and (2) purchasing power parity. Each tells the level at which an exchange rate should be. A.

Law of One Price 1. Exchange rates do not guarantee or stabilize the buying power of a currency; purchasing power fluctuates. 2. Law of one price says an identical product must have an identical price in all countries when expressed in the same currency. Product must be identical in quality or content and be entirely produced within each country. 3. If price were not identical in each country, an arbitrage opportunity would arise. Traders would buy in the low-priced market and sell in the high-priced market; buying drives up the price in one market and drives down the price in the other. 4. The Economist publishes its “Big Mac Index” using the law of one price to determine the exchange rate between the U.S. dollar and other currencies. Fair predictor of the “direction” rates should move.

Purchasing Power Parity PPP is the relative ability of two countries’ currencies to buy the same “basket” of goods in those two countries. Tells how much of currency “A” a person in nation “A” needs to buy the same amount of products that someone in nation “B” can buy with currency “B.” • Considers price levels in adjusting the relative values of the two currencies. • Economic forces will push a market exchange rate toward that calculated by PPP or an arbitrage opportunity arises. • Holds for internationally traded products not restricted by trade barriers and entailing few or no transportation costs. 1. Role of Inflation Inflation erodes purchasing power. If money is injected into an economy not producing greater output, a greater amount of money is spent on a static amount of products. Demand soon outstrips supply and prices rise. a. Impact of Money-Supply Decisions i. Governments manage the supply of and demand for currency with policies that influence the money supply. ii. Monetary policy refers to activities that directly affect a nation’s interest rates or money supply. Governments buy or sell government securities on the open market to influence the money supply. iii. Fiscal policy involves using taxes and government spending to influence the money supply indirectly. Governments can increase or lower taxes, or increase or decrease government spending. b. Impact of Unemployment and Interest Rates i. Threat of a company moving abroad for lower wages holds down wages at home. Companies then need not raise prices to pay higher wages, lowering inflationary pressures.

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Low unemployment puts upward pressure on wages. To maintain profit margins with higher labor costs, producers pass the cost of higher wages on to consumers in higher prices, causing inflationary pressure. iii. Low interest rates encourage consumers and businesses to borrow and spend, causing inflationary pressure. c. How Exchange Rates Adjust to Inflation i. Exchange rates adjust to different rates of inflation across countries, which is necessary to maintain purchasing power parity between nations. ii. For example, if inflation in Mexico is higher than in the United States, the exchange rate adjusts to reflect that a dollar will buy more pesos due to higher inflation in Mexico. iii. U.S. goods become more expensive for Mexican firms, and Mexican goods become cheaper for U.S. companies. Role of Interest Rates The interest rate a bank quotes a borrower is the nominal interest rate. a. Fisher Effect i. The Fisher effect is the principle that the nominal interest rate is the sum of the real interest rate and the expected rate of inflation over a specific period. ii. The real rate of interest should be the same in all countries because of arbitrage. iii. The international Fisher effect is the principle that a difference in nominal interest rates supported by two countries’ currencies will cause an equal but opposite change in their spot exchange rates. iv. Because real interest rates are theoretically equal across countries, any difference in interest rates in two countries is due to inflation. Evaluating PPP PPP is better at predicting long-term exchange rates than short-term rates. Short-term forecasts, however, are most beneficial to managers. a. Impact of Added Costs PPP assumes no transportation costs, and thus overstates the threat of arbitrage. The presence of transport costs can allow unequal prices between markets to persist, causing PPP to fail. b. Impact of Trade Barriers PPP assumes no trade barriers. But a high tariff or outright ban on a product can impair price leveling, causing PPP to fail to predict exchange rates accurately. c. Impact of Business Confidence and Psychology PPP overlooks business confidence and human psychology. Yet nations try to maintain confidence of investors, businesspeople, and consumers in their economies and currencies.

FORECASTING EXCHANGE RATES A.

Efficient Market View

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In an efficient market, prices of financial instruments quickly reflect new public information made available to traders. The efficient market view says prices of financial instruments reflect all publicly available information at any given time. Forward exchange rates are accurate forecasts of future rates, and reflect market expectations about the future values of two currencies. Forward exchange rates are the best possible predictors of exchange rates and worthless to seek out information that may affect future rates.

Inefficient Market View 1. The inefficient market view says prices of financial instruments do not reflect all publicly available information. Proponents believe that companies can search for information to improve forecasting. 2. This view is more compelling considering private information (e.g., if a currency trader holds privileged information, the trader can act on this information to make a profit).

Forecasting Techniques 1. Fundamental Analysis Fundamental analysis employs statistical models based on fundamental economic indicators to forecast exchange rates. Economic variables in these models include inflation, interest rates, the money supply, tax rates, government spending, the nation’s balance-of-payments situation, and government intervention in foreign exchange markets. 2. Technical Analysis Technical analysis employs past trends in currency prices and other factors to forecast exchange rates. Using statistical models and past data trends, analysts estimate the conditions prevailing during changes in exchange rates and estimate the timing, magnitude, and direction of future changes.

Difficulties of Forecasting Beyond problems with data used, failings can be traced to human error (e.g., people might miscalculate the importance of certain economic events, placing too much emphasis on some elements and ignoring others).

EVOLUTION OF THE INTERNATIONAL MONETARY SYSTEM A.

Early Years: The Gold Standard Gold was internationally accepted for paying for goods and services. Pros: its limited supply caused high demand and it can be traded, stored, and melted into coins or bars making a good medium of exchange. Cons: its weight made transport expensive, and if a ship sank, the gold was lost. Gold standard was an international monetary system in which nations linked the value of their paper currencies to a specific value of gold. The gold standard operated from the early 1700s until 1939. 1. Par Value a. The value of a currency expressed in terms of gold. All nations fixing their currencies to gold also indirectly linked their currencies to one another. Thus, the gold standard was a fixed exchange rate system—one in which the exchange rate for

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converting one currency into another is fixed by international governmental agreement. b. The U.S. dollar was fixed at $20.67/oz of gold, the British pound at £4.2474/oz.; exchange rate was $4.87/£ ($20.67 ÷ £4.2474). Advantages of the Gold Standard a. Reduced the risk in exchange rates because it locked exchange rates between currencies. Fixed exchange rates reduced the risks and costs of trade and grew as a result. b. Imposed strict monetary policies that required nations to convert paper currency into gold if demanded by holders of the currency. This forced nations to keep adequate gold reserves on hand. A nation could not let paper currency grow faster than the value of its gold reserves, which controlled inflation. c. Helped correct a nation’s trade imbalance. i. If a nation imports more than it exports, gold flowed out to pay for imports. The government must decrease the supply of paper currency in the domestic economy because it could not have paper currency in excess of gold reserves. As the money supply falls, so do prices of goods and services because fewer dollars are chasing the same supply of goods and services. Falling prices make its exports cheaper on world markets and exports rise until the nation’s international trade is in balance. ii. In the case of a trade surplus, the inflow of gold supports an increase in the supply of paper currency. This increases the demand for and cost of goods and services; exports fall in reaction to their higher prices until trade is in balance. Collapse of the Gold Standard a. Gold standard was violated when nations in the First World War financed the war by printing paper currency. This caused rapid inflation and caused nations to abandon the gold standard. b. Britain returned to the gold standard in the early 1930s at the same par value that existed before the war. The United States returned to the gold standard at a new, lower par value that reflected the inflation of previous years. c. The U.S. decision in 1934 to devalue its currency and Britain’s decision not to do so lowered the price of U.S. exports and increased the price of British goods imported. It now took $8.24 to buy a pound ($35.00 ÷ £4.2474). d. Countries retaliated against one another through “competitive devaluations” to improve their own trade balances. Faith in the gold standard vanished, as it was no longer an accurate indicator of a currency’s true value.

Bretton Woods Agreement 1944 accord among nations to create a new international monetary system based on the value of the U.S. dollar. Designed to balance strict discipline of the gold standard with flexibility to manage temporary domestic monetary difficulties. 1. Fixed Exchange Rates

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Incorporated fixed exchange rates by tying the value of the U.S. dollar directly to gold, and the value of other currencies to the value of the dollar. b. Fixed U.S. dollar par value at $35/oz of gold; other currencies had par values against the U.S. dollar, not gold. c. Members were to keep their currencies from deviating more than 1.0 percent above or below their par values. Extended the right to exchange gold for dollars only to national governments. Built-In Flexibility a. Allowed devaluation only in extreme circumstances called fundamental disequilibrium—when a trade deficit causes a permanent negative shift in the balance of payments. b. Devaluation in such situations was to reflect a permanent economic change in a country, not temporary misalignments. World Bank Created the World Bank (IBRD) to fund national economic development. a. World Bank’s immediate purpose was to finance European reconstruction after the Second World War. It later shifted its focus to the general financial needs of developing countries. b. World Bank finances economic development projects in Africa, South America, and Southeast Asia, and offers funds to countries unable to obtain capital for projects considered too risky. It often undertakes projects to develop transportation networks, power facilities, and agricultural and educational programs. International Monetary Fund IMF was created to regulate fixed exchange rates and enforce the rules of the international monetary system. Purposes of the IMF are to: a. Promote international monetary cooperation. b. Facilitate expansion and balanced growth of international trade. c. Promote exchange stability with orderly exchange arrangements, and avoid competitive exchange devaluation. d. Make resources temporarily available to members. e. Shorten the duration and lessen the degree of disequilibrium in the international balance of payments of member nations. Collapse of the Bretton Woods Agreement Bretton Woods faltered in the 1960s because of U.S. trade and budget deficits. Nations holding U.S. dollars doubted the U.S. government had gold reserves to redeem all its currency held outside the United States. Demand for gold in exchange for dollars caused a large global sell-off of dollars. a. Smithsonian Agreement In 1971, the U.S. government held less than one-fourth of the amount of gold needed to redeem all U.S. dollars in circulation. The Smithsonian Agreement was to restructure and strengthen the international monetary system: (1) lowered the value of the dollar in terms of gold to $38/oz. of gold, (2) required that other countries increase the value of their currencies against the dollar, and (3) increased the 1 percent floatation band to 2.25 percent. b. Final Days Many nations abandoned the system in 1972 and 1973, and currency values floated freely against the dollar.

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A Managed Float System Emerges The new system of floating exchange rates was to be a temporary solution. Instead of the emergence of a new international monetary system, there emerged several efforts to manage exchange rates. 1. Jamaica Agreement IMF accord (1976) formalized the present system of floating exchange rates. Three main provisions included: (1) endorsement of a managed float system of exchange rates; (2) elimination of gold as the primary reserve asset of the IMF; and (3) expansion of the IMF to act as a “lender of last resort” for nations with balance-of-payments difficulties. 2. Later Accords Between 1980 and 1985 the U.S. dollar rose against other currencies, pushing up prices of U.S. exports and adding to a U.S. trade deficit. a. The Plaza Accord (1985) was an agreement among the largest industrialized economies known as the G5 (Britain, France, Germany, Japan, and the United States) to act together in forcing down the value of the U.S. dollar. b. The Louvre Accord (1987) was an agreement among the G7 nations (the G5 plus Italy and Canada) that affirmed the dollar was appropriately valued and that they would intervene in currency markets to maintain its current market value.

Today’s Exchange-Rate Arrangements Remains a managed float system, but some nations maintain more stable exchange rates by tying their currencies to other currencies 1. Pegged Exchange-Rate Arrangement a. Pegged exchange-rate arrangements “peg” a country’s currency to a more stable and widely used currency in international trade. b. Many small countries peg their currencies to the dollar, euro, the special drawing right of the IMF, or other individual currency. Others peg their currencies to “baskets” of currencies. 2. Currency Board a. A currency board is a monetary regime based on a commitment to exchange domestic currency for a specified foreign currency at a fixed exchange rate. The government is legally bound to hold an amount of foreign currency equal to the amount of domestic currency; this helps cap inflation. b. The currency board’s survival depends on sound budget policies.

European Monetary System Europe looked for a system that could stabilize currencies and reduce exchangerate risk. In 1979, they created the European monetary system (EMS) to stabilize exchange rates. It was ended in 1999 when the EU adopted a single currency. 1. How the System Worked a. The exchange rate mechanism (ERM) limited fluctuations of EU member currencies within a trading range (or target zone). b. The EMS was successful; currency realignments were infrequent and inflation was controlled. Problems arose in 1992 and the EMS was revised in 1993 to allow currencies to fluctuate in a wider band from the midpoint of the target zone.

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ERM II introduced in 1999 to link the euro to the currencies of nations applying for membership in the EU.

Recent Financial Crises Despite nations’ best efforts to head off financial crises within the international monetary system, the world has seen several wrenching crises. 1. Developing Nations’ Debt Crisis a. By the early 1980s, developing countries (especially in Latin America) had amassed huge debts payable to large international commercial banks, the IMF, and the World Bank. To prevent a meltdown of the entire financial system, international agencies revised repayment schedules. b. In 1989, the Brady Plan called for large-scale reduction of poor nations’ debt, exchange of high-interest loans for low-interest loans, and debt instruments tradable on world financial markets. 2. Mexico’s Peso Crisis a. Rebellion and political assassination shook investors’ faith in Mexico’s financial system in 1993–1994. Mexico’s government responded slowly to the flight of portfolio investment capital. b. In late 1994, the Mexican peso was devalued, forcing a large loss of purchasing power on ordinary Mexican people. The IMF and private commercial banks in the United States provided about $50 billion in loans to shore up Mexico’s economy. c. Mexico repaid the loans ahead of schedule and once again has a sizable reserve of foreign exchange. 3. Southeast Asia’s Currency Crisis a. On July 11, 1997, the speculators sold off Thailand’s baht on world currency markets; the baht plunged and every other economy in the region was in a slump. b. The shock waves of Asia’s crisis could be felt throughout the global economy. Indonesia, South Korea, and Thailand needed IMF and World Bank funding. As incentives to begin economic restructuring, IMF loan packages came with strings attached. c. Crisis likely caused by a combination of: (1) Asian style capitalism (lax regulation, loans to friends and relatives, lack of financial transparency); (2) currency speculators and panicking investors; and (3) persistent current account deficits. 4. Russia’s Ruble Crisis a. Russia’s problems in the 1990s included: (1) spillover from the Southeast Asia crisis; (2) depressed oil prices; (3) falling hard currency reserves; (4) unworkable tax system; and (4) inflation. b. In 1996 as currency traders dumped the ruble, the Russian government attempted to defend the ruble on currency markets. The government received a $10 billion aid package from the IMF and promised to reduce debt, collect taxes, cease printing sums of currency, and peg its currency to the dollar. c. Things improved for a while, but then in mid-1998 the government found itself once again trying to defend the ruble. By late 1998, the IMF had lent Russia more than $22 billion. 5. Argentina’s Peso Crisis

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By late 2001, Argentina had been in recession for nearly 4 years. Argentina’s goods remained expensive because its currency was linked to a strong U.S. dollar through a currency board. The country finally defaulted on its $155 billion of public debt in early 2002, the largest default by any country ever. The government scrapped its currency board that linked the peso to the U.S. dollar and the peso quickly lost about 70 percent of its value on currency markets. Argentina has in many respects recovered. It has registered growth of around 9 percent a year and unemployment around 8 percent in 2008, down from a high of 25 percent in 2002. Argentina’s plan of boosting wages, imposing price controls, keeping the peso low, and increasing public spending seems to be working. Growth was expected to be around 4 percent to 5 percent but inflation was at 9 percent a year and reducing purchasing power. As of 2012, another economic collapse was unlikely although Argentina was experiencing 26 percent inflation.

b. c.

Future of the International Monetary System 1. Recurring crises are raising calls for a new system designed to meet the challenges of a global economy. 2. Revision of the IMF and its policy prescriptions are likely; transparency on the part of the IMF is being increased to instill greater accountability. The IMF is increasing its surveillance of members’ macroeconomic policies and abilities in the area of financial sector analysis. 3. Ways must be found to integrate international financial markets to manage risks. The private sector must become involved in the prevention and resolution of financial crises.

BOTTOM LINE FOR BUSINESS Recent financial crises underscore the need for managers to fully understand the complexities of the international financial system. Chapters 9 and 10 discuss the international financial markets and international monetary system. Understanding this material improves managers’ knowledge of financial risks in international business. But this knowledge must be paired with vigilance of financial market conditions to manage businesses in the global economy effectively.

Quick Study Questions Quick Study 1 1.

Q: Why are exchange rates important to managers’ decisions? A: First, exchange rates affect demand for a company’s products in the global marketplace. A weak domestic currency makes a nation’s products more pricecompetitive on world markets. Second, exchange rates affect how and when a company pays its dividends. Companies often pay dividends to shareholders in another country when the home currency is strong because less of the home currency is needed to obtain the foreign currency. Third, exchange rates affect the amount of profits a company earns

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from its international subsidiaries. Translating subsidiary profits into a strong home currency reduces the amount of these profits when stated in the home 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. Devaluation lowers the price of a country’s exports on world markets and increases the price of imports because the country’s currency is now worth less on world markets. Thus, a government might devalue its currency to give its domestic companies an edge over competition from other countries. However, devaluation reduces consumers’ buying power. It might also allow inefficiencies to persist in domestic companies because there is now less pressure to be concerned with production costs. Revaluation has the opposite effects: it increases the price of exports and reduces the price of imports.

Q: Why is it desirable for exchange rates to be stable and predictable? A: Stable exchange rates improve the accuracy of financial planning, including cash flow forecasts. Predictable exchange rates reduce the likelihood that companies will be caught off-guard by sudden and unexpected rate changes. This reduces the need for costly insurance (usually by currency hedging) against possible adverse movements in exchange rates.

Quick Study 2 1.

Q: Define the law of one price and explain its limitations. A: The law of one price is a principle that an identical product must have an identical price in all countries when expressed in the same currency. This product must be identical in quality and content and be entirely produced within each country. If the price is not identical in each country, an arbitrage opportunity would arise—an opportunity to buy a product at a specific price in one country and sell it at a higher price in another country. The law of one price holds because if people were to attempt arbitrage, the greater demand for the product in the lower-priced market would increase its price there and the greater supply in the higher-priced market would lower its price there. The limitations of the law of one price are several. First, the law of one price requires that the products must be identical in quality and content in each country, and must be entirely produced within each particular country. This is very hard to accomplish in today’s global economy except for most raw materials, fruits and vegetables, and the like. The Big Mac index comes close to an ideal but it has its own limitations. Second, the products must be “tradable” in the sense that it is practical to buy the product in one country and sell it in another to take advantage of an arbitrage opportunity. For example, the Big Mac index fails in this regard. Third, using a single product to determine what a nation’s exchange rate should be is far too simplistic a method. Probably every economy is far too complex to have its exchange rate determined by a single product.

Q: What is purchasing power parity in the context of exchange rates? A: Purchasing power parity is the relative ability of two countries’ currencies to buy the same “basket” of goods in those two countries. It tells us how much of currency “A” that a person in country “A” needs in order to buy the same amount of products that a person in country “B” can buy with currency “B.” Purchasing power parity holds for

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Q: Briefly explain how both inflation and interest rates influence exchange rates. A: Inflation is the result of supply and demand for a currency. When a greater supply of money chases a fixed amount of goods, prices rise. Therefore, inflation erodes people’s purchasing power and influences a nation’s exchange rate with other nations. Consumers and companies in countries experiencing high inflation see their purchasing power (and their exchange rate) eroded. Governments often raise interest rates to slow consumer spending and borrowing—one cause of inflation, which can erode the exchange rate.

Q: What are the limitations of PPP in predicting exchange rates? A: There are limitations to the PPP concept. First, purchasing power parity is better at predicting long-term exchange rates than short-term rates. Unfortunately, short-term forecasts are often more beneficial to managers. Second, although PPP assumes a world of no transportation costs, this is clearly unrealistic. If adding transportation costs to the cost of a product makes the product equally or more expensive in the otherwise cheaper market, trade will not occur. Thus, because of the absence of an arbitrage opportunity after transaction costs, no leveling of prices between the two markets will occur. Third, although PPP assumes no trade barriers, we know this to be false in reality. Trade might not occur if a high tariff on an import increases the cost of the product significantly. Of course, the same is true if importing the product is made illegal. Fourth, PPP overlooks business confidence and human psychology. The confidence of businesspeople and consumers impacts the value of a nation’s currency. Confidence in a nation’s economic outlook encourages companies to invest and consumers to increase their spending. Currency traders can also influence the exchange rate of a nation’s currency. If traders believe a currency is overvalued, they can sell the currency on currency markets— thereby causing its value to fall and the exchange rate to adjust accordingly.

Quick Study 3 1.

Q: What are the two market views regarding exchange-rate forecasting? Explain each briefly. A: The efficient market view holds that prices of financial instruments reflect all publicly available information at any given time. In the context of exchange rates, this means that forward exchange rates are accurate forecasts of future exchange rates. Accepting this view requires a belief that companies waste time and money examining information thought to affect future exchange rates. But deviations between forward and actual exchange rates inspire companies to search for more accurate forecasting techniques. The inefficient market view holds that prices of financial instruments do not reflect all publicly available information. Proponents of this view believe that companies can search for new pieces of information to improve forecasting. However, the cost of searching for further information must not outweigh the benefits of its discovery. The inefficient market view is more compelling when we consider private information. If a currency trader holds privileged information regarding a nation’s currency, the trader can act on this information and thereby make a profit.

Q: Identify the two main methods of forecasting exchange rates. What are the difficulties of forecasting? A: Because some analysts believe that exchange-rate forecasts can be improved by uncovering information, techniques have been developed to improve such forecasts. Two

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main methods of forecasting exchange rates are fundamental analysis and technical analysis. Fundamental analysis employs statistical models based on fundamental economic indicators to forecast exchange rates. Economic variables used in these models include factors such as inflation, interest rates, the money supply, tax rates, government spending, and the balance-of-payments situation. Technical analysis is a technique that employs charts of past trends in currency prices and other factors to forecast exchange rates. Under this technique, analysts estimate the conditions prevailing during changes in exchange rates and try to estimate the timing, magnitude, and direction of future exchange-rate changes. Quick Study 4 1.

Q: How did the gold standard function? Briefly describe its evolution and collapse. A: In the earliest days of international trade, gold was the internationally accepted currency for payments of goods and services. The gold standard was an international monetary system in which nations linked the value of their paper currencies to specific values of gold. The value of a currency expressed in terms of gold is called its par value. Because each nation fixed its currency to gold, it also indirectly linked its own currency to those of other nations. Thus, the gold standard was called a fixed exchange rate system—one in which the exchange rate for converting one currency into another is fixed by international governmental agreement. There are three main advantages associated with an international monetary system based on the gold standard. First, because the gold standard maintained highly fixed exchange rates between currencies, it drastically reduced exchange-rate risk. Second, because the gold standard requires governments to convert paper currency into gold if demanded by holders of the currency, governments must always have adequate gold reserves on hand to pay them. Thus, a government cannot allow the volume of its paper currency to grow faster than its gold reserves. This created an effective tool in helping nations control inflation. Third, the gold standard also helped nations to correct trade imbalances. Suppose a nation is importing more than it is exporting. As gold flows out to pay for imports, the government must decrease the supply of paper currency in the domestic economy because it cannot have paper currency in excess of gold reserves. As the money supply falls, so do prices of goods and services in the country because demand is falling while supply is unchanged. The falling prices of the country’s goods make its exports cheaper on world markets. Exports rise until the nation’s international trade is once again in balance. The fundamental principle of the gold standard was violated when nations involved in the First World War needed to finance their enormous war expenses by printing additional paper currency. This caused rapid inflation for these nations and caused them to abandon the gold standard altogether. Britain returned to the gold standard in the early 1930s at the same par value that existed before the war. However, the United States returned to the gold standard at a new, lower par value that reflected the inflation of previous years. The decision by the United States to devalue its currency and Britain’s decision not to do so lowered the price of U.S. exports on world markets and increased the price of British (and other nations’) goods imported into the United States. Countries retaliated against one another through “competitive devaluations” to improve their own trade balances. Faith in the gold standard vanished, as it no longer indicated a currency’s true value.

Q: Describe the most important features of the Bretton Woods Agreement.

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Ch 10: International Monetary System A: The Bretton Woods Agreement was an accord among nations to create a new international monetary system based on the value of the U.S. dollar. It was designed to balance the strict discipline of the gold standard with the flexibility that countries needed to deal with temporary domestic monetary difficulties. The Agreement incorporated fixed exchange rates by tying the value of the U.S. dollar directly to gold and the value of other currencies to the value of the dollar. Member nations were expected to keep their currencies from deviating more than 1 percent above or below their par values. The Agreement also extended the right to exchange gold for dollars only to national governments, not anyone who demanded it. The Agreement ruled out competitive currency devaluation but allowed large devaluation under an extreme set of circumstances called fundamental disequilibrium—an economic condition in which a trade deficit causes a permanent negative shift in a country’s balance of payments. Devaluation in such situations was to reflect permanent economic changes in a country, not temporary misalignments.

Q: What factors led to the demise of the monetary system created at Bretton Woods? A: The monetary system created by the Bretton Woods Agreement began to falter in the 1960s. Governments holding U.S. dollars began to doubt that the U.S. government had adequate gold reserves to redeem all its currency held outside the United States. Demand for gold on world markets caused a large sell-off of dollars worldwide. This was the result of the United States experiencing a trade deficit and budget deficit simultaneously. The Smithsonian Agreement (1971) among IMF members was designed to restructure and strengthen the international monetary system created at Bretton Woods. The Agreement 1) lowered the par value of the U.S. dollar to $38/oz. of gold, 2) required that other countries increase the value of their currencies against the dollar, and 3) increased the 1 percent floatation band to 2.25 percent. High inflation and a persistent trade deficit had kept the dollar weak and so demonstrated a fundamental flaw in the system. Many nations found it difficult to maintain exchange rates with the U.S. dollar and thus abandoned the system in 1972 and 1973.

Quick Study 5 1.

Q: Why did the world shift to a managed float system of exchange rates? Briefly describe the performance of this system. A: The new system of floating exchange rates that emerged after the collapse of Bretton Woods was expected to be a temporary solution. But instead of the emergence of a new international monetary system, there emerged several independent efforts to manage exchange rates. Thus far, the system has worked rather well with respect to managing exchange rates among the world’s most advanced economies. However, the system has been less than optimal for certain developing and newly industrialized nations—in particular Mexico’s peso crisis and Southeast Asia’s currency crisis.

Q: What was the purpose of the European monetary system? Describe how it functioned and performed. A: Many European nations did not abandon hopes for a stabilizing exchange-rate regime following the collapse of Bretton Woods. The European monetary system (EMS) was a complex system designed to manage exchange rates among EU countries. It was established to stabilize exchange rates, promote trade among nations, and keep inflation low through monetary discipline. The exchange rate mechanism (ERM) limited the fluctuations of members’ currencies to 2.25 percent above and below a stated central exchange rate. Although some countries were allowed wider bands, governments are

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expected to intervene to keep their currencies within the 2.25 percent range. They intervene by buying or selling a currency on world markets. Early years of success (1979–1992) were followed by several years of turmoil. In the early 1990s, Germany responded to high inflation at home by raising interest rates. This caused money to flow into Germany from other nations in Europe to take advantage of higher interest rates in Germany. Demand for German marks also increased while demand for other currencies decreased—particularly the British pound and Italian lira. In September 1992, speculators sold the pound and lira, forcing them out of the ERM. 3.

Q: What role did the International Monetary Fund have in assisting nations during recent financial crises? A: The World Bank and IMF assisted in alleviating financial burdens for developing nations that had amassed large debt burdens in the debt crisis of the early 1980s. These agencies stepped in to provide liquidity to international financial markets and to restructure debt repayment schedules for debtor nations. These agencies were assisted by the Bank for International Settlements (BIS)—an international banking institution that serves national central banks around the world and helps to stabilize the international monetary system. See the chapter section titled, “Recent Financial Crises” for a summary of how the IMF responded to financial difficulties of nations in recent years.

Talk It Over 1.

Q: Do you think an international monetary system with currencies valued on the basis of gold would work today? Why or why not? Do you think implementing a global version of the old European monetary system would work today? Why or why not? A: The simple fact is that countries today are continually selling more and more of their gold reserves. In fact, the value of gold on world markets has been depressed for roughly one decade. The gold standard collapsed because of several inherent problems with that system. Any new system based upon gold would need to build in a high degree of flexibility to overcome the rigidity of the gold standard. Implementation of a system similar to the European monetary system on a global scale would be a monumental task. Economies having highly disparate economic conditions would find it difficult to address domestic economic problems that could be dealt with easily at the national level. Perhaps the world’s industrialized economies could develop a system similar to the European monetary system, but without including the least developed economies. Getting the world’s poorest countries in line economically with the world’s most advanced economies (with requirements similar to those laid down by the Maastricht Treaty) would be practically impossible. Furthermore, the huge amounts of subsidies to the poor economies could severely drain the resources of the world’s most industrialized countries. Only one thing is for certain—any single global currency, if it ever happens, is perhaps centuries away.

Q: The activities of the IMF and the World Bank largely overlap each other. Devise a plan that reduces this duplication of services and assigns distinct responsibilities. Would you have them assume a greater role on the environment and corruption? Describe and justify your proposed solution. A: To answer this question more completely, students might be well advised to do outside research to gain a fuller understanding of the activities of the IMF and World Bank. No matter what plan students do devise, they must consider the political realities of

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Ch 10: International Monetary System any merging or reduction of these institutions’ services. There is likely to be a great deal of resistance to change. Greater involvement in the environment and corruption are also thorny issues for many countries and ones that are likely to cause disagreement among them. Again, students proposing a greater role for either of these institutions in the environment or corruption must consider the political realities of taking on these issues.

Teaming Up 1.

Q: Suppose you and several classmates are a marketing team assembled by your Brazilbased firm to estimate demand in the U.S. market for its newly developed product. The market research firm you hired requires $150,000 to perform a thorough study. But your group is informed that the total research budget for the year is 3 million Brazilian real and that no more than 20 percent of the budget can be spent on any one project. (3a.) If the current exchange rate is 5 real/$, will you have the market study conducted? Why or why not? (3b.) If the exchange rate changes to 3 real/$, will you have the study conducted? Why or why not? (3c.) At what exchange rate do you change your decision from rejecting the proposed research project to accepting the project? A: (3a.) The answer is no. Converting real into dollars at an exchange rate of 5 real/$, we arrive at $600,000 (3,000,000/5 real/$ = $600,000). The research project costing $150,000 is 25 percent of the total research budget of $600,000 ($150,000/$600,000 = 0.25). This exceeds the cutoff figure of 20 percent for the cost of any single research project. (3b.) The answer is yes. Converting real into dollars at an exchange rate of 3 real/$, we arrive at $1,000,000 (3,000,000 real/3 real/$ = $1,000,000). The research project costing $150,000 is 15 percent of the total research budget of $1,000,000 ($150,000/$1,000,000 = 0.15). This is below the cutoff figure of 20 percent for the cost of any single research project. (3c.) The threshold exchange rate at which the project decision changes from “accept” to “reject” is 4 real/$. We can set up the problem as an equation which is .20x = $150,000. (The .20x is the 20 percent cutoff figure and the $150,000 is the cost of the project.) Solving the equation and dividing $150,000 by 0.20 gives us a figure of $750,000—the total research budget stated in dollars. Then, dividing the research budget stated in real (3 million real) by that stated in dollars ($750,000), we arrive at a real/$ exchange rate of 4 real/$.

This item can be assigned as a Discussion Question in MyManagementLab. Student responses will vary. Q: Market Entry Strategy Project. This exercise corresponds to the

MESP online simulation. For the country your team is researching, is it a member of the IMF? Does it participate in a regional monetary system to manage exchange rates? 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? How has the exchange rate recently affected: (a) the activities of companies operating in the country, and (b) the purchasing power of consumers? What is the forecasted exchange rate for the coming weeks, months, and year? Integrate your findings into your completed MESP report. (Hint: Good sources are the IMF’s monthly International Financial Statistics and annual Exchange Arrangements and Exchange Restrictions.)

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A: This may be a good time to get students working on their Market Entry Strategy Project. This exercise gets students to learn more about a country, and to generate interest in countries other than their own. The project focuses on important aspects of each country and the process can begin to develop teamwork in the course. Take It to the Web We invite you to visit MyManagementLab.com, an innovative set of course-management tools for delivering all or part of your course online. MyManagementLab makes it easier for you to add meaningful assessment to your course. Whether you’re interested in testing your students’ recall of concepts and theories or in asking them to apply their new knowledge to real-world scenarios, MyManagementLab offers a variety of assessment questions to fit your needs. Ethical Challenges 1.

Q: You are the senior economic advisor for currency analysis with the United Nations (UN). The President of Malaysia has accused international currency speculators of conspiring to devalue the Malaysian ringgit and wants the UN to create a formal policy that is designed to prevent similar financial crises in the future. Some years ago, when currency speculators turned their backs on Malaysia and forced a devaluation of the ringgit, Prime Minister Mahathir Mohamad denounced currency speculators as “immoral” and argued that currency trading should take place only to facilitate deals between countries. Although most observers dismiss these comments as coming from a man known for his outspoken tirades against Western investors, others contend that the prime minister’s rhetoric voices a genuine concern. Do you think an international policy that restricts currency trading can prevent future problems? What other implications might stem from such a policy? Is it ethical for global currency speculators to bet against national currencies, perhaps sending whole economies into a tailspin while they profit? Or do you think that currency speculators perform a valuable service by correcting overvalued or undervalued currencies? A: One issue is the role that international organizations should play in monitoring and regulating currency trading across borders. Different individuals and different nations have differing views on the subject. Some people believe currency speculators are essential to keeping currency markets efficient. Others believe they are greedy destroyers of whole economies. Still others are uneasy with either polar position but believe the true worth of currency speculators lies somewhere in-between. Students wishing to gain a better feel for how ferocious this debate became should be guided to articles appearing from late 1997 through 1999 in the main business publications. Russia’s and Argentina’s crises may also give students a feel for larger issues surrounding the debate.

Q: You are the chair of an IMF task force. Your job is to reevaluate the policy of bailing out national governments that suffer losses in the private sector. Current policy is to enlist the governments of industrialized countries in bailing out emerging nations in the midst of financial crises. Taxpayers in industrial countries typically foot the bill for IMF activities, with total loans running into the many billions of dollars. Recent examples are the bailouts of Mexico, Indonesia, and Thailand. Some critics call this system a kind of “remnant socialism” that rescues financial institutions and investors from their own

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Ch 10: International Monetary System mistakes with money from taxpayers. For instance, the financial crisis in Thailand was largely a private-sector affair. Thai banks and insurance companies were heavily in debt and the central bank had recklessly pledged its foreign exchange reserves to shore up the currency. As chair of the task force, what is your position on this dilemma? Do you believe that the current system socializes losses (the government bails them out) and privatizes profits? Explain exactly who benefits from such bailouts. What is an alternative to an IMF bailout? A: Students might look at the recent events in the U.S. financial system meltdown for ideas on this topic. They may research articles around the time of the Southeast Asian crisis to understand who benefits and loses when losses are socialized—the argument that private financial institutions earn healthy returns when times are good and taxpayers do not share in these gains (though stockholders in these companies do). The question is why should taxpayers bear losses when these institutions make bad investments? The companies may be more cautious if they know taxpayers would not bail them out. This may be a good question to pose as a debate between classmates playing the roles of proponents of private financial institutions on one side, and taxpayers on the other.

Practicing International Management Case Banking on Forgiveness 1.

Q: In negotiating the HIPC Debt Initiative, the World Bank and the IMF worked closely together. At one point, however, the plan came to a standstill when the two organizations produced different figures for Uganda’s coffee exports, with the IMF giving a more optimistic forecast and so arguing against the need for debt relief. In your opinion, is there any benefit to these organizations working together? Explain. Which organization do you think should play a greater role in aiding economic development? Why? A: This first question of the case overlaps somewhat with “Talk It Over” question 3. Students should be encouraged to visit the Web sites of the International Monetary Fund and World Bank and gather other printed documents they publish in order to gain a fuller understanding of these organizations’ activities before answering this question.

This item can be assigned as a Discussion Question in MyManagementLab. Student responses will vary. Q: The World Bank and the IMF had once argued that the leniency of

debt forgiveness would make it more difficult for the lenders themselves to borrow cheaply on the world’s capital markets. If you were a World Bank donor, would you support the HIPC Debt Initiative or argue against it? Explain your answer. A: This question could set up a debate between groups arguing for and against debt relief. Students arguing for debt relief must explain the benefits (humanitarian, economic, etc.) that debt forgiveness is expected to have for the debtors and lenders. Students arguing against debt forgiveness must explain the harm to the institutional lenders and lending countries from the debt forgiveness and explain why debtor nations would be better off mired in crippling debt that denies their people basic health care and education.

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 A Final Word

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. A.

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 a. Mission statements often describe how a company’s operations affect stakeholders—all parties, ranging from suppliers and employees to stockholders and consumers, affected by a company’s activities.

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The mission statement of an international business depends on the type of business, the stakeholders, and the most important 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 2020.” 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.

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Formulate Strategies 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. Drawback: 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. 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 i. Reduces the scale or scope of a corporation’s businesses. Corporations cut back the scale of operations when economic conditions worsen or competition increases by closing factories with unused capacity and laying-off employees. Corporations reduce the scope of activities by selling unprofitable business units. c. Stability Strategy

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

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Ch 11: International Strategy and Organization 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 among 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. d. Participative Management and Accountability i. Decentralization fosters participative management practices. Employee morale is higher if subsidiary managers and subordinates are involved in decisions.

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If delegated to subsidiaries, decisions about production, promotion, distribution, and pricing can generate greater commitment from managers and workers. 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. c. 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

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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. 2. 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.

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b. 3.

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.

A FINAL WORD 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 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 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.

Q: What is value-chain analysis? Explain the difference between primary and support 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

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Ch 11: International Strategy and Organization 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 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.

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

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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. 4.

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 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 among 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.

Quick Study 4 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.

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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 among 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 among 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.

Talk It Over 1.

This item can be assigned as a Discussion Question in MyManagementLab. Student responses will vary. Q: “Cultures around the world are becoming increasingly similar, so

companies should standardize both their products and global marketing efforts.” Do you agree or disagree with this reasoning? Are there certain industries for which it might be more or less true? A: There is some homogenization of product preferences worldwide. However, although people of many countries desire the same products, they must often be modified at least slightly to increase their appeal in the local market. Only a few products can be made entirely the same and marketed in the exact same manner worldwide.

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Teaming Up 1.

Q: Ideas Project. As a team, list five products that you consumed (breakfast, chewing gum, etc.) or used (Wi-Fi Internet service, radio program, etc.) within the past 24 hours. What strategy does the company behind each good or service employ: low-cost, differentiation, or focus? For each company, write one or two paragraphs on how you arrived at your answer. A: Students should be encouraged to select two or three goods and two or three services for this project, not all goods or not all services. Of course, the students will need to consider the competition of each product in answering these questions regarding strategy. Therefore, they should select products with which they are highly familiar.

Q: Research Project. As a group, select an international company that interests you and locate its annual report from its investor relations department or the Internet. What is the company’s mission statement or overriding objective? What are its corporate- and business-level strategies? In which nations does it produce and market its products? Are its production facilities centralized or decentralized? Does it standardize products or adapt them for different markets? What type of organizational structure does it have? Which of the two types of international strategy does it seem to follow? Does the company make use of work teams? Present your group’s findings to the class. A: This may be a good time to get students working on their Market Entry Strategy Project. This exercise gets students to learn more about a country, and to generate interest in countries other than their own. The project focuses on important aspects of each country and the process can begin to develop teamwork in the course.

Q: Debate Project. In this project, two groups of four students each will debate the merits of adopting either a multinational or global strategy (each side will advocate one strategy). After the first student from each side has spoken, the second student will question the opposing side’s arguments, looking for holes and inconsistencies. The third student will attempt to answer these arguments. The fourth student will present a summary of each side’s arguments. Finally, the class will vote to determine which team has offered the more compelling argument. A: Students should be sure to support their arguments with features of each of the two types of strategies discussed in this chapter. They should also be prepared to defend their positions, after the debate, if they are called on to give a synopsis of their position in class. It may also be useful to give students some time to do outside research to prepare for the debate.

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Ethical Challenges 1.

Q: You are the CEO of a multinational corporation that operates in more than 100 nations worldwide. Recent changes in the global economy are redrawing many geographical and political borders. The growing interdependence of socially, politically, economically, and legally diverse countries is causing firms to revise operating policies and strategies. You are personally involved in developing a code of ethics for your firm that reflects today’s legal and moral atmosphere. You want your firm’s code to be effective across all markets in which it operates. Given the complexity of the issues involved, what sort of policy do you think is appropriate for a firm involved in dissimilar nations? Do you think that it is possible to create a uniform code of ethics that is applicable to any business operating in any culture? What issues should such a code address? A: Many CEOs wrestle with the idea of adapting their firm’s code of ethics to local laws and customs around the world. Clearly, such global codes of conduct do exist. However, students should try to think of situations in which such a code could be challenging to implement. Although such codes look nice in the company’s annual report, the real difficulties lie on the front lines in international markets when they are implemented (to varying degrees of success).

Q: You are a member of an international ethics commission assembled by the World Trade Organization (WTO). Your team has been asked to assess the global tactics of Microsoft in recent years. A primary issue is whether Microsoft took unfair advantage of its powerful position in the computer industry by using “strong-arm tactics” on software customers throughout the world, and by crushing weaker rivals. Regardless of whether or not Microsoft is guilty of anticompetitive acts in a legal sense, do you believe Microsoft has conducted itself ethically in its business dealings? Do you argue that Microsoft has abused its power in the industry or is simply a tough competitor? Do you think the WTO should develop a policy on the competitive tactics of global powerhouses such as Microsoft? Why or why not? A: A discussion of the role and authority of the WTO is perhaps a good starting point for this dilemma. Students must also consider how the significant power of a company—that has taken many years of hard work to develop—should be used. From a purely business standpoint, one can argue that use of power within the boundaries of the law is not only desirable, but is necessary to help the company be as successful as possible. However, from an ethical standpoint, the question is asked how much power is too much. Students again should consider how various stakeholders would react to the course of action chosen by managers.

Q: You are the new president of Star Manufacturing, an international subsidiary of a large multinational firm that makes automotive parts. Since you arrived at Star three months ago, you are finding it difficult to get your firm’s materials and finished products through customs quickly. Local legal counsel suggests a payment to local officials to eliminate your problem with customs, an apparently common local practice. The bribe would expedite the entire shipping process, which will help improve profits. What do you do? Is there a specific policy your firm could develop that all Star employees could follow? What other issues must you consider? If additional information would be helpful to you, what would it be? A: A key issue in this dilemma is the legality of bribery in the local country. Although there may well be a law that prohibits bribery of customs officials, the level of

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enforcement probably varies widely. Moreover, the penalties for bribery must be weighed. Although a complete ban of bribery in any form is the most moral option, it may be impractical. The U.S. Foreign Corrupt Practices Act does permit grease payment, and the bribe being solicited in this dilemma appears to fall into this category. It may be virtually impossible to clear customs in the country without some form of payment to government officials. The situation may vary depending on the individuals and goods involved with each shipment, which makes a blanket policy impractical. Nevertheless, as president of Star, you should be striving for the highest moral standards possible. 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 the United States? Why? A: Some main competition will come from stores such as Home Concept 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 policies 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.

CHAPTER 12 ANALYZING INTERNATIONAL OPPORTUNITIES LEARNING OBJECTIVES: 1. Explain each of the four steps in the market- and site-screening process. 2. Describe the three primary difficulties of conducting international market research. 3. Identify the main sources of secondary international data and explain their usefulness. 4. Describe the main methods used to conduct primary international research.

CHAPTER OUTLINE: Introduction Screening Potential Markets and Sites Step 1: Identify Basic Appeal Determining Basic Demand Determining Availability of Resources Step 2: Assess the National Business Environment Cultural Forces Political and Legal Forces Government Regulation Government Bureaucracy Political Stability Economic and Financial Forces Other Forces Cost of Transporting Materials and Goods Country Image Step 3: Measure Market or Site Potential Measuring Market Potential Industrialized Markets Emerging Markets Measuring Site Potential Step 4: Select the Market or Site Field Trips Competitor Analysis Conducting International Research Difficulties of Conducting International Research Availability of Data Comparability of Data Cultural Differences Sources of Secondary International Data International Organizations Government Agencies Industry and Trade Associations Service Organizations Internet Methods of Conducting Primary International Research Trade Shows and Trade Missions Interviews and Focus Groups

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Surveys Environmental Scanning A Final Word

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 Technological advances in communication and transportation open national markets around the globe. Managers screen and analyze locations as potential markets and as potential sites for operations. The attraction to distant markets and the integrated nature of location decisions demand that location decisions be made in a systematic manner.

SCREENING POTENTIAL MARKETS AND SITES Managers try to keep search costs low yet examine every potential market or location when screening potential markets and sites. The screening process has four steps. A

Step 1: Identify Basic Appeal For a potential market, this entails determining basic product demand. For a potential site, this involves determining the availability of resources required. 1. Determining Basic Demand Must explore the suitability of a nation’s climate, and whether there are bans on a product (e.g., alcohol in Islamic nations). 2. Determining Availability of Resources a. Raw materials for manufacturing must be local or imported. Imports may face tariffs, quotas, or other trade barriers. b. Companies making labor-intensive products often relocate to low-wage countries. c. Financing can send production abroad if it is not available at home or when interest rates are high at home. d. Markets and sites not meeting requirements are dropped.

Step 2: Assess the National Business Environment Managers must understand differences in cultures, politics, laws, and economies and incorporate that understanding into market and site selection decisions. 1. Cultural Forces a. Countries differ in language, attitudes toward business, religious beliefs, traditions, and customs. Cultural elements can influence what kinds of products are sold and how. b. Culture affects site-selection decisions; companies sometimes locate production in the local market when changes must be made to a product’s physical features for cultural reasons. c. The local work ethic, education, and level of managerial skills affect site-selection decisions.

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Political and Legal Forces a. Government Regulation i. Nations differ in their attitudes toward trade and investment based on culture, history, and current events. A nation’s attitude is reflected in the quantity and types of restrictions it places on imports. ii. Can quickly eliminate a market or site from further consideration. They create investment barriers to ensure domestic control of a company or industry by imposing investment rules on business ownership. iii. Restrict international companies from freely removing profits, forcing them to hold cash in the host country or to reinvest it in new projects there. iv. Impose strict environmental regulations such as pollution-control devices or close monitoring of nearby air, water, and soil quality. v. Extend investment rules to bar international companies from competing in certain sectors of the economy. b. Government Bureaucracy i. Lean and smoothly operating bureaucracy can encourage investment while an inefficient, cumbersome, or corrupt one can discourage it. ii. Companies will endure an inefficient bureaucracy if the benefits outweigh the cost of inefficiencies. c. Political Stability i. Companies must monitor political events that threaten operations and future earnings. Political risk can threaten activities of any international business activity. ii. Key to political risk is unforeseen political change: if a company cannot estimate the future political environment with accuracy, political risk is increased. iii. Companies can obtain political risk information from political-risk agencies, international relations scholars, political and union leaders, reporters, bankers, and so on. Economic and Financial Forces a. Poor fiscal and monetary policies can increase inflation and budget deficits, weaken a currency, lower productivity levels, and slow innovation. These reduce investor confidence and cause companies to scale back or cancel proposed investments. b. Currency and liquidity issues: a volatile currency complicates the prediction of future earnings in the home-country currency. c. Managers can obtain information about economic and financial conditions from international agencies. Other Forces A country’s image and the cost of transporting materials and goods are important in assessing a nation’s business environment. a. Cost of Transporting Materials and Goods i. Can affect where manufacturing facilities are located. ii. Logistics is managing the physical flow of products from point of origin as raw materials to end users as finished products. Logistics wed production to delivery.

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Country Image i. Embodies all facets of a nation’s business environment and affects the selection of sites for any activity. ii. Affects product image because products are stamped with labels identifying country of origin or assembly. iii. Country image can be good for certain products but unfavorable for others. iv. Country image can also change over time.

Step 3: Measure Market or Site Potential Despite local demand for a product or availability of resources, consumers might not be ready or able to buy a product or certain sites may be unable to supply the resources needed. 1. Measuring Market Potential Level of economic development affects the products sold, how they are sold, and their features. Different levels of economic development require varying approaches to researching market potential. a. Industrialized Markets i. Great deal of information on market potential is available about industrialized countries. ii. Information in a typical industry analysis: • Names, production volumes, and market shares of largest competitors • Volume of exports and imports of the product • Structure of wholesale and retail distribution networks • Market background, including population, social trends, and marketing approaches used • Total expenditure on product (and similar products) • Retail sales volume and market prices of product • Future market outlook and potential opportunities iii. These reports provide a quick overview of the size and structure of a nation’s market for a product. iv. One way to forecast market demand is to determine a product’s income elasticity—sensitivity of demand for a product relative to a change in income. Calculated by dividing a percentage change in the quantity of a product demanded by a percentage change in income. v. Income-elastic product: demand increases in a greater proportion to increase in income. These are discretionary purchases such as video games, jewelry, and so on. vi. Income-inelastic product: demand increases less relative to increase in income. These are considered essential and include food, utilities, beverages, and so on. b. Emerging Markets i. Companies often face a lack of information. Data on market size or potential may be unavailable.

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Can rank locations using a market-potential indicator if company is considering exporting: • Market size: snapshot of market size at the moment. • Market growth rate: Identify large (but shrinking) markets and small (but expanding) markets. • Market intensity: Estimate a market’s wealth or buying power (both individuals and businesses). • Market consumption capacity: Estimate a market’s spending capacity. • Commercial infrastructure: Assess channels of distribution and communication. • Economic freedom: Estimate extent that freemarket principles predominate. • Market receptivity: Estimate market “openness.” • Country risk: Estimate risk of doing business, including political, economic, and financial risks. iii. After analyzing each factor, the importance of each to demand for a product is determined; then potential locations are ranked according to their market appeal. Measuring Site Potential a. Managers must assess the quality of resources they will employ locally. For many companies, the most important resource will be labor and management. b. Wages are lower if labor is abundant, relatively less skilled (though perhaps well-educated), or both. Yet, training local managers requires a substantial investment of time and money. c. Companies must assess the productivity of local labor and managers; low wages may reflect low productivity levels. d. Managers should examine local infrastructure, including roads, bridges, airports, seaports, and telecommunications systems; each can impact efficiency.

Step 4: Select the Market or Site This involves intensive efforts of assessing remaining potential markets and sites. Managers visit each location to confirm earlier expectations and perform a competitor analysis. Managers evaluate each potential location’s contribution to cash flows by undertaking a financial evaluation. 1. Field Trips Trips to each remaining site let managers experience the culture, observe the workforce, or make personal contact with potential new customers and distributors. 2. Competitor Analysis Intensely competitive markets put downward pressure on the prices firms charge their customers. Intensely competitive sites for production and R&D activities increase the costs of doing business. Competitor analysis should address the following:

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Number of competitors in each market (domestic and international) Market share of each competitor Whether each competitor’s product appeals to a small market segment or has mass appeal Whether each competitor focuses on high quality or low price Whether competitors tightly control channels of distribution Customer loyalty commanded by competitors Potential threat from substitute products Potential entry of new competitors into the market Competitors’ control of production inputs (labor, capital, raw materials, etc.)

CONDUCTING INTERNATIONAL RESEARCH Market research is the collection and analysis of information in order to assist managers in making informed decisions. It applies to the assessment of markets and sites. International market research provides information on business environments: cultural practices, politics, regulations, the economy, a market’s potential size, buyer behavior, logistics, and distribution. It is helpful in designing a marketing strategy and understanding buyer preferences and attitudes. Market research informs managers about employment levels, wage rates, and local infrastructure before committing to the new location. It supplies timely and relevant market information to anticipate market shifts, changes in current regulations, and the potential entry of new competitors. A.

Difficulties of Conducting International Research Unique circumstances present difficulties that force adjustments in conducting market research in different nations. Companies must be aware of such obstacles to ensure their research data is reliable. 1. Availability of Data a. Most industrialized markets have secondary data on product markets. In many emerging and developing countries, previously gathered information can be difficult to obtain; even when market data is available, its reliability is questionable. b. Government-collected information in emerging markets is often stated in the most favorable light and thus suspect. c. Large international research agencies are entering these markets, providing a source of higher-quality information. 2. Comparability of Data a. Data obtained from other countries must be interpreted with great caution. Terms such as poverty, consumption, and literacy can differ greatly from one country to another. b. Different ways governments measure data affects comparability among nations. Misinterpreting data can sabotage the best marketing plans and production strategies. 3. Cultural Differences a. Marketers conducting research in unfamiliar markets must explore how cultural variables influence information. The most important variable is language; interpreters might unintentionally misrepresent certain comments or not convey the sentiment with which statements are made.

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High illiteracy rates can force researchers to conduct timeconsuming verbal surveys with potential customers. Hiring local research agencies is good when a company faces cultural obstacles to research; they understand which practices are acceptable and which types of questions can be asked. They know how to interpret information and know its reliability.

Sources of Secondary International Data Secondary market research is obtaining information that already exists within the company or that is obtainable from outside sources. Secondary data can estimate market demand for a product or form a general impression of a business environment. Its appeal is that it is relatively inexpensive. 1. International Organizations a. International organizations are excellent sources of free and inexpensive information about product demand. b. These include the United Nations, the International Trade Center, the World Bank, IMF, and the Asian Development Bank. 2. Government Agencies a. Commerce departments and international trade agencies data: import and export regulations, quality standards, and market size. b. Visiting embassies and attending social functions are excellent for making contact with potential business partners. Seek sources with an objective view of a potential location. c. Central Intelligence Agency (CIA) World Factbook: useful throughout the market- or site-screening process because of its facts on each nation’s business environment. d. Trade Information Center (TIC) provides product standards and advice for U.S. companies in individual markets; information includes trade laws, trade shows, export counseling, import tariffs, and customs procedures. e. National agencies abroad promoting trade and investment. f. Trade-data libraries of governments (e.g., JETRO in Japan). 3. Industry and Trade Associations a. Associations of firms within an industry or trade often publish newsletters (and Web sites) to keep members abreast of market happenings and opportunities in their particular industry. b. Sometimes commission specialized studies of their industries and offer them to members at subsidized prices. 4. Service Organizations a. International service organizations in banking, insurance, management consulting, and accounting offer information on cultural, regulatory, and financial conditions. b. Newsletters cover trends in population growth, consumer spending, purchase behavior, media, and advertising. 5. Internet a. Leading online information provider is LEXIS-NEXIS: a database of full-text news reports from around the world. It provides profiles of executives and products, and information on financial conditions, marketing strategies, and public relations.

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The Internet is an inexpensive means to conduct secondary research considering the high cost of other research tools.

Methods of Conducting Primary International Research Primary market research is the process of collecting and analyzing original data and applying the results to current research needs. Primary research helps complete the broad picture supplied by secondary data. 1.

Trade Shows and Trade Missions a. Trade show is an exhibition at which members of an industry or group of industries showcase their latest products, see what rivals are doing, and learn about recent trends and opportunities. b. Trade mission is an international trip by government officials and businesspeople organized by agencies of national or provincial governments to explore business opportunities. c. Trade missions appealing for small- and medium-size firms: (1) visible support of home-country government officials gives them clout in the host country, and (2) cost-effective because they often include several national markets across a region. Interviews and Focus Groups a. These techniques can uncover potential or current buyers’ emotions, attitudes, and general impressions of a company or its product. Interviewing customers in other countries is difficult and getting unbiased and reliable results is challenging. b. Focus group: unstructured but in-depth interview of a small group of individuals (8 to 12 people) by a moderator to learn attitudes about a company or its product. Uncovers negative perceptions among buyers to correct marketing strategies. c. Because subtle differences in verbal and body language could go unnoticed, focus group interviews work best when moderators are natives of the countries in which the interview is held. d. A consumer panel is research in which people record, in personal diaries, information on their attitudes, behaviors, or purchasing habits. This can be useful when people in a focus group might agree with others in the group—as in grouporiented cultures. Surveys a. Research in which an interviewer has current or potential buyers answer written or verbal questions to obtain facts, opinions, or attitudes. Can gather a vast amount of data in a single sweep. b. Survey methods must be adapted to local markets. Written surveys are impractical in countries with high illiteracy rates although verbal responses can be obtained. Environmental Scanning a. Ongoing process of gathering, analyzing, and dispensing information for tactical or strategic purposes. Entails obtaining factual and subjective information on the business environments in which a company is operating or considering entering. b. Contributes to well-informed decisions and effective strategies by helping develop contingency plans in a volatile environment.

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A FINAL WORD In competitive global business, companies should follow a systematic screening process that incorporates high-quality research methods. This chapter provides a systematic way to screen potential locations as new markets or sites for business operations. Yet this is only the first step in “going international.” The next step involves actually accomplishing the task of entering selected markets and establishing operations abroad. Later chapters cover entry modes available to companies, acquiring resources needed to carry out activities, and managing sometimes far-flung international business operations.

Quick Study Questions Quick Study 1 1.

Q: What are the four steps in the screening process? A: First, a company must identify a location’s basic appeal. This is true whether determining basic demand for a company’s product or determining basic availability of resources needed to carry out local business activities. Second, a company must assess the national business environment. This refers to determining cultural, political, legal, economic, and financial forces. Furthermore, logistics issues such as the cost of transporting materials and goods must be addressed as well. Country image is also a factor to consider when assessing a potential production site. Third, a company must measure the market or site potential. This requires collection of as much data as possible on each market and site, such as market size, market growth rate, and the condition of the local infrastructure. Fourth, a company must select the single best market or site. This step often involves field trips to those sites making the final cutoff and performing competitive analyses.

Q: Identify the main factors to investigate when identifying the basic appeal of a market or site for operations. A: The first factor essential in determining basic demand is the suitability of a nation’s climate for a product. Also important is finding out whether absolute bans on a product exist (such as alcohol in Islamic nations). Determining basic appeal of a potential site initially involves assessing the availability of required resources. Raw materials needed for manufacturing must be either found in the national market or imported. However, imports may have high tariffs, quotas, or other government barriers placed upon them. The availability of labor is essential to production in any country. This is especially important for companies producing labor-intensive products. Obtaining financing can also be an important impetus for going abroad with production activities. This is especially true when there is little availability of financing in the home market or when interest rates there are too high.

Q: What key forces should be examined when assessing a nation’s business environment? A: Cultural differences in language, attitudes toward business, religious beliefs, traditions, and customs can influence what products are sold and how they are sold. Companies sometimes locate production in the local market when significant changes must be made to a product’s physical features for cultural reasons. Cultural elements such as work ethic, educational attainment, or the level of managerial skills of the local people also affect site-location decisions.

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Nations differ in their attitudes toward trade and investment from other countries. Governments can create barriers to investment, for example, by placing restrictions on the percent ownership foreign companies can have in domestic firms or by forcing the formation of joint ventures with local firms. Governments can bar foreign companies from competing in certain sectors of the economy. They can restrict companies from freely removing capital from the host nation. This can force companies to hold cash in the country or invest in new investment projects there. Governments can impose strict environmental regulations that can significantly increase production costs. They can require that companies divulge certain information—such as India’s demand for CocaCola’s secret recipe. A clean and smoothly operating bureaucracy can encourage investment whereas an inefficient, cumbersome, or corrupt one can discourage it. Political risk can threaten the activities of any type of international business activity. Companies must analyze a nation’s economic policies before selecting a new market or site. Poor fiscal and monetary policies can cause high rates of inflation, increasing budget deficits, a depreciating currency, falling productivity levels, and flagging innovation. Such conditions can lessen investor confidence and cause companies to scale back or cancel proposed investment projects. Volatile currency exchange rates can make it difficult to calculate the amount of funds needed for an investment, and increase the uncertainty of how much money can be obtained in liquidation situations. 4.

Q: How do transport costs and country image affect the location decision? A: The cost of transporting materials and goods affects any decision about where to locate manufacturing facilities. Logistics refers to the management of the physical flow of products from point of origin as raw materials to end users as finished products. This includes all modes of transportation, storage, and distribution. Because country image embodies every facet of a nation’s business environment, it is highly relevant to the selection of sites for production, R&D, or any other activity. Country image affects the location of manufacturing or assembly operations because products must typically be stamped with labels identifying where they were made or assembled such as “Made in China.” Products in relatively more developed countries tend to be evaluated more positively than those from relatively less developed nations. Country image can be good for certain products but unfavorable for others. Country image can also change over time. Although “Made in India” once applied only to textiles and sporting goods, it now has a respectable image for quality software and services.

Quick Study 2 1.

Q: What is the significance of income elasticity in measuring market potential? A: Income elasticity is the sensitivity of demand for a product relative to changes in income and is one way of forecasting market demand. It is calculated by dividing the percent change in the quantity of a product demanded by a percent change in income. A coefficient of greater than 1.0 conveys an income-elastic product: one for which demand increases in a greater proportion to growth in income. The concept helps managers forecast future demand for products under certain economic conditions. It allows them to work up demand figures under several different scenarios of economic conditions. This allows companies to supplement all the current data collected in earlier screening stages with actual forecasts of potential demand for their products.

Q: Identify each component of a market-potential indicator. Why is each component useful in assessing emerging markets?

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Ch 12: Analyzing International Opportunities A: The main variables commonly included in market-potential analysis are: market size, market growth rate, market intensity, market consumption capacity, commercial infrastructure, economic freedom, market receptivity, and country risk. Its usefulness lies in the fact that hard data on market size (which is readily available in industrialized markets) is often unavailable in emerging markets. The market-potential indicator is one way for companies to rank different markets in terms of their appeal. However, it should be noted that this indicator is only useful for companies considering exporting to markets.

Q: What are the most important factors to consider when measuring site potential? A: For the site-screening process, managers must carefully assess the quality of the resources that they will employ locally. For many companies, the most important of these will be human resources—both labor and management. Managers should also closely examine the local infrastructure, including roads, bridges, airports, seaports, and telecommunications systems when assessing site potential. Each of these can greatly impact the efficiency of local operations.

Q: Explain why a field trip and competitor analysis are useful in the final stage of the screening process. A: The final step in the screening process represents the most intensive efforts of assessing remaining potential markets and sites—typically less than a dozen, sometimes just one or two. At this stage of the screening process, managers often want to take trips to each remaining site. The trip gives managers an opportunity to experience the culture, observe in action the workforce that they might soon employ, or make personal contact with potential new customers and distributors. There are also competitive issues managers should analyze in the final step of screening. Some of these are the number of competitors and their market shares, the customer segment of each competitor and the loyalty of their customers, potential new entrants, and competitors’ control over key inputs. Intensely competitive markets typically put downward pressure on the prices that firms can charge their customers. An intensely competitive site can also increase the cost of doing business at that location. Lower prices and higher costs due to competitive forces must be balanced against the potential benefits offered by each market and site under consideration.

Quick Study 3 1.

Q: Identify the benefits associated with conducting international secondary market research. A: Market research is the collection and analysis of information in order to assist managers in making informed decisions. This definition applies to the assessment of both markets and sites. International market research provides information on national business environments including cultural practices, politics, regulations, the economy, a market’s potential size, buyer behavior, logistics, and distribution systems.

Q: What are the three main difficulties of conducting research in international markets? Explain each briefly. A: Availability of data: In the most industrialized markets, much secondary data already exists on various product markets. However, in many emerging and developing countries, previously gathered information of high quality can be difficult to obtain. Even when market data is available, its reliability can be questionable. Government-collected information in emerging markets is often stated in the most favorable light—and

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therefore somewhat suspect. However, large international research agencies are entering these markets, thereby providing a source of higher-quality information. Comparability of data: Data obtained from other countries must be interpreted with great caution. Terms such as poverty, consumption, and literacy can differ greatly from one country to another. The different ways governments measure data also affects comparability among nations. Misinterpreting data because one does not know how it was compiled can sabotage even the best marketing plans and production strategies. Cultural differences: Marketers conducting research in unfamiliar markets must pay attention to the ways that cultural variables influence information. Perhaps the most important variable is language. For example, even the use of interpreters can complicate matters as they may unintentionally place more or less emphasis on a certain point they are translating by the words they choose or their voice inflections. High illiteracy rates can force researchers to conduct time-consuming verbal surveys with potential customers. Hiring local research agencies (or international ones with local affiliations) is a good avenue when a company runs into cultural obstacles to research. 3.

Q: Identify some of the main sources of secondary market research data. A: The main sources of secondary research data include international organizations, government agencies, industry and trade associations, service organizations, and the Internet and World Wide Web.

Quick Study 4 1.

Q: How does primary market research differ from secondary market research? A: Primary market research is the process of collecting and analyzing original data and applying the results to current research needs. It helps complete the broad picture supplied by secondary data. Primary research differs from secondary research in that a company (or an outside agency on behalf of the company) gathers it for the first time.

Q: Describe each main method used to conduct primary market research. A: A trade show is an exhibition at which members of an industry or group of industries showcase their latest products, see what rivals are doing, and learn about recent trends and opportunities. A trade mission is an international trip by government officials and businesspeople that is organized by agencies of national or provincial governments for the purpose of exploring international business opportunities. An unstructured but indepth interview of a small group of individuals (8 to 12 people) by a moderator to learn the group’s attitudes about a company or its product is a focus group. A consumer panel is research in which people record, in personal diaries, information on their attitudes, behaviors, or purchasing habits. Research in which an interviewer asks current or potential buyers to answer written or verbal questions to obtain facts, opinions, or attitudes is a survey. The ongoing process of gathering, analyzing, and dispensing information for tactical or strategic purposes is environmental scanning.

Q: What are some of the difficulties of conducting international market research? A: A survey is research in which an interviewer has current or potential buyers answer written or verbal questions to obtain facts, opinions, or attitudes. Written surveys are impractical to conduct in countries with high illiteracy rates, although this problem can perhaps be overcome by obtaining verbal responses to verbally asked questions. A focus group is an unstructured but in-depth interview of a small group of individuals (8 to 12 people) by a moderator to learn the group’s attitudes about a company or its product. Because subtleties in verbal and spoken language could go unnoticed, focus group

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Ch 12: Analyzing International Opportunities interviews tend to work best when moderators are natives of the country in which the interview is held. Also, it can be difficult to conduct a focus group in group-oriented cultures—those in which people might have a tendency to agree with one another in a roundtable discussion.

Talk It Over 1.

Q: Although Sony’s (www.sony.com) MiniDisc recorder and player was a huge hit in Japan, the initial response to MiniDisc in the United States was lukewarm. When Sony mounted its third official attempt to launch its MiniDisc in the United States, it thought it finally had the right formula. A Sony executive noted, “This time around, we’ve done our homework, and we’ve found out what’s in consumers’ heads.” What type of research do you think Sony used to “get inside the heads” of its target market? Do you think different cultures prefer to conduct certain types of market research? Explain. A: The types of research Sony likely used to “get inside the heads” of consumers were “soft research” techniques, including in-depth interviews, focus groups, and observing people using prototypes of the product and obtaining feedback. This research helps Sony understand how and why individuals feel about their product and the opinions they form after using them. Most Japanese companies conduct “soft” research and rarely conduct written questionnaires to potential buyers. Meanwhile, Western companies, mostly the United States, tend to employ “hard research” techniques such as survey questionnaires and consumer panels. They then supplement this research with a few focus groups. However, these are only generalizations and exceptions certainly exist in every culture.

Teaming Up 1.

Q: Research Project. As a group, visit your college’s library and consult the Encyclopedia of Associations or similar organization on the Web. Select one or two industry associations of interest to your group. Write or call the association(s) and request an information packet, and compile a summary of the information received. Compare the information your group receives with information sent by trade associations researched by the other student groups. Rank the trade associations in terms of the usefulness of their information. A: The purpose of this project is to illustrate the kinds, quantity, and quality of information that different industry associations provide to their members.

This item can be assigned as a Discussion Question in MyManagementLab. Student responses will vary. Q: Emerging Markets Project. Select an emerging market that your

team would like to learn more about. Start by compiling fundamental country data, and then do additional research to flesh out the nature of the market opportunity offered by this country or its suitability as a manufacturing site following the steps in this chapter. Make a list of the international companies pursuing market opportunities in the country, and identify the products or brands that the companies are marketing. Are their reasons for doing business in the country consistent with the market opportunity as you have researched it? Determine whether these companies have established facilities for manufacturing, sales, or both. A: This may be a good time to get students working on their Market Entry Strategy Project. This exercise gets students to learn more about a country, and to generate interest

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in countries other than their own. The project focuses on important aspects of each country and the process can begin to develop teamwork in the course. Take It to the Web We invite you to visit MyManagementLab.com, an innovative set of course-management tools for delivering all or part of your course online. MyManagementLab makes it easier for you to add meaningful assessment to your course. Whether you’re interested in testing your students’ recall of concepts and theories or in asking them to apply their new knowledge to real-world scenarios, MyManagementLab offers a variety of assessment questions to fit your needs. Ethical Challenges 1.

Q: You are a member of the Council of Economic Advisors to the U.S. President. The Council is asked to assess the moral basis for outsourcing to low-wage countries. Many globalization protesters argue that multinational corporations from wealthy countries endanger the global economic system by investing capital in developing countries and laying off workers at home. They say globalization pits the interests of more prosperous workers in wealthy countries against the interests of lower-paid workers in developing countries. It is also claimed that the practice pits nations against one another as companies move from one developing country to another in search of lower wages or bigger market opportunities. Do multinationals have an ethical obligation to try to preserve jobs for workers in their home-country markets? How do you believe the Council should advise the President on this issue? Justify your advice. A: A major issue that should be considered in this debate is the ultimate destination(s) of profits made by the multinational firms involved in outsourcing. Students should consider, for example, the question of whether a company that earns a greater portion of its earnings outside the home market must be loyal to workers in the home market. What about loyalty to those workers in the company’s international markets (perhaps developing countries where workers and their families would otherwise be far worse off than workers would be at home if they lose their jobs)? Is a company really responsible to workers and citizens of the home country or is that the government’s job? This question is often interesting to pose as a debate between those who argue for the freedom of multinationals to locate wherever they choose versus those who believe that multinationals must remain loyal to workers in the home market.

Q: You are the CEO of a large multinational company that has become highly profitable by investing in a Latin American country. As a catalyst in mobilizing the nation’s lowcost labor force, your company has helped the nation achieve double-digit economic growth. Following a political upheaval, however, a military government takes control. Workers’ rights are being violated, as are those of individual citizens. As CEO, it is up to you to decide on a course of action. Do you pull out of the country, effectively abandoning your employees? Do you publicly and directly confront the leaders of the new government and insist that they respect workers’ rights? Do you proceed more discreetly and pursue diplomacy out of the public’s eye? Or, do you advise a different course of action? Can you make an ethical decision that is also a good business decision?

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Ch 12: Analyzing International Opportunities A: This is an excellent question to pose to the class as a whole. After receiving the input of students and pointing out the pitfalls of different potential courses of action, a consensus may begin to materialize. Then the instructor can begin to poke holes in that course of action and have students defend it if they can. Or perhaps two or more avenues will gain support and then the instructor can contrast each optional course of action to show students how each may benefit the situation or backfire. Finally, students can tackle the issue of whether a business decision in this context can also be an ethical decision.

Q: You are executive director of Qualitative Research Consultants Association (QRCA), an organization designed to assist market research practitioners. As part of their membership agreement, QRCA members agree to abide by a nine-point code of ethics that forbids practices such as discriminating in respondent recruitment and offering kickbacks or other favors in exchange for business. The code also calls for research to be conducted for legitimate research purposes, and not as a front for product promotion. Why do you think the QRCA and other market research organizations create such codes? Do you believe they are helpful in reducing unethical research practices? As QRCA director, what other areas of marketing research do you believe should be covered by ethical codes of conduct? A: Clearly, such codes are designed to provide researchers with ethical guidelines of conduct. The question of whether they help reduce unethical behavior is a tricky one. Many students will likely respond that the code at least becomes part of the subconscious and therefore will guide researchers toward ethical conduct. However, researchers can just easily recall the code, make an evaluation, disregard the code, and go ahead with the opportunistic behavior. As far as new areas for inclusion in the code, certainly there are many online research techniques that must be incorporated into a newly updated code. Data privacy issues, such as medical and financial scenarios, have been brought before the U.S. Congress and laws passed that deal with online snooping and “cookies.”

Practicing International Management Case Vietnam’s Emerging Market Potential 1.

Q: Update the political, legal, and economic situation in Vietnam; then select a product of your choosing and evaluate Vietnam’s potential both as a market and as a manufacturing site. A: As in earlier assignments, the screening process presented in this chapter with its many points for comparison is an excellent guideline to answer this question. Students will also want to consult sources such as The Economist and its sister publication Economic Outlook, among many others.

Q: What, if anything, can Western countries do to help improve the political climate for doing business in Vietnam? Give specific examples. A: Governments in the West can probably best help improve the business climate in Vietnam by developing closer ties with the government. They can provide aid for infrastructure improvements and help the government to streamline the bureaucracy. However, beyond this, Vietnam itself and its people must want to become more open to investment from Western companies. Without a change in the mindset of the nation’s government and its people, Vietnam is not likely to experience rapid progress.

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Q: What problems might a company encounter while conducting market research in Vietnam? Explain your answer. A: Students should review the problems covered in this chapter and consult the business press for stories about the cultural, political, legal, economic, and financial obstacles companies face when researching the market of Vietnam.

Q: What is your perception of products labeled “Made in Vietnam”? Do you think the type of product would play a role in forming your perception? If so, why? A: As discussed in this chapter, certain low-cost products will be unlikely to have any negative connotation if labeled “Made in Vietnam.” However, high-priced luxury or technical products would likely suffer from such a label. However, as Vietnam develops economically over time, any negativity of such a label on sophisticated goods would be expected to decline.

CHAPTER 13 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/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 A Final Word

A comprehensive set of specially designed PowerPoint slides is available for use with Chapter 13. 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 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. 2. Diversify sales to level off cash flow, making it easier to coordinate 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. 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. 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. iii. Governments, financial institutions, and companies have closer working relationships in Asia. The U.S. regulatory environment is wary of such arrangements, and the lines between companies and industries are clearly drawn.

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. 6. Disadvantages a. Can restrict a licensor’s future activities.

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Might reduce the global consistency of the quality and marketing of a product. 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. 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.

Management Contracts 1. One company supplies another with managerial expertise for a specific 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. b. 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. 4. 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.

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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. A.

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 Parties invest together in downstream business activities. b. Backward Integration Joint Venture Parties invest together in upstream business activities. c. Buyback Joint Venture Input provided by, and output absorbed by, each partner. d. Multistage Joint Venture One partner integrates downstream, and the other, upstream. 2. Advantages a. Can reduce risk. b. Penetrate international markets that are otherwise off-limits.

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Ch 13: Selecting and Managing Entry Modes Access another company’s international distribution network. 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. c. d. 3.

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 1. Culture can differ greatly, and managers can feel less confident in their ability to manage operations in the host country. 2. 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. 3. Importance of cultural differences diminishes when managers are knowledgeable about the culture of the target market.

Political and Legal Environment

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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 import regulations such as high tariffs or low quota limits can encourage investment. Company producing locally avoids tariffs that increase product cost; it does not have to worry about making it into the market below quota. 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. 2. Growing demand in China is attracting investment in joint ventures, 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 1. As companies gain international experience, they select entry modes that 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.

A FINAL WORD 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.

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Quick Study Questions Quick Study 1 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.

Quick Study 2 1.

Q: Why do companies engage in countertrade? List 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.

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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. 2.

Q: What are the four main methods of export/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. 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 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

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Ch 13: Selecting and Managing Entry Modes 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.

Quick Study 4 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

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many small- and medium-size firms; and (2) risk exposure is high because a wholly owned subsidiary requires substantial company resources. 2.

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 advantages and disadvantages 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 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.

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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.

Teaming Up 1.

Q: Research/Interview Project. As a team of three or four students, interview a manager of a company involved in international business. What method did the company use initially to go international? Does the company export? If so, is it a direct or an indirect exporter? How does the company receive payment for its goods? Does the company use different entry modes in different markets? What factors influenced its choice of entry mode in each case? How do managers deal with cultural differences when negotiating across cultures? Provide any other information on the company your team believes is relevant to the discussion of market entry. A: Students could be asked to present the results from this project to the class in a brief, ten-minute presentation so that all the students can benefit from each team’s research.

Q: Negotiation Project. This project is designed to introduce you to the complexity of negotiations and to help develop your negotiating skills. Background: A western European automobile manufacturer is considering entering markets in Southeast Asia. The company wants to construct an assembly plant outside Bangkok, Thailand, to assemble its lower-priced cars. Major components would come in from manufacturing plants in Brazil, Poland, and China. The cars would then be sold in emerging markets throughout Southeast Asia and the Indian subcontinent. Managers are hoping to strike a $100 million joint venture deal with the Thai government. The company would supply technology and management for the venture, and the government would contribute a minority share of financing to the venture. The

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company considers the government’s main contributions to be providing tax breaks (and other financial incentives) and a stable business environment in which to operate. Financial capital is flowing into Thailand at a fair pace. The currency is strong, and inflation remains low. As with other nations in the region, investors are generally wary of the nation’s stability. The new auto assembly plant would boost the local economy, reduce unemployment, and increase local wages. But some local politicians fear the company might be interested only in exploiting the country’s relatively low cost labor. Activity: Break into an equal number of negotiating teams of three or four persons. Half the teams are to represent the company and the other half the government. As a group, meet for 15 minutes to develop the team’s opening position and negotiating strategy. Meet with a team from the other side and undertake 20 minutes of negotiations. After the negotiating session, spend 15 minutes comparing the progress of your negotiations with that of the other pairs of teams. A: This exercise can teach students to evaluate investment projects not only from the standpoint of companies, but also from the perspective of governments. If taken very seriously, the students will also be able to judge their abilities as international negotiators. Take It to the Web We invite you to visit MyManagementLab.com, an innovative set of course-management tools for delivering all or part of your course online. MyManagementLab makes it easier for you to add meaningful assessment to your course. Whether you’re interested in testing your students’ recall of concepts and theories or in asking them to apply their new knowledge to real-world scenarios, MyManagementLab offers a variety of assessment questions to fit your needs. Ethical Challenges 1.

Q: You are the director of international operations for a leading clothing designer based in New York. Your firm recently formed a 50/50 joint venture with a top Latin American manufacturer. On a recent trip to the joint venture’s factory in Latin America, you uncovered discrepancies between the financial results sent to the U.S. parent company and those sent to the local parent firm. Further investigation has convinced you that the local venture’s top management is keeping two sets of accounting records to facilitate the diversion of funds to personal bank accounts. This scenario is not surprising to you, however, because it is rather common in the local country. What do you do? Do you confront your local joint venture partner directly or find another solution? Might you devise a policy that encourages the local partner to be honest in its financial reporting? If so, how do you go about doing this? A: Many firms are confronted with a dilemma similar to this one when they acquire firms or sign joint venture agreements with firms from developing countries that have cultures where corruption prevails. It is common practice for certain individuals to have two or three sets of financial statements (with the one with the lowest profits going to the government for tax purposes). As the director of international operations, you must reassure the local partners that it is expected that they are completely transparent in all financial reporting. A policy of rewards, such as profit sharing, and punishments, such as fines, could be implemented to encourage more openness and honesty in the process.

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Q: You own a small manufacturing firm in California and are considering entering either Australia or Hong Kong. You are unsure which country you should target and unclear about which entry mode is most appropriate. A recent study investigated the differences between ethical perceptions of business managers from Australia and Hong Kong. The researchers determined two factors that impact the perception of ethical problems: (a) culture and (b) the particular mode of market entry (e.g., exporting, contractual, investment in subsidiaries, or joint ventures). What ethical issues do you think might arise in conjunction with the various market entry modes discussed in this chapter? How might these issues influence your entry-mode selection? A: Certainly you must consider the cultural nuances that make Australia and Hong Kong distinctly different markets. Perceptions of trustworthiness, honesty, candor, and commitment are just a few of the countless ethical issues that can arise in any international entry mode. Cultural traditions and rituals tend to play an influential role in the mode of entry process and make an impact through such issues as relationship building, saving face, and communication styles.

Q: You are chief operating officer of a Germany-based telecommunications firm considering a joint venture inside China with a Chinese firm. The consultant you’ve hired to help you through the negotiations has just informed you that ethical concerns can arise when international companies consider a cooperative form of market entry (such as a joint venture) with a local partner. This is especially true when each partner contributes personnel to the venture because cultural perspectives cause people to see ethical decisions differently. This is of special concern to you because the venture plans to employ people from both China and Germany—which have very different cultural backgrounds. Is there anything that your two companies can do to establish ethical principles in such a situation—either before or after formation of the cooperative arrangement? Can you think of a company that succeeded in the face of such difficulties? A: There are many differences between the German and Chinese cultures that can add to the complexity of a joint venture agreement. The differences in saving face, low versus high context culture, and individualism between German and Chinese workers should be considered when developing any cooperative policies. These differences can lead to ethical misconceptions due to different behavioral expectations. Further, up-front and frank discussions of potentially damaging ethical issues can help avoid potentially disastrous results based in ethical dilemmas. Better late than never if the formation has already taken place.

Practicing International Management Case Telecom Ventures Unite the World 1.

This item can be assigned as a Discussion Question in MyManagementLab. Student responses will vary. 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.

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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.

CHAPTER 14 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 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 Developing Pricing Strategies

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Worldwide Pricing Dual Pricing Factors That Affect Pricing Decisions Transfer Prices Arm’s-Length Pricing Price Controls Dumping A Final Word

A comprehensive set of specially designed PowerPoint slides is available for use with Chapter 14. 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. 2. Companies reduce production and marketing costs by standardizing the physical features of their products and marketing strategies. 3. Other researchers say that standardization is just one strategy for going 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. b. Certain products do appeal to practically all cultures. c. Product standardization is more likely when nations share the same level of economic development.

DEVELOPING PRODUCT STRATEGIES A.

Laws and Regulations

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Companies must adapt their products to satisfy laws and regulations in a target market. 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. 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.

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. 2. Image can be positive for some products but negative for others. 3. Because it affects buyers’ perceptions of quality and reliability, national image is an important element of product policy. 4. 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

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fails to deliver on expectations, the buyer is dissatisfied and the company’s reputation is tarnished. F.

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. c. 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. Standardizing or Adapting Advertisements a. Most advertising in any one nation is produced solely for that domestic audience. Companies that advertise in multiple markets

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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 14.1): i. The company with an idea to communicate is the source. ii. 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.

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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 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.

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Ch 14: Developing and Marketing Products 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. c. One-level channel: One intermediary between producer and buyer. Two intermediaries make up a two-level channel, and so on. d. 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

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these products is small relative to their values, they can be processed or manufactured and then shipped. C.

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. A.

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

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

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Free-market price that unrelated parties charge one another. 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. 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. 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.

A FINAL WORD 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.

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Quick Study Questions Quick Study 1 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.

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

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Ch 14: Developing and Marketing Products 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 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 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.

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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 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.

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.

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Quick Study 4 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 between 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.

This item can be assigned as a Discussion Question in MyManagementLab. Student responses will vary. 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 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. Teaming Up 1.

Q: Research Project. With several of your classmates, choose a company in which you are interested. Consult recent annual reports and Internet sources to find out what new products that company has brought to market in the past year or two. Are those products truly new innovations, or are they simply extensions of existing products? What considerations likely guided the company in its product development efforts? A: Students should be encouraged to search through the company’s annual report and other information on the company’s Web site. They also might visit the company’s filings on the Securities and Exchange Commission (SEC) Web site (www.sec.gov).

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Q: Advertisement Project. For this team project, ask each member of your group to select a magazine publication from a nation other than their own. Look through each of them for ads from a single international firm or for advertisements featuring a particular product or brand. After you have identified three or four such ads, determine which of the five types of product and promotion policies is being used: dual extension, product extension/communications adaptation, product adaptation/communications extension, dual adaptation, or product invention. What explanation do you have for the particular method being used? A: Students might need to do some further research into the company’s business activities before answering this question fully.

Q: You are a lawyer working with the International Court of Justice in The Hague in the Netherlands. You have been asked to review a recent decision regarding extraterritoriality. The case: French survivors of the Holocaust sued Yahoo! U.S.A. because French citizens were purchasing Nazi memorabilia on Yahoo!’s U.S. Web site. The lawsuit also charged Yahoo! U.S.A. with hosting the Web sites of anti-Semitic groups. Although both these actions are illegal according to French law, they are permitted in the United States because of U.S. legislation protecting free speech. Because Yahoo!’s French Web site did not violate French law, the U.S. federal judge hearing the case threw it out. The judge ruled that French law does not have the right to dictate the behavior of U.S. firms operating inside the United States. Today, the Internet sometimes makes it difficult to determine where jurisdictions begin and end. If you had been the judge in this case, would you have ruled similarly? List the factors you considered in arriving at your decision. Can you think of any Internet controls that could stop such cases from happening in the future? A: There are a number of ways to view this dilemma. From the U.S. perspective, French law does not have jurisdiction over the operations of U.S. firms within their own country. Although with the Internet it does become a challenge at times to determine the exact area of operations of a Web site. Thus, from the French perspective it could be argued that because French citizens can access Yahoo.com (as opposed to Yahoo.fr in France), their laws apply. The Yahoo! managerial perspective must be considered as well. Is this negative publicity worth the marginal income for Yahoo!? Finally, the individuals who accessed the Nazi Web sites as well as the creators of these sites and sellers of memorabilia should be factored in to a final decision.

Q: You are an independent consultant currently working for Philip Morris. Competitors are alleging that in important developing markets such as Turkey, Philip Morris created

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Ch 14: Developing and Marketing Products special tobacco blends containing additives that give brands such as Marlboro an extra “kick.” If true, practices such as this by tobacco companies put the “standardization versus adaptation” issue in an unusual perspective. If Philip Morris does, in fact, adapt its products this way, do you argue such policies are ethical? If summoned before the firm’s board of directors, what advice would you give regarding the company’s policy on this issue? A: There are a number of underlying debates in this dilemma. The policies of the tobacco companies differ around the world because smoking is viewed quite differently around the world. In Turkey, smoking is not perceived as an evil, cancer-causing substance as it is in the United States. And in China, smoking can be considered a status symbol that you are successful and can afford the habit. Students should consider their own cultural bias in answering this question. If there are students from other countries in the class, it is very interesting to compare their different responses. With respect to image management, certainly Philip Morris must address the critics and the best way to do this may be to assert that they are adhering to local laws abroad and they are satisfying local demand for a stronger product.

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: 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 landline 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 on the more basic needs of young people, such as education and health.

CHAPTER 15 MANAGING INTERNATIONAL OPERATIONS LEARNING OBJECTIVES: 1. Identify the elements that are important to consider when formulating production strategies. 2. Identify key considerations when acquiring physical resources. 3. Identify several production matters that are of special concern to managers. 4. Describe the three potential sources of financing and the main financial instruments of each. CHAPTER OUTLINE: Introduction Production Strategy Capacity Planning Facilities Location Planning Location Economies Centralization versus Decentralization Process Planning Standardization versus Adaptation Facilities Layout Planning Acquiring Physical Resources Make-or-Buy Decision Reasons to Make Lower Costs Greater Control Reasons to Buy Lower Risk Greater Flexibility Market Power Barriers to Buying Raw Materials Fixed Assets Key Production Concerns Quality-Improvement Efforts Total Quality Management ISO 9000 Shipping and Inventory Costs Reinvestment versus Divestment Financing Business Operations Borrowing Issuing Equity Issuing American Depository Receipts Advantages of ADRs Venture Capital Emerging Stock Markets Internal Funding Internal Equity, Debt, and Fees Revenue from Operations Capital Structure

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A Final Word

A comprehensive set of specially designed PowerPoint slides is available for use with Chapter 15. 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 Essential to success in international markets are production strategies, including the decision to centralize or decentralize production and standardize or adapt production to national markets.

PRODUCTION STRATEGY Careful planning of production helps companies cut costs to become low-cost leaders and to design new products or product features necessary for a differentiation strategy. A.

Capacity Planning 1. Assessing a company’s ability to produce enough output to satisfy market demand. 2. If capacity now used is greater than the expected market demand, production must be scaled back. 3. Countries have different laws regulating the ability of employers to eliminate jobs; depending on the country, a firm may or may not need to give advance notice of layoffs or plant closings. 4. If market demand is growing, managers must determine in which facilities to expand production or whether additional facilities are needed to expand capacity. 5. Capacity planning is also extremely important for service companies.

Facilities Location Planning 1. Selecting a location for production facilities. 2. Key environmental factors in planning include the cost and availability of labor and management, raw materials, component parts, and energy. Other factors include political stability, the extent of regulation and bureaucracy, economic development, and the local culture, including beliefs about work and important traditions. 3. Reducing production costs through lower wages is often essential to keep products at competitive prices, especially when labor accounts for a large portion of total production. Lower wages must be balanced against worker productivity, which is lower in developing and emerging nations. 4. Service companies must locate near their customers and consider customers’ needs when locating facilities. 5. Supply issues are important in location planning; the greater the distance between production facilities and target markets, the longer it takes for customers to receive shipments.

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Marketing managers must compensate for delays by maintaining larger inventories in target markets—adding to storage and insurance costs. Shipping costs are greater when production is conducted far from target markets. Transportation costs are a driving force behind the globalization of the steel industry. Location Economies a. Economic benefits derived from locating production activities in optimal locations. b. Companies undertake business activities in a location or obtain products and services from companies located there. c. The key fact is that each production activity generates more value in a particular location than could be generated elsewhere. The productivity of a location is heavily influenced by labor and capital. Centralization versus Decentralization a. Centralized production refers to the concentration of production facilities in one location. Decentralized production spreads facilities over several locations and could mean one facility for each business environment. b. Companies often centralize production facilities in pursuit of low-cost strategies and to take advantage of economies of scale. c. Transportation costs and the physical landscape affect the centralization versus decentralization decision. d. Because they typically sell undifferentiated products in all markets, low-cost competitors do not need to locate near their markets to respond to changes in buyer preferences. They choose locations with the lowest combined production and transportation costs. e. Firms must balance the cost of getting inputs into production and getting products to market. f. Companies with differentiated products find decentralized production the better option; locating separate facilities near different markets, they remain close to customers and respond to buyer preferences. g. When R&D and manufacturing must cooperate for differentiation, they tend to be located in the same place, although today technology allows for separate locations.

Process Planning 1. Deciding the process a company will use to create its product. 2. Low-cost strategies require large-scale production because producers want the cost savings of economies of scale. 3. Differentiation strategies demand extra value by offering something unique, such as superior quality, added features, or special brand images. 4. Availability and cost of labor in the local market is crucial to process planning; if labor in the host country is cheap, a company opts for less technology and more labor-intensive methods in production. 5. Standardization versus Adaptation a. Production processes must be standardized or adapted for different markets.

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Large production batches reduce the cost of producing each unit, offsetting the higher initial investment in automation; costs are further reduced as employees repeat the process and learn. Differentiation demands decentralized facilities to improve local responsiveness; these facilities produce for a national or regional market and tend to be smaller. Eliminates economies of scale and increases per-unit production costs. R&D costs are higher for products with special product designs, styles, and features.

Facilities Layout Planning 1. Deciding the spatial arrangement of production processes within production facilities. 2. Facility layout depends on the type of production process, which depends on a company’s business-level strategy.

ACQUIRING PHYSICAL RESOURCES International companies must acquire physical resources to begin operations. They must decide whether to make or buy the components for production processes. What will be the sources of any required raw materials? Will the company acquire facilities and production equipment or build its own? A.

Make-or-Buy Decision Deciding whether to make a component or buy it from another company. 1. Reasons to Make Vertical integration is the process by which a company extends its control over additional stages of production—either inputs or outputs. When a company makes a product, it engages in “upstream” activities: Production activities that precede current business operations. a. Lower Costs i. The company decides to make the products rather than buy them in order to reduce total costs. ii. Companies use in-house production when it costs less than buying on the open market. iii. Small companies are less likely to make rather than buy, except if the company possesses technology or another competitive advantage. b. Greater Control i. Making rather than buying can give managers greater control over raw materials, product design, and the production process itself—all of which are important factors in product quality. ii. Companies often undertake in-house production when persuading a supplier to make special modifications to a product on their behalf is difficult. iii. Companies keep greater control over product design and features if they manufacture components themselves. iv. Companies also make rather than buy when buying requires providing key technology. 2. Reasons to Buy a. Outsourcing is the practice of buying from another company a good or service that is not central to a company’s competitive

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advantage. Outsourcing results from continuous specialization and technological advancement. By outsourcing, a company reduces vertical integration and its overall amount of specialized skills and knowledge. “Stealth manufacturing” calls for outsourcing the assembly of computers plus shipping to distributors and other intermediaries. Outsourcing is catching on in the pharmaceutical industry. Lower Risk i. Social unrest or open conflict can threaten physical facilities, equipment, and employee safety. ii. Eliminate the exposure of assets to political risk by refusing to invest in plants and equipment abroad; it can purchase products from international suppliers. iii. Eliminates the need to purchase expensive insurance coverage needed in an unstable country. But does not completely shield the buyer from disruptions; political instability can cause delays in receiving needed parts. Greater Flexibility i. Making in-house products that require huge investment in equipment and buildings often reduces flexibility. ii. Companies that buy products from one or more outside suppliers retain or gain flexibility. Added flexibility is key in a change of attitude toward outsourcing. iii. Maintaining flexibility is important when the national business environments of suppliers are volatile. Buying from several suppliers or establishing production facilities in several countries allows outsourcing from one location if instability erupts in another. iv. Volatility in exchange rates can increase or decrease the cost of importing; by buying from multiple suppliers in several countries, a company maintains the flexibility to change sources and reduce risk. v. Companies maintain operational flexibility by not investing in production facilities; it can then alter its product line very quickly. vi. A company has financial flexibility if its capital is not locked up in plants and equipment; it uses excess capital to pursue opportunities. Market Power i. Companies can gain power in their relationships with suppliers by becoming important customers. ii. Sometimes a supplier becomes a hostage to one customer when the supplier depends on a company with its production capacity; if the buyer outsources elsewhere, the supplier has few other customers. iii. This situation gives the buyer significant control in dictating quality improvements, forcing cost reductions, and making special modifications. Barriers to Buying i. Companies sometimes face obstacles when purchasing products from international suppliers.

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The government of the buyer’s country may impose import tariffs to improve the balance of trade. The services provided by intermediaries increase the cost of buying abroad.

Raw Materials 1. The twin issues of quality and quantity drive many decisions about raw material acquisition. 2. Some industries and companies rely almost exclusively on the quantity of locally available raw materials. 3. Raw material quality has a huge influence on the quality of a company’s end product.

Fixed Assets 1. Fixed assets are company assets such as production facilities, inventory warehouses, retail outlets, and production and office equipment. 2. Companies can (1) acquire or modify existing factories, or (2) build new facilities—called a greenfield investment. 3. Considering either option involves many individuals, such as production managers, site-acquisition experts, legal staff, and public relations staff. 4. Local infrastructure must support proposed on-site business operations.

KEY PRODUCTION CONCERNS How manufacturing operation companies maximize quality and minimize shipping and inventory costs, and important reinvestment versus divestment decisions. A.

Quality Improvement Efforts 1. Companies strive toward quality improvement for two reasons: costs and customer value. 2. Quality products keep production costs low by reducing waste in valuable outputs, reducing the cost of retrieving defective products, and reducing disposal costs due to defective products. 3. Some minimum level of acceptable quality is an aspect of every product today. A company that combines a low-cost position with a high-quality product can gain a competitive advantage. 4. Improving quality is important for service providers; quality is complex because a service is created and consumed at the same time. The interaction between an employee who delivers a service and the buyer is part of service quality. 5. Activities conducted prior to service delivery are also important. 6. Total Quality Management a. Emphasis on continuous quality improvement to meet or exceed customer expectations. It places responsibility on each individual to focus on the quality of output. b. By continuously improving quality, a company differentiates itself from rivals and attracts loyal customers. 7. ISO 9000 a. The International Standards Organization (ISO) 9000 is an international certification that companies receive when they meet the highest quality standards in their industries.

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To become certified, companies must demonstrate the reliability and soundness of all business processes affecting the quality of their products.

Shipping and Inventory Costs 1. Shipping costs can have a dramatic effect on the cost of getting materials and components to the location of production facilities. 2. Shipping costs are affected by a nation’s business environment, such as its level of economic development, including the condition of seaports, airports, roads, and rail networks. 3. Because storing inventory is costly, companies adopt just-in-time (JIT) manufacturing—in which inventory is kept to a minimum and inputs to production arrive exactly as needed. 4. JIT drastically reduces the costs of large inventories and reduces wasteful expenses because defective materials and components are spotted quickly during production.

Reinvestment versus Divestment 1. Managers need to decide whether to invest further in operations abroad or to reduce or divest international operations. 2. Companies continue investing in markets requiring long payback periods if the outlook is good. 3. Companies reinvest when a market is experiencing rapid growth. Investing in expanding markets is attractive because potential customers may not yet be loyal to the products of any one company or brand. 4. Companies scale back their international investments when it is apparent that profitability will take longer than expected. 5. Problems in the political, social, or economic sphere can force companies either to reduce investment or eliminate operations altogether. 6. Companies invest in operations offering the best return on investment; this means reducing investments or divesting operations in profitable markets to invest in more profitable opportunities elsewhere.

FINANCING BUSINESS OPERATIONS Companies need financial resources to pay for operating expenses and investment projects. They must buy raw materials and component products for manufacturing and assembly activities. They need capital for expanding production capacity or entering new geographic markets and financing to pay for training and development, to compensate workers and managers, and to advertise. A.

Borrowing 1. International companies (like domestic companies) try to get the lowest interest rates possible on borrowed funds. 2. Difficulties include exchange-rate risk, restrictions on currency convertibility, and restrictions on the international flow of capital. 3. Borrowing locally can be advantageous, especially when the value of the local currency has fallen against that of the home country. But companies are not always able to borrow funds locally; they are forced to seek international sources of capital.

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A back-to-back loan is a loan in which a parent company deposits money with a host-country bank, which then lends it to a subsidiary located in the host country.

Issuing Equity The international equity market consists of all stocks bought and sold outside the home country of the issuing company. This helps firms to access investors with funds unavailable domestically. Yet getting shares listed on another country’s stock exchange can be a complex process. Complying with all the rules and regulations governing a stock exchange costs time and money. 1. Issuing American Depository Receipts a. To maximize international exposure, non–U.S. companies list themselves on U.S. stock exchanges. A non–U.S. company can list shares in the United States by issuing American Depository Receipts (ADRs)—certificates that trade in the United States and represent a specific number of shares in a non–U.S. company. b. International companies also use Global Depository Receipts (GDRs), which are similar to ADRs but are listed and traded in London and Luxembourg. c. Advantages of ADRs: Buyers pay no currency-conversion fees, and there are no minimum purchase requirements. Also, companies offer ADRs in the United States to appeal to mutual funds because U.S. investment laws limit the amount that a mutual fund can invest in companies not registered on U.S. exchanges. 2. Venture Capital a. Venture capital is financing obtained from investors who believe that the borrower will experience rapid growth and receive equity (part ownership) in return. b. Venture capitalists invest in new risky ventures because they can generate large returns on investment. c. The venture capital industry has become global. 3. Emerging Stock Markets a. Companies in countries with emerging stock markets face two problems. First, emerging stock markets are often volatile. i. Investments can be either hot money—money that can be quickly withdrawn in a crisis—or patient money— investment in factories, equipment, and land that cannot be withdrawn easily. ii. Large and sudden sell-offs of equity are signs of market volatility that characterize emerging stock markets. Large sell-offs occur because of uncertainty regarding the nation’s future economic growth. b. Second is the issue of poor market regulation. i. Large local companies can wield influence over their domestic stock markets; if domestic shareholders dominate such exchanges, international investors may hesitate to enter. ii. The problem lies in regulation that favors insiders over international investors.

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Internal Funding Ongoing business activities and new investments can also be financed internally with funds supplied by the parent company or its international subsidiaries. 1. Internal Equity, Debt, and Fees a. Time is needed for new subsidiaries to become financially independent; so, parent companies finance operations. b. Subsidiaries often obtain capital by issuing equity solely to the parent, which benefits from an appreciating share price. c. Parent companies lend money to subsidiaries during the start-up phase and for new investments; subsidiaries with excess cash lend money to parent or sister companies when they need capital. 2. Revenue from Operations a. Revenue is earned from the sale of goods and services; this source of capital is the lifeblood of international companies and their subsidiaries. b. For long-term success, a company must generate sufficient revenue to sustain day-to-day operations; outside financing is required only to expand operations or to survive lean periods. c. A transfer price is the price charged for a good or service transferred between a company and a subsidiary. Companies set subsidiaries’ transfer prices high or low according to their own goals (e.g., to minimize taxes in a high taxation country).

Capital Structure 1. A company’s capital structure is the mix of equity, debt, and internally generated funds that it uses to finance its activities. 2. Firms try to strike the right balance among financing methods in order to minimize the cost of capital and risk. 3. Debt requires periodic interest payments to creditors such as banks and bondholders. If the company defaults on interest payments, creditors can sue the company or force it into bankruptcy; preferred stock equity holders can force bankruptcy because of default. 4. Companies prefer not to carry so much debt in relation to equity that it increases its risk of insolvency. 5. Debt appeals to companies because interest payments are deducted from taxable earnings—lowering the taxes a firm must pay. 6. National restrictions can influence the choice of capital structure. Restrictions include limits on international capital flows, the cost of local versus international financing, access to international financial markets, and currency exchange controls. 7. Choice of capital structure for subsidiaries is highly complex.

A FINAL WORD Whether an international company’s production activity involves manufacturing a product or providing a service, it must acquire many resources before beginning operations. It needs to resolve such issues as where it will get raw materials or components, how much production capacity it needs, whether to construct or buy new facilities, the size of service centers, and where it will get financing. The answers to these questions are complex and interrelated.

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Quick Study Questions Quick Study 1 1.

Q: Explain why capacity planning is important when formulating production strategy. A: Capacity planning is the process of assessing a company’s ability to produce enough output to satisfy market demand. If capacity is inadequate to fulfill forecasted demand, capacity must be expanded, and vice-versa. This affects production strategy.

Q: How is facilities location planning affected by (a) location economies and (b) centralized versus decentralized production? A: Facilities location planning is the process of selecting a location for production facilities. Key environmental factors in facilities location planning are 1) the cost and availability of labor and management, 2) raw materials, 3) component parts, and 4) energy. Location economies are economic benefits derived from locating production activities in optimal locations. Location economies can involve practically any business activity that companies in a particular location do very well, including performing research and development or providing financial services. The key point is that each production activity generates more value in a particular location than could be generated anywhere else. Centralized production refers to the concentration of production facilities in one location. With decentralized production, facilities are spread over several locations. Companies trying to be the low-cost leader of their industry often try to concentrate production as much as possible. Companies following a differentiation strategy often decentralize production to be closer to the nuances of different national markets.

Q: Explain how process planning is affected by the standardization-versus-adaptation decision. A: Process planning is deciding the process that a company will use to create its product. Availability and cost of labor in the local market is crucial to process planning. An important production issue in strategic planning is deciding whether the production process will be standardized for all markets or adapted to manufacture products modified for different markets. Low-cost leadership typically dictates automated, standardized production in large batches. Differentiation often requires smaller batches and much product tailoring or adaptation.

Q: How is facilities layout planning relevant to the formulation of production strategies? A: Facilities layout planning is deciding the spatial arrangement of production processes within production facilities. Facilities layout planning depends upon the type of production process a company employs, which in turn depends on the company’s business-level strategy.

Quick Study 2 1.

Q: List the main reasons why a company might decide to either make or buy a component. A: The make-or-buy decision entails deciding whether to make a component or buy it from another company. Companies often decide to make a product rather than buy it in order to reduce total costs. In general, companies will undertake in-house production when they can produce for less cost than they can buy on the open market. Also, making

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rather than buying can give managers greater control over raw materials, product design, and the production process itself—all of which are important factors in product quality. Companies often undertake in-house production when persuading a supplier to make special modifications to a product on their behalf is difficult. Companies also make rather than buy when buying from a supplier requires providing them with a key technology. 2.

Q: Explain the roles of vertical integration and outsourcing in the make-or-buy decision. A: Vertical integration is the extension of company activities into stages of production that provide a firm’s inputs or absorb its outputs. Vertical integration can influence the make-or-buy decision through its advantages of lower production costs, allowing greater control over production, making product modifications without persuading a supplier, and keeping key technology in-house. Outsourcing is the practice of buying from another company a good or service that is not central to a company’s competitive advantage. One reason why a company may buy rather than make a product is to lower risk. Political risk is quite high in certain markets. Sometimes the government of an intensely nationalistic nation might decide to expropriate or nationalize industries without concern for the interest of an international company. Although companies can shield themselves from such risks by outsourcing, international outsourcing can result in longer delivery times that can increase the probability that products will be delayed in transport. Another reason to buy is to gain flexibility. Making an in-house product that requires large investments in equipment and buildings often reduces flexibility. Companies that buy products from one or more outside suppliers retain or gain flexibility. Finally, companies can gain a great deal of power in their relationships with suppliers simply by becoming important customers.

Q: What are the main factors involved in acquiring (a) raw materials and (b) fixed assets? A: (a) The twin issues of quality and quantity drive many decisions about raw material acquisition. First, some industries and companies rely almost exclusively on the quantity of locally available raw materials. For example, companies involved in mining, forestry, and fishing. Second, raw material quality has a huge influence on the quality of a company’s end product (e.g., food-processing and beverage companies). (b) Fixed assets are company assets such as production facilities, inventory warehouses, retail outlets, and production and office equipment. When importing certain fixed assets, managers must assess both the cost in tariffs that will be imposed on imported equipment and the cost in time and effort that will be required to import it.

Quick Study 3 1.

Q: How do TQM and ISO 9000 help companies to improve quality and control costs? A: Companies strive toward quality improvement for two reasons. First, quality products help keep production costs low because they reduce waste in valuable outputs, reduce the cost of retrieving defective products from buyers, and reduce disposal costs due to defective products. Second, some minimum level of acceptable quality is an aspect of every product today. Total quality management is an emphasis on continuous quality improvement to meet or exceed customer expectations. Total quality management stresses a company-wide commitment to quality-enhancing processes. The International Standards Organization (ISO) 9000 is an international certification that companies get when they meet the highest quality standards in their industries. To become certified, companies must demonstrate the reliability and soundness of all business processes affecting the quality of their products.

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Q: Explain how shipping and inventory costs influence a firm’s international logistics decisions. What is just-in-time (JIT) manufacturing? A: Shipping costs can have a dramatic effect on the cost of getting materials and components to the location of production facilities. Then, shipping and inventory costs will heavily influence moving materials and components into and through the company. Companies manage the physical flow of raw materials and finished products to minimize the cost of logistics. Just-in-time (JIT) manufacturing is a production technique in which inventory is kept to a minimum and inputs to the production process arrive exactly when they are needed. It has become popular because the cost of storing inventory can be very high.

Q: What are several considerations that underlie the reinvest-versus-divest decision? A: If new and potentially profitable opportunities present themselves in the market, managers might decide to expand operations. In general, the reinvestment decision is based on four conditions. 1) Companies must decide whether to continue investing in markets requiring long payback periods. 2) Firms must decide whether increasing local investment is necessary merely to maintain market share and its competitive position. 3) Companies usually decide to reinvest when a market is experiencing rapid growth. 4) Companies may try to reduce international competition by investing in the home markets of international competitors. All companies have a limited supply of resources at their disposal to invest in current operations or new endeavors. There are three reasons why companies decide either to scale back or to eliminate operations abroad. 1) Companies scale back their international investments when it becomes apparent that making operations profitable will take longer than expected. 2) Problems in the political, social, or economic sphere can force companies either to reduce investment or eliminate operations altogether. 3) Companies invest in those operations offering the best return on their investments. That policy often means reducing investments or divesting operations in some markets even though they may be profitable, in order to invest in more profitable opportunities elsewhere.

Quick Study 4 1.

Q: Explain when a back-to-back loan might be useful to a company. A: A back-to-back loan is a loan in which a parent company deposits money with a hostcountry bank, which then lends it to a subsidiary located in the host country. This loan is useful when a foreign parent company has a subsidiary in a host country and has not yet built a reputation with local lending institutions.

Q: Why might a firm list its stock in the international capital market? Explain the advantages of an American Depository Receipt. A: Companies issue stock outside the home country primarily to access pools of investors with funds that are unavailable domestically. A non–U.S. company can list shares directly in the United States by issuing American Depository Receipts (ADRs)— certificates that trade in the United States and represent a specific number of shares in a non–U.S. company. There are three main advantages of ADRs. First, investors who buy

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ADRs pay no currency-conversion fees. Second, there are no minimum purchase requirements for ADRs, as there sometimes are for shares of a company’s stock. Third, companies offer ADRs in the United States to appeal to mutual funds. Investment laws in the United States limit the amount of money that a mutual fund can invest in the shares of companies not registered on U.S. exchanges. 3.

Q: Identify several difficulties facing companies that issue equity on emerging stock markets. A: Companies from countries with emerging stock markets face two main problems. First, emerging stock markets commonly experience extreme volatility. With this kind of market, you experience hot money—money that can be quickly withdrawn in times of crisis. This is in contrast to patient money—foreign direct investment in factories, equipment, and land that cannot be pulled out as readily. Second, companies that issue equity on their countries’ emerging stock markets are often plagued by poor market regulation.

Q: What is meant by the term capital structure? Explain its significance. A: A company’s capital structure is the mix of equity, debt, and internally generated funds that it uses to finance its activities. Firms try to strike the right balance among financing methods in order to minimize the cost of capital and their risk.

Talk It Over 1.

Q: Companies around the world are increasingly committing themselves to attaining International Standards Organization (ISO) certification in a variety of areas, including quality and pollution minimization. Do you think this is just the beginning of a trend toward worldwide homogenization of product and process standards? Do you think that someday all companies and their products will need certification in order to conduct international business? Explain your answers. A: This is probably the beginning of global product and process standards because firms want to sell their products globally, and customers worldwide demand high-quality products. European and non-European companies alike are working toward certification in order to ensure access to the European marketplace. The EU, especially when it has expanded, will become a huge market that companies will want to explore and will need certification to do so. Many companies also seek ISO 9000 certification because of the message of quality that certification sends to prospective customers.

Teaming Up 1.

Q: Research Project. The United States is home to some of the world’s leading computer software companies, most of which commonly outsource software development to other countries, including Egypt, India, Ireland, Israel, Malaysia, Hungary, and the Philippines. As a group, select one of these countries and explain why it has become a supplier to the computer software industry. Do you think that development of the industry in your chosen country is a threat to companies in the United States? Why or why not? A: Students will likely need to do research (in the library or on the Internet) to answer this question adequately. The perspective of students in the class from these countries would clearly be of interest to many of their classmates.

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Q: Interview Project. With several classmates, contact a manager at a local company that does business internationally. Talk to the manager about total quality management and ISO standards. Find out whether the company has a formal TQM program and whether it has obtained any type of ISO certification. Compile your findings and present them to the class in a short presentation. Compare and contrast the findings obtained for each company the class studied. A: This project can be done as a term paper over several weeks in the semester.

Q: Financing Project. Suppose you and several classmates are a team assembled by the chief financial officer of a consumer-goods company based in Mexico. Your company wishes to expand internationally but lacks the necessary financial capital. Describe all the financing options that are available to your company. Explain why each option is feasible, taking into account the prevailing situation in the Mexican and international capital markets. Develop a short presentation to be delivered to your board of directors (the rest of your classmates). A: Students should be sure to consider the current financial and economic conditions prevailing in Mexico at the present time. Options for financing can rapidly change depending on financial and economic conditions. Students should supply several financing options under different scenarios for the Mexican economy.

Q: You are senior vice president of human resources for a major multinational company. Your firm recently “reengineered” and fired a number of long-time workers. Your firm then rehired many of the same workers, but this time as consultants with no benefits paid by your firm. Critics charge that your firm’s practice of reengineering is synonymous with “downsizing”—laying off employees or reducing employment ranks through early retirement or other means. Is it ethical for your company to behave in this manner? As the head of human resources, is there an alternative to the current practice of your firm? A: Contract labor is a strategy used to keep the costs down and still have skilled employees. It is ethical because many contract workers desire the arrangement and understand the company’s need to keep costs down. Workers can accept or reject an assignment and perhaps enjoy job flexibility. Many retirees wish to work part-time. On the other hand, dissatisfied contract workers can seek employment elsewhere or retrain and pursue a different line of work. As the head of HR, there are a number of plausible solutions; perhaps partial benefits could be offered to certain contract workers who are working a significant number of hours. Or if more permanent positions become available, the contract workers could be first in line.

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Q: You are special assistant to the governor of a southeastern U.S. state in which unemployment (especially in rural areas) is well above the national average. After nearly three years in office and elected on a pledge to attract industry and create jobs, the governor is concerned. Because he respects your moral stance on issues, the governor has come seeking your insights. A European automobile maker has just told the governor that your state is on its short list of potential sites for a new manufacturing facility. The facility is expected to employ about 1,500 people, with plenty of spillover effects on the wider economy. The governor informs you the European automaker expects significant incentives and concessions. The governor would like to offer some $300 million in tax breaks and subsidies in an effort to bring the new plant to the state. How do you advise the governor? Would the outlay be proper use of taxpayer money? Why or why not? Would you feel comfortable defending your advice if it were to become public? A: A similar scenario actually occurred in Alabama when Mercedes signed a deal to open its new state-of-the-art manufacturing facility. Taxpayer money often fosters economic development packages in large and small communities throughout the United States. Many jobs are subsequently created as a result of the influx of new businesses. It can be a proper use of taxpayer money based on the rationale that a new facility brings new jobs plus increased activity for the local real estate market, retail businesses, health care providers, and the local educational facilities.

Practicing International Management Case Toyota’s Strategy for Production Efficiency 1.

This item can be assigned as a Discussion Question in MyManagementLab. Student responses will vary. Q: Chrysler engineers helped Toyota develop its Sienna minivan. In

return, Toyota provided input on automobile production techniques to Chrysler. Why do you think Chrysler was willing to share its minivan know-how with a key competitor? A: Clearly, Chrysler felt that obtaining insight into Toyota’s production techniques outweighed the costs of giving Toyota engineering designs on a model that (as normally is the case) will be redesigned a few years down the road. However, insight into Toyota’s methods could give Chrysler a huge advantage over its domestic rivals. 2.

Q: What other benefits do you think Toyota obtains from its production system? Think in broader terms than just production, and consider financial, marketing, and human resource management issues. A: Toyota must feel it can outdo the competition. Based on its past performance of gaining a cost advantage in its other products, Toyota might also gain a cost advantage in minivans and put a great deal of pressure on Chrysler.

CHAPTER 16 HIRING AND MANAGING EMPLOYEES LEARNING OBJECTIVES: 1. Explain the three different types of staffing policies used by international companies. 2. Describe the recruitment and selection issues facing international companies. 3. Discuss the importance of training and development programs, especially cultural training. 4. Explain how companies compensate managers and workers in international markets. 5. Describe the importance of labor–management relations and how they differ around the world.

CHAPTER OUTLINE: Introduction 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 Nonmanagerial Workers Selecting Human Resources Culture Shock Reverse Culture Shock Dealing with Reverse Culture Shock Training and Development Methods of Cultural Training Environmental Briefings and Cultural Orientations Cultural Assimilation and Sensitivity Training Language Training Field Experience Compiling a Cultural Profile Nonmanagerial Worker Training Employee Compensation Managerial Employees Bonus and Tax Incentives Cultural and Social Contributors to Cost Nonmanagerial Workers Labor–Management Relations Importance of Labor Unions

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International Labor Movements A Final Word

A comprehensive set of specially designed PowerPoint slides is available for use with Chapter 16. 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 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 relations. International HRM differs considerably from HRM in a domestic setting because of differences in national business environments. There is the issue of expatriates—citizens of one country who are living and working in another; many issues arise when expatriate employees have job assignments that last several years. Culture is central to the discussion of how international companies manage their employees. Training and development programs and recruitment and selection practices must often be tailored to local practices.

INTERNATIONAL STAFFING POLICY Staffing policy is the means by which a company staffs its offices; staffing policy is influenced by international involvement. The main approaches to the staffing of international operations are ethnocentric, polycentric, and geocentric. Companies often blend different staffing policies. A.

Ethnocentric Staffing Individuals from the home country manage operations abroad. Appeals to companies that want control over decision making in offices abroad and that formulate policies designed to work in every country of operations. Firms pursue this policy only for top managerial posts in their international operations because at lower levels, it is impractical. 1. Advantages of Ethnocentric Staffing a. Locally qualified people are not always available. In developing and newly industrialized countries, there is often a shortage of qualified personnel—resulting in a highly competitive local labor market. b. Companies use ethnocentric staffing to re-create operations in the image of home-country operations. c. Expatriate managers infuse branch offices with the corporate culture; important to shared values in each international office implementing global strategies. The image of home-office operations can ease the transfer of special know-how.

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Some firms feel managers sent from the home country will look out for the company’s interests more than host-country natives. e. Companies that operate in highly nationalistic markets and those worried about industrial espionage use an ethnocentric approach. Disadvantages of Ethnocentric Staffing a. Relocating managers from the home country is expensive. Bonuses for relocating, plus relocation expenses for families, increase the cost of a manager. Cultural differences and long periods away from relatives and friends contribute to the failure of international assignments. b. Can create barriers for the host-country office. Home-country managers in the host country encourage a “foreign” image of the business; lower-level employees feel that managers do not understand their needs. Expatriate managers may not overcome cultural barriers or understand the needs of their local employees or their local customers.

Polycentric Staffing Individuals from the host country manage operations abroad. 1. Well suited to companies that want to grant autonomy in decision making. But this policy does not mean that host-country managers are left to run operations any way they see fit. 2. Large international companies conduct extensive training programs in which host-country managers visit home offices for extended periods to be exposed to the company’s culture and business practices. 3. Advantages and Disadvantages of Polycentric Staffing: a. Places managerial responsibility in the hands of people familiar with the local business environment. b. Managers with deep cultural understanding of the local market can be an enormous advantage. c. They need not overcome cultural barriers created by being an outsider, and they have a better feel for the needs of employees, customers, and suppliers. d. Eliminates the high cost of relocating expatriate managers and families. e. But with natives of each country managing, a company becomes a collection of national businesses. f. For a firm following a global strategy, a lack of integration, knowledge sharing, and a common image may negatively affect performance.

Geocentric Staffing Best-qualified individuals, regardless of nationality, manage operations abroad. The local manager is from the host country, from the home country, or from a third country, depending on specific needs. Reserved for top-level managers. 1. Advantages and Disadvantages of Geocentric Staffing: a. Develops global managers who adjust to any business environment and to cultural differences. b. Useful for companies trying to break down nationalistic barriers among managers in an office or between different offices.

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The main drawback is cost. The high demand for people with special skills and their short supply have inflated salaries.

RECRUITING AND SELECTING HUMAN RESOURCES Companies try to recruit and select qualified managers and nonmanagerial workers well suited to their tasks and responsibilities. How does a company recruit and select the best available individuals? A.

Human Resource Planning 1. Forecasting both a company’s human resources needs and supply. 2. Phase one: take inventory of a company’s current human resources. Data is collected on employees, including education, job skills, previous jobs, language skills, and experience living abroad. 3. Phase two: estimate future HR needs to decide whether to hire employees or to subcontract production to other producers. a. This decision can raise ethical questions. Subcontracting work to low-wage nations and allegations of workplace abuse cause many firms to establish codes of conduct and step up efforts to ensure compliance. 4. Phase three: managers develop a plan for recruiting and selecting people to fill vacant and anticipated new positions. 5. A firm must make plans for reducing its workforce—a process called decruitment—when HR levels are greater than anticipated.

Recruiting Human Resources Identifying and attracting qualified applicants for vacant positions. 1. Current Employees a. Likely candidates within the company are those managers who were involved in previous stages of an international project. b. These individuals may have important contacts in the host country and have been exposed to its culture. 2. Recent College Graduates a. Companies also recruit from among recent college graduates who have come from other countries to attend college in the firm’s home country. b. This is a common practice among U.S. companies; new hires receive general and specialized training and receive positions in their native countries. They learn about the organization’s culture and how it conducts business. c. Most important is their familiarity with the culture of the target market, including its customs, traditions, and language. 3. Local Managerial Talent a. Hiring local managers is common when cultural understanding is a key job requirement. b. Hiring local managers with government contacts may speed the approval process for local operations. c. Governments may force a company to recruit local managers to develop its own managerial talent. d. Governments may restrict the number of international managers that can work in the host country. 4. Nonmanagerial Workers

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Companies recruit locally for nonmanagerial positions if there is little need for specialized skills or training. A specialist from the home country is brought in to train people chosen for more demanding positions. Firms turn to the local labor market when governments restrict the number of workers allowed into the host country; such efforts reduce unemployment among the local population. Countries sometimes permit the importation of nonmanagerial workers.

Selecting Human Resources 1. Screening and hiring the best-qualified applicants with the greatest performance potential. 2. For international assignments, it is essential to measure a person’s ability to bridge cultural differences. 3. Expatriate managers must adapt to a new way of life in the host country and work with others from different cultural backgrounds. 4. Culturally sensitive managers increase the likelihood that a company will achieve its business goals. 5. Recruiters assess cultural sensitivity by asking candidates questions about their receptiveness to new ways of doing things and questions about racial and ethnic issues. They can employ global aptitude tests. 6. The cultural sensitivity of each family member going to the host country needs assessment; the inability of a family member or spouse to adapt is the most common reason for the expatriate failure.

Culture Shock 1. Culture shock is a psychological process that affects people living abroad, characterized by homesickness, irritability, confusion, aggravation, and depression. 2. A person experiencing it has trouble adjusting to the new environment in which they find themselves. 3. Expatriate failure—the early return by an employee from an international assignment because of inadequate job performance—often results from cultural stress. 4. The higher cost of expatriate failure is convincing many companies to invest in cultural-training programs for employees sent abroad.

Reverse Culture Shock 1. Reverse culture shock is the psychological process of re-adapting to one’s home culture. 2. Values and behavior that once seemed so natural now seem strange, and returning managers find that either no position or a “standby” position awaits them in the home office. 3. Companies often do not take full advantage of the cross-cultural abilities of managers who have spent valuable years abroad. 4. Expatriates who successfully adapt to new cultures often leave their companies within a year of returning home because of difficulty blending back into the company culture. 5. Spouses and children often have difficulty leaving the adopted culture and returning home.

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Dealing with Reverse Culture Shock a. Home-culture reorientation programs and career-counseling sessions for returning managers and their families can be highly effective. b. The employer might bring the family home for a short stay before the return to prepare for reverse culture shock. c. Good career development programs help companies retain valuable managers. Ideally, a career development plan is created before an employee goes abroad. d. Mentors can be assigned to returning managers; mentor becomes a confidant so the expatriate manager can discuss problems about work, family, and readjustment to the home culture.

TRAINING AND DEVELOPMENT After recruitment and selection, a company identifies the skills and knowledge needed to perform duties. Employees lacking the necessary skills or knowledge go into training or development programs. Companies realize the need for in-depth training and development programs if they want maximum productivity from managers abroad. A.

Methods of Cultural Training 1. The extent of a company’s international involvement demands a corresponding level of cultural knowledge from employees. 2. Companies that are highly international need employees with language fluency and in-depth experience in other countries; small companies or those new to global business begin with basic cultural training. 3. Companies use many methods to prepare managers for international assignments. The goal of most programs is to create informed, openminded, and flexible managers with a level of cultural training appropriate to the duties required of them. 4. Environmental Briefing and Cultural Orientations a. Environmental (area) briefings include information on local housing, health care, transportation, schools, and climate. b. Cultural orientations offer insight into social, political, legal, and economic institutions. 5. Cultural Assimilation and Sensitivity Training a. Cultural assimilation teaches the culture’s values, attitudes, manners, and customs. b. Guerilla linguistics, which involves learning some phrases in the local language, is used at this stage. c. Also useful at this stage is role-playing: the trainee responds to a situation and is evaluated by a team of judges. d. Sensitivity training teaches people to be considerate and understanding of other peoples’ feelings and emotions. 6. Language Training a. This level of training gets a trainee “into the mind” of local people—to learn more about why people behave as they do. b. This is perhaps the most critical part of cultural training for longterm assignments. c. A survey of top executives found that foreign-language skills topped the list of skills needed for a competitive edge. 7. Field Experience

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Field experience means visiting the culture, walking the streets of its cities and villages, and becoming absorbed by it for a short period of time. The trainee enjoys the unique cultural traits and feels the stresses inherent in living in the culture.

Compiling a Cultural Profile Cultural profiles can be quite helpful in deciding whether to accept an international assignment. Sources for constructing a cultural profile include: 1. CultureGrams: This guide can be found in the reference section of many libraries. Updates make this a timely source of information. 2. Country Studies Area Handbooks: This series explains how politics, economics, society, and national security issues are related and shaped by culture in more than 70 countries. 3. Background Notes: These notes contain relevant factual information on human rights and related issues. Published by the U.S. State Department, they take a U.S. perspective. 4. Information can also be obtained by contacting the embassies of other countries and by locating people with firsthand knowledge and specific books and films.

Nonmanagerial Worker Training 1. Nonmanagerial workers have training and development needs, especially in developing and newly industrialized countries where people have not completed primary school. 2. Even when well educated, workers may lack industry experience. 3. The need for basic-skills training grows as companies explore opportunities in emerging markets. 4. In some countries, students who are unable or unwilling to enter college can enter programs paid for by the government and private industry and undergo extensive training for cutting-edge technologies (e.g., Japan and Germany lead the world in vocational training and apprenticeship programs for nonmanagerial workers).

EMPLOYEE COMPENSATION Goal should be to attract and retain the best and brightest employees and reward them for their performance. Because a country’s compensation practices are rooted in its culture, legal, and economic systems, determining compensation is complicated. A.

Managerial Employees 1. Compensation packages must reflect the cost of living, which includes the cost of groceries, dining out, clothing, housing, schooling, heath care, transportation, and utilities. 2. It costs more to live in some countries, and within a country the cost of living varies from large cities to rural towns. 3. Managers who relocate to lower cost-of-living countries are paid the same amount that they were receiving at the home office; otherwise, they would be penalized for accepting an international job. 4. Companies cover other costs incurred by expatriate managers such as high-quality local education. 5. Bonus and Tax Incentives

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Companies commonly offer inducements for international postings; the most common is a financial bonus. b. Hardship pay involves bonuses for an unstable country or one with a very low standard of living. c. The U.S. government permits citizens working abroad to exclude “foreign-earned income” from their taxable income in the United States. Cultural and Social Contributors to Cost a. Culture is a key to the compensation of expatriate managers. b. Some nations offer more paid holidays, free medical care, and plans for taking seriously ill expatriates and family members home or to nearby countries. c. Companies that hire managers in the local market might encounter additional costs engendered by social attitudes (e.g., paid maternity leave). d. Host-country managers receive the same pay as managers who work for local companies but receive special perks.

Nonmanagerial Workers Two main factors influence the wages of nonmanagerial workers. 1. First, their compensation is strongly influenced by increased cross-border business investment. 2. Employers can relocate fairly easily to nations where wages are lower. But workers at home must accept lower wages or see jobs lost. 3. This may create a trend toward greater equality in workers’ pay worldwide. An equalizing effect may encourage improvement in workers’ lives in some countries at the expense of those in others. 4. But freedom to relocate differs from country to country; some countries allow firms to move with little notice, others impose restrictions. 5. Second, labor is more mobile than ever before. 6. Although labor laws in Europe are more stringent than in the United States, EU countries are abolishing the requirement that workers from one EU nation obtain visas to work in another (e.g., if workers in Spain have no work or the pay is inadequate, they can move to another EU country).

LABOR–MANAGEMENT RELATIONS The positive or negative condition of relations between management and workers. When management and workers realize they depend on each other, the company is better prepared to meet its goals and surmount unexpected obstacles. Giving workers a greater stake in the company—through profit-sharing plans—can increase morale and generate commitment to improved quality and customer service. Because relations between laborers and managers are human relations, they are rooted in culture and are affected by political movements. To control operations, large companies make high-level labor decisions at home; but lower-level decisions are typically left to managers in each country. Localizing management decisions contributes to better labor–management relations because local managers may handle local matters more effectively. A.

Importance of Labor Unions

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3. 4. 5. 6.

The strength of labor unions where a company has operations affects performance and the selection of a location. Developing and emerging markets in Asia are popular for international companies, and some Asian governments appeal to companies by promising to keep labor unions in check. Developed nations are attractive if a cooperative atmosphere exists between company management and labor unions. Labor unions are stronger in France and Germany although union membership in Germany has fallen. Under codetermination, German workers enjoy a direct say in the strategies and policies of their employers. International Labor Movements a. Unions around the globe try to improve the treatment of workers and reduce incidents of child labor. b. It is difficult for a union in one nation to support its counterpart abroad. Events abroad are difficult to comprehend, and workers compete for jobs at multinational companies. c. Labor unions in one country might offer concessions to attract the jobs created by a new production facility; in this way, unions in different nations compete against one another. d. Some argue that this phenomenon creates downward pressure on wages and union power worldwide.

A FINAL WORD This chapter concludes our survey of international business. We studied how firms, ranging from small- and medium-size businesses to large global companies, hire and manage their most important resource—their employees. We hope we piqued your interest in the goings-on of the global marketplace and in the activities of international companies of all types and sizes.

Quick Study Questions Quick Study 1 1.

Q: List several ways in which human resource management differs in the international versus domestic environment. A: International HRM differs considerably from domestic HRM due to differences in culture, politics, law, and economics. Hiring practices in some nations need not be nondiscriminatory. Training and development often needs tailoring to local practices. For example, Germany and Japan have numerous vocational-training schools that turn out highly skilled graduates. Many companies go abroad in the first place to take advantage of a lower pay scale in another country. Companies must determine how to compensate expatriate employees on job assignments that could last several years.

Q: What are the three different types of international staffing policies that companies can implement? A: In ethnocentric staffing, operations outside the home country are managed by individuals from the home country. This policy tends to appeal to companies that want to maintain tight controls over the decision making of branch offices abroad.

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In polycentric staffing, operations outside the home country are managed by individuals from the host country. This policy does not mean that host-country managers are left to run operations in any way they see fit. Large international companies usually conduct extensive training programs in which host-country managers visit home offices for extended periods. In geocentric staffing, operations outside the home country are managed by the best-qualified individuals, regardless of nationality. This policy is typically reserved for top-level managers. 3.

Q: Identify the advantages and disadvantages of each type of international staffing policy. A: Ethnocentric staffing: First, locally qualified people are not always available. Second, companies use ethnocentric staffing to re-create local operations in the image of homecountry operations. Third, 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. There are two main 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. Polycentric staffing: First, it can eliminate the high cost of relocating expatriate managers and their families. Second, it places managerial responsibility in the hands of people intimately familiar with the local business environment. The one major drawback of this policy is the potential for losing control over the host-country operation. Geocentric staffing: This staffing policy helps a company develop global managers who can adjust easily to any business environment, particularly to cultural differences. The main disadvantage of this policy is that it is expensive. The combination of a high demand for people with these special skills and their short supply has inflated their salaries.

Quick Study 2 1.

Q: Why is human resources planning important? Identify its three phases. A: Human resource planning is important in order for the firm to forecast its human resource needs and supply. The process involves three stages: (1) taking an inventory of the company’s human resources; (2) estimating the company’s future needs for human resources; and (3) developing a plan for recruiting and selecting human resources.

Q: What are the main sources from which companies recruit their international managers? A: Companies recruit their employees internally or through external sources. Likely candidates within the company (current employees) are those managers who were involved in previous stages of an international project. Companies also recruit from among recent college graduates who have come from other countries to attend college in the firm’s home country. Hiring local managerial talent is common when cultural understanding is a key job requirement. In some cases, a government forces a company to recruit local managers so that the nation can develop its own internal pool of managerial talent. Companies typically recruit locally for nonmanagerial workers because there is often little need for highly specialized skills or training.

Q: What is meant by the term culture shock? Describe its four stages and how its effects can be reduced.

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Ch 16: Hiring and Managing Employees A: Culture shock is a psychological process that affects people living abroad and is characterized by homesickness, irritability, confusion, aggravation, and depression. It is important in the selection of international managers because it is often the cause of managers failing in their international assignment and returning home. This can be extremely expensive for companies. Culture shock typically involves four stages: (1) In the “honeymoon” stage, the new arrival is thrilled by the new environment and its opportunities. (2) After the new experience has worn off, expatriates experience frustration with the culture and its quirks and relationships may become strained. (3) Expatriates hit bottom and begin to learn to appreciate the culture and its people. And finally, (4) expatriates begin to effectively assimilate into the culture and to adapt to the unique situations. Culture shock can be reduced by: (1) psychological assessment to determine if the employee and family can emotionally handle the assignment; (2) obtaining language and cultural training; (3) visiting the country before the assignment; (4) meeting people and discussing experiences; (5) taking a worldly perspective and keeping a sense of humor.

Q: Under what circumstances might someone experience reverse culture shock? A: Reverse culture shock is the psychological process of re-adapting to one’s home culture. Expatriates who successfully adapt to new cultures often leave their companies within a year of returning home because of difficulty blending back into the company culture. In addition, spouses and children may have difficulty adapting to their own culture after an extended stay abroad.

Quick Study 3 1.

Q: Identify the types of training and development used for (a) international managers and (b) nonmanagerial workers. A: For managers, the goal is often to create informed, open-minded, and flexible employees with cultural training appropriate to their duties. Environmental briefings typically include information on local housing, health care, transportation, schools, and climate. Cultural orientations offer insight into social, political, legal, and economic institutions. Cultural assimilation teaches the culture’s values, attitudes, manners, and customs. Sensitivity training teaches people to be considerate and understanding of other peoples’ feelings and emotions. In-depth language training gets a trainee “into the mind” of local people to learn why people behave as they do. Field experience means visiting the culture, and becoming absorbed by it for a short period of time. Nonmanagers also have a need for training and development, especially in developing countries where basic educational opportunities are limited and industrial experience may be new. In many countries, national governments cooperate with businesses to train nonmanagerial workers. Japan and Germany lead the world in vocational training and apprenticeship programs for nonmanagerial workers.

Q: Describe each type of cultural training used to prepare managers for international assignments. A: Many methods of cultural training are available to prepare managers for international assignments: environmental briefings, cultural orientations, cultural assimilations, sensitivity training, language training, and field experience.

Q: What variables are involved in decisions regarding employee compensation for (a) managers and (b) nonmanagerial workers?

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A: Compensation for managerial employees must reflect the cost of living in that country. Culture plays an important role in the compensation of expatriate managers. For example, many countries offer free medical care to everyone living and working there. Companies that hire managers in the local market might encounter additional costs engendered by social attitudes. In some countries, employers are expected to provide free or subsidized housing. Two main factors influence the wages of nonmanagerial workers. First, their compensation is strongly influenced by increased cross-border business investment. Second, because labor is more mobile today than ever before, wages are affected. Quick Study 4 1.

Q: What is meant by the term labor–management relations? A: Labor–management relations are the positive or negative condition of relations between company management and its workers. Positive relations between labor and management can give a firm a competitive advantage. Because labor–management relations are human relations, they are rooted in culture and are often influenced by political movements in a market.

Q: Explain how labor–management relations differ around the world. A: The strength of labor unions in a country where a company has operations is important to its performance and can even affect the selection of a location. Unions around the globe are trying to improve the treatment of workers and reduce incidents of child labor. Although a union in one nation might wish to support its counterpart in another country, it is difficult for two reasons. First, events taking place in one country are difficult for many people to comprehend. Second, workers in different countries sometimes compete against one another for jobs with multinational companies.

Talk It Over 1.

This item can be assigned as a Discussion Question in MyManagementLab. Student responses will vary. Q: Many Japanese companies utilize 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: Many Japanese companies prefer to have Japanese in top management positions in international subsidiaries. Japanese managers may be more likely to act in the best interest of the company and have a better understanding of how the home office wants the subsidiary run. Also, many Japanese companies feel that without Japanese in the top positions, they cannot have faith that orders will be dutifully executed. 2.

Q: Did you ever experience culture shock? If so, in which country did it occur? What, if anything, did you do to overcome it? Did your methods work? Did you experience reverse culture shock on returning home? A: This is an interesting opportunity to have students who have experienced culture shock to discuss their experiences with the rest of the class. Students who have not experienced it find it a difficult concept to understand. But listening to the travails of fellow classmates is likely to make it more relevant and really bring it home for them.

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Teaming Up 1.

Q: Labor-Relations Project. Suppose you and several of your classmates are the senior management team for a major automobile manufacturer. Among your company’s worldwide operations are plants in Spain and Germany. Your company is considering closing these two plants and moving production to Poland in order to take advantage of lower wages. As a group, write a short report explaining how easy (or difficult) it will be for your company to close the plant and lay off workers in both Spain and Germany. A: Students will likely need to do research (in the library or on the Internet) to answer this question adequately. The perspective of students in the class from Spain or Germany would clearly be of interest to many of their classmates.

Q: Research Project. Small- and medium-sized businesses sometimes face significant obstacles when expanding operations abroad. Write a group report on the obstacles they face in the area of recruiting and selecting employees when first venturing internationally. Address specific issues such as financial constraints, a lack of contacts, cultural differences, legal issues, geographical distance, and so on. A: This research exercise can be presented orally to the class and used as a short term paper. Encourage students to consult publications such as the Economist.

Q: You are an expatriate manager at a manufacturing facility in Asia on your first assignment abroad. You are aware of increasing concern among your employees (mostly young women) about wages that barely permit them to live at subsistence level. The plant is not unionized, and you know that your superiors in your home country are not particularly supportive of efforts to organize workers. You also know that if workers vote to form a union and then demand higher wages, headquarters is likely to shift production elsewhere. If the plant were shut down, your employees would lose their jobs, and you would be transferred. Should you encourage or discourage your workers in their efforts to unionize? Explain your decision. A: As manager of the manufacturing facility, headquarters could be asked for things other than salary that could improve the standards of living for the workers. A donation to a local charity that helps out poor families is one option. Another is to give local schools and hospitals grant money for needed repairs or equipment. Another option is to provide health check-ups free of charge for the workers and their immediate families. Anything that could be helpful in terms of raising living standards yet would not jeopardize the jobs of employees is probably the best avenue to follow.

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This item can be assigned as a Discussion Question in MyManagementLab. Student responses will vary. Q: You are an assistant marketing manager for a financial services

firm expanding operations in Latin America. You were sent to Mexico City, Mexico, in part because you double-majored in Spanish and marketing and spent a semester abroad there. Your company’s policy is to provide you and your expatriate colleagues with hardship pay, a generous housing allowance, a company car, and a fund of several thousand dollars to be used at your discretion. You are quite comfortable living abroad, but you have some expatriate friends who have not adjusted so well. Every two months or so, they fly back home to visit friends and get a change of scenery. You are not homesick at all, but your friends want you to go with them on an upcoming holiday. What would you do? Would you dip into your discretionary funds and go along? Or, would you remain in the community and do volunteer work with a local charity? A: This is a highly personal question for the students and one that they likely can relate to very well. The variety of answers provided to this question should make for a lively discussion of what is the “right” thing to do with the money in this context. It may be interesting to also ask why the other students seem to miss home so much. Further, the living situation and duration of the contract in Mexico City may play a role in the final decision. Practicing International Management Case Expatriation or Discrimination? 1.

Q: In addition to those mentioned in the case, what are some other advantages associated with the hiring of local managers in emerging markets? A: Local managers have intimate knowledge of the local culture and how the local business community functions. This can help a company get farther ahead than it might possibly have been able to do with an expatriate in charge.

Q: What steps should a company take to ensure that, if taken to court, it can demonstrate that staffing cuts have not been discriminatory? A: It should do exactly as Ricoh had done in the case. It must have documentation and hard evidence of poor performance in job-related activities. These cannot be simply “trumped-up charges” but must be made honestly and ethically in the best interests of the company’s performance.