Solution Manual For International Business The Challenges of Globalization, 10th Edition by John J. by StudyGuide

CHAPTER 1 GLOBALIZATION TODAY LEARNING OBJECTIVES: 1.1: Identify the types of companies active in international business. 1.2: Explain globalization and the significance of global markets and production. 1.3: Detail the forces that drive globalization. 1.4: Summarize the main arguments in the debate about globalization. 1.5: Identify the skills this course will help you develop for your career. CHAPTER OUTLINE: Introduction and Key Players Key Players in International Business What Is Globalization? Evolution of Globalization Recent Events Measuring 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 Drivers of Globalization Falling Barriers to Trade and Investment World Trade Organization Regional Trade Agreements Other International Organizations Global E-commerce The Internet Intranets and Extranets Digital Transformation Communication and Transportation Communication Transportation Technologies

Globalization Debate Globalization Harms Jobs and Wages Globalization Improves Jobs and Wages Summary of the Jobs and Wages Debate Debate about Income Inequality Inequality within Nations Inequality between Nations Globalization and Culture Globalization and National Sovereignty Menace to Democracy? Guardian of Democracy? Globalization and the Environment Workplace Skills Skill for Your Career The Global Business Environment 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 1.1

INTRODUCTION AND KEY PLAYERS International business is rooted in the cultural political, economic and legal moorings of nations. The study of international business involves learning about government policies, company activities, the work of managers, the work and social lives of ordinary people, and a host of social issues. People are at the center of each of these topics and are what makes international business a dynamic and thrilling journey of discovery. 1.1.1 Key Players in International Business 1. 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. a. Some MNCs have more employees than small nations have citizens (e.g., Walmart has 2.3 million employees globally). b. If Walmart were a country, it would rank one place behind Poland in terms of economic power (Figure 1.1). 2. A born global firm is a company that has a global perspective, engages in international business from inception, and quickly

achieves a competitive advantage. a. They tend to have innovative cultures and knowledge-based organizational capabilities that are difficult to imitate. 1.2

WHAT IS 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.‖ See Figure 1.2 which shows the home country for each of the 500 largest companies in the world. You can see a rise of Chinese firms, going from having no companies in the top 500 in 1990 to having 124 in 2020. You will also see a drop in the number of US firms, peaking from 175 top 500 firms in 2000 and 20 years later having 121. Over the same period, Japan lost more than half of its top spots from 1990 to 220 and around half of Britain’s firms dropped off the list. 1.2.1 Evolution of Globalization During the first age of globalization trade and capital flowed more freely than ever before. Trade was becoming increasingly more important. Up until around 1870 the global trade to GDP ratio never exceeded 10 percent. This means that, on average, a country traded around 10 percent of its total annual output. Figure 1.3 shows that the global trade to GDP ratio grew to 27 percent by 1970. This means countries traded 27 percent of their yearly output, a gain of 17 percentage points in 100 years. 1. Recent Events Throughout the 1990s and early 2000s trade has been expanding. Membership in the European Union has been expanding, the agreement between the United States, Mexico and Canada had been revised, and China entered the World Trade Organization. The global trade to GDP ratio has been growing significantly. But a trade war between China and the United States forced companies to re-examine their strategies of outsourcing to China and their lengthy supply chains placed distant production and distribution activities at risk. Then the global pandemic arrived and the economic shutdowns it prompted helped shrink the economy by 8 percent in 2020.

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Measuring Globalization Although we intuitively feel that the world is getting smaller, researchers have measured the extent of globalization. a. The KOF Swiss Economic Institute’s Globalization Index ranks nations on their economic, social, and political engagement. b. Richest nations are the most global, with many in Europe. The United States is currently ranked 25th (see Map 1.1). c. The least global nations are found in Africa, East Asia, South Asia, Latin America, and the Middle East. Globalization of Markets 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. Companies must not overlook local 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 Globalization of Production 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 (e.g., tech support, record keeping) c. Access production inputs unavailable or more costly at home

DRIVERS OF GLOBALIZATION Forces increase competition among nations by leveling the global business playing field. 1.3.1 Falling Barriers to Trade and Investment 1947 General Agreement on Tariffs and Trade (GATT) promoted 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. d. Critics say the WTO is at risk of becoming irrelevant today because it is not adequately addressing changes in the global trading system. 2. Regional Trade Agreements a. Groupings of nations smaller than the WTO are also integrating their economies (e.g., USMCA, European Union, Asia-Pacific Economic Cooperation). b. A key advantage of regional trade agreements is that negotiating with fewer nations can be easier than dealing with the WTO’s many more members. 3. Other International Organizations a. The World Bank was formed to finance European reconstruction after the Second World War. It later shifted its focus to the general financial needs of developing countries. Today it finances development projects in Africa, South America, and Southeast Asia. b. The International Monetary Fund was created to regulate fixed exchange rates and to enforce the rules of the international monetary system. Among the purposes of the IMF are promoting international monetary cooperation, facilitating the expansion and balanced growth of international trade, avoiding competitive exchange devaluation, and making financial resources temporarily available to members that suffer from severe balance of payment problems.

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Global E-commerce Technology accelerates globalization by making it easier, faster, and less costly to move data, goods, and equipment around the world. Businesses and consumers use technology to conduct transactions. E-commerce is the use of computer networks to purchase, sell, or exchange products; to service customers; and to collaborate with partners. 1. 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. c. North America comprised 12 percent of the world’s internet users in 2011 but just 6.5 percent in 2021. Africa made up 6.2 percent of world internet users in 2011 but grew to 12.5 percent in 2021. d. The Internet of Things (IoT) includes all devices and equipment that are readable, recognizable, locatable, addressable, and/or controllable via the internet. 2. 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. 1.3.3 Digital Transformation This is fundamental change in which digital technologies penetrate all areas of operations, strategy, and culture to produce customer-focused competitive advantage. Technological innovation involves the process of changing information from analog to digital form for use by computers and other information technologies, referred to as digitization. This leads to efficiency gains and cost savings. Digitalization is the use of digital data and

technology to develop new business operations, strategies, or business models. 1.3.4 Communication and Transportation Operating across borders and time zones complicates the job of coordinating and controlling business activities. Technological innovation in the various methods of communication and transportation can ease the task of international management. 1. Communication a. Communication technology can speed the flow of information and ease the task of coordination and control (i.e., videoconferencing). 2. Transportation Technologies a. Makes global shipping more efficient and dependable (i.e., GPS, RFID). Outsourcing lengthens and complicates supply chains and distribution channels. Corporate logistics departments and logistic specialist firms assist international companies in dealing with these issues. 1.4

GLOBALIZATION DEBATE 1.4.1 Globalization Harms Jobs and Wages 1. Critics say globalization eliminates manufacturing jobs in developed nations as good-paying manufacturing jobs go abroad to developing countries. They say lower-priced goods are not worth lost jobs. 2. They say it causes worker dislocation that gradually lowers wages because new jobs that replace lost manufacturing jobs often pay less. 3. They say it exploits workers in lower-wage nations who work for lower wages servicing western consumers. 1.4.2 1.

Globalization Improves Jobs and Wages Supporters say globalization increases wealth and efficiency in all nations because trade openness raises output. Firms grow more efficient and pass savings on to consumers. They say it generates labor market flexibility in developed nations that allows an economy to rapidly deploy labor where demand is relatively high. They say it advances the economies and

living standards of developing nations by injecting capital that creates higher-paying jobs. This helps expand the middle class. Summary: Although globalization eliminates jobs in some economic sectors, it creates jobs in other sectors. The key point of difference in the debate is whether or not overall gains in a nation’s economy is worth the lost livelihoods that some individuals suffer. 1.4.3 Debate about Income Inequality 1. Inequality within Nations a. Globalization critics claim that income disparity in developed nations is increasing as firms move factory jobs to developing and emerging nations. b. The evidence is mixed, but people in developing nations seem to benefit from an open economy. 2. Inequality between Nations a. Globalization opponents say it is widening the gap in average incomes between developed and developing nations. b. But evidence shows that open nations are benefiting from trade whereas closed ones are not. 1.4.4 Globalization and Culture 1. Critics say globalization homogenizes our world and lets MNCs destroy cultural diversity. 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 values and cultural norms. 1.4.5 Globalization and National Sovereignty 1. Menace to Democracy? a. Critics say supranational institutions with international goals and appointed officials undermine national sovereignty and democracy. b. They say political authorities undercut democracy and local and regional authority with international agreements on citizens’ behalf. 2. Guardian of Democracy? a. Supporters say globalization has helped spread democracy worldwide (e.g., more democratic nations than ever).

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Some losses of sovereignty have had positive social impacts, as in human rights, workers’ rights, and discrimination. Globalization and the Environment Most international firms today support reasonable environmental laws because (if for no other reason) they want to expand future local markets for their goods and services. They recognize that healthy future markets require a sustainable approach to business expansion.

WORKPLACE SKILLS International business today is rapidly changing. Driving disruption across all industries are digitalization strategies, automation of routine physical and cognitive tasks, implementation of artificial intelligence, and expansion of the green economy. 1.5.1 Skills for Your Career The most competitive businesses focus on constantly upgrading their employees’ skills to keep pace with technological advancements. This course will assist in developing employability skills. 1. Application of knowledge refers to the ability to learn a concept and appropriately apply that knowledge to another setting to achieve a higher level of understanding. 2. Reflective (critical) thinking involves purposeful and goal directed thinking used to define and solve problems, make decisions, or form judgments related to a set of circumstances. 3. Analytical thinking involves following a fact pattern to draw a conclusion. 4. Communication skills which involve the use of oral, written and nonverbal language along with technology to communicate ideas effectively and to listen effectively. 5. A keener sense of ethical understanding and social responsibility serves as guiding principles that influence the way individuals and organizations behave with society. 1.5.2 The Global Business Environment What makes international business special is that it occurs within a dynamic, integrated system that weaves together four distinct elements: 1. Global forces are transforming societies and commercial activities. Globalization increases competition everywhere, forcing

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companies to be vigilant to ethical situations, social responsibility issues, and sustainability in all its forms. 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. The international business environment influences how business is conducted so firms must closely monitor events. The 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.

Quick Study Questions Quick Study 1.1 1.

Q: How do you define the terms international business, imports, and exports?

A: International business is a commercial transaction that crosses the border of two or more nations. 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. 2.

Q: What is a multinational corporation, and why is it

significant to our study of international business? A: A multinational corporation (MNC) is a business that has direct investments abroad in multiple countries. They generate significant jobs, investment, and tax revenue for the regions and nations they enter. They are economically powerful entities and the largest of them generate revenue that exceeds the output of medium-sized nations. 3.

Q: Why might a company be referred to as a ―born global firm? A: A born global firm is a company with a global perspective that engages in international business from inception and quickly achieves a competitive advantage. They tend to have innovative cultures and knowledge-based organizational capabilities that are difficult to imitate.

Quick Study 1.2 1.

Q: How does globalization influence the institutions and economies of nations? A: Nations historically retained absolute control over the products, people, and capital crossing their borders. Today, economies are increasingly intertwined. This greater interdependence can mean an increasingly freer flow of goods, services, money, people, and ideas across national borders. Globalization is the name we give to this trend toward greater economic, cultural, political, and technological interdependence among national institutions and economies.

2. Q: What has been the evolution of globalization and what is its recent history? A: The first age of globalization extended from the mid-1800s to the 1920s. In 1870, countries traded an average of around 10 percent of their total annual output but traded 27 percent of output by 1970. The second age of globalization began around 1989 with the decline of communism. Countries then traded nearly 40 percent of their output. Globalization today involves greater competition and forces companies to grow more competitive in the face of greater rivalry. Today, countries trade nearly 70 percent of their annual output. 3.

Q: What benefits might a company 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 uneven income stream by letting international sales offset domestic sales for a company selling a global seasonal product. Yet companies must not overlook buyer needs and should concern itself with sustainability in all of its operations. 4.

Q: For what reasons might a company wish to globalize its production activities? A: Globalization of production refers to the dispersal of production activities to locations that help a company achieve its cost-minimization or qualitymaximization objectives. Potential benefits for companies include (1) access to lower-cost workers, (2) access to technical expertise, and (3) access to production inputs and resources that are unavailable or more costly at home.

Quick Study 1.3 1.

Q: How have falling barriers to trade and investment encouraged globalization? A: 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, and average tariffs dropped from 40 percent to 5 percent. A 1994 GATT revision created the World Trade Organization, the goals of which 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 was designed to be the spine of the global trading system. Smaller groups of nations are integrating their economies by fostering trade and investment within the framework of regional trade agreements. A key advantage of regional trade agreements is that negotiating with fewer nations can be easier than dealing with the WTO’s many more members. The World Bank and the International Monetary Fund have also helped expand globalization by financing development projects.

Q: What role has e-commerce, the internet and digitization played in propelling globalization? A: E-commerce makes it easier for companies to make their products abroad and to import or export finished goods. Firms use the internet to sharpen forecasting,

lower inventories, and improve communication with suppliers, and to communicate with distant managers quickly, cheaply, and efficiently. The internet also reduces the cost of reaching international customers— important for the competitiveness of small firms. Companies use the Internet of Things (IoT) in many ways because it transmits data in real time. 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. Companies proceed with digitization to change their data from analog to digital form for use by information technologies and to improve efficiency. In digital transformation, technology helps create customer-focused competitive advantage and increases the global reach of companies. 3.

Q: How have advancements in communication and transportation technologies affected globalization? A: Operating across borders and time zones complicates the job of coordinating and controlling business activities. E-mail and videoconferencing speed information flows and ease the tasks of coordination and control. The global pandemic drove rapid growth in the use of videoconferencing. Innovation in transportation technologies is facilitating globalization by making shipping more efficient and dependable.

Quick Study 1.4 1.

Q: How would you summarize the debate about globalization’s impact on jobs and wages? A: Opponents state that globalization eliminates manufacturing jobs in developed nations, causes worker dislocation that gradually lowers wages in developed nations, and exploits workers in lower-wage countries. Supporters state that globalization increases wealth and efficiency in all nations, generates labor market flexibility in developed nations, and advances developing nations’ economies and living standards. In summary, although globalization eliminates jobs in some economic sectors, it creates jobs in other sectors. The key point of difference in the debate is whether or not overall gains in a nation’s economy is worth the lost livelihoods that some individuals suffer.

Q: What does the evidence tell us about globalization’s effect on income inequality within and between nations? A: Inequality Within Nations: Opponents of globalization argue that freer trade and investment allow international companies to close factories in higher wage, developed nations and to move them to lower wage, developing nations. Studies exploring the openness to the global economy and incomes find that globalization appears to contribute to income inequality. However, additional contributors to income inequality can include advancements in technology, deregulation, education quality, tax structure, labor policies, and more. Inequality Between Nations: Globalization supporters say it lessens inequality between nations. Developing countries and post-communist countries that embraced globalization increased personal incomes, extended life expectancies, and improved education systems. Much of the decline in inequality between nations is due directly to China’s integration with the global economy. India is also embracing globalization and narrowing the income gap with the United States. Nations closed off from the world economy have not fared as well.

Q: What are the main arguments surrounding the debate about globalization’s impact on cultures? A: National culture is a strong shaper of people’s values, attitudes, customs, beliefs, and communication. People opposed to globalization say it homogenizes our world and destroys the rich diversity of cultures. Yet globalization allows nations to specialize and trade for goods they do not produce, import other peoples’ cultural goods, and still protect deeper values and cultural norms.

Q: What do supporters and opponents of globalization argue regarding national sovereignty and the environment? A: Globalization supporters argue that the consequence of globalization has been the spread of democracy worldwide. For instance, some losses of sovereignty have had positive social impacts, as in human rights, workers’ rights, and discrimination. Opponents say that globalization helps supranational institutions gain power, may force nations to violate the rights of local and state governments, and undercuts the democratic process and individual liberty. Regarding

the natural environment, most international firms today support reasonable environmental laws because (if for no other reason) they want to expand future local markets for their goods and services. They recognize that healthy future markets require a sustainable approach to business expansion. Quick Study 1.5 1.

Q: Why are certain workplace skills becoming increasingly important? A: International business today is rapidly changing. Jobs with high levels of human interaction are seeing the greatest acceleration in automation. While automation eliminates some jobs, it also creates new ones. By 2030, slightly more than 6 percent of currently employed workers might need to find a different occupation. The most competitive businesses will constantly upgrade their employees’ skills to keep pace with technological advancements. Many emerging professions are in technology fields. Companies seek qualified employees in areas such as artificial intelligence, cloud computing, data analysis, process automation, and many others. Skilled businesspeople will also be sought after in areas including business services and administration, business development, risk management, project management, and strategy, to name several.

Q: What are some employability skills this course will help you develop for your career? A: Twenty-first century skills will make you a better match for the needs of your future employer and prepare you for success in an expanding digital economy characterized by e-commerce, remote work, and automation. Technology is accelerating change in workplace skills that companies want employees to have so they hit the ground running as soon as they are hired. This course will help you develop these highly useful capabilities, or employability skills, including application of knowledge, reflective or critical thinking, communication, as well as ethical understanding and social responsibility.

Q: How would you describe the Global Business Environment model used in this text? A: It is helpful to view international business as occurring within an integrated global system consisting of four main elements: (1) Global forces are transforming our societies and commercial

activities. They increase competition everywhere as managers view the entire world as an opportunity. Firms at home and abroad must also remain vigilant to ethical situations, social responsibility issues, and sustainability in all its forms. (2) Each national business environment includes cultural, political, legal, and economic characteristics. (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 involves all the duties of management in a domestic setting, but integrate the influence of globalization. Teaming Up Imagine that you and several of your classmates own a company that manufactures cheap sunglasses. To lower production costs, you decide to move your factory from your developed country to a more cost-effective location. 1-3. Q: Which elements of the national business environment might influence your decision where to move production? A: Students should address the forces at work within potential country locations and between that country and the home country. These include cultural, political, legal, economic, and financial forces. Trends in inflation rates, exchange rates, and interest rates are included here. Credit availability, the paying habits of customers and the potential return on the investment should be considered. Additional national forces include market entry barriers, profit remittance barriers, and other barriers such as political instability, tax laws, safety standards, price controls, and so forth. Finally, competitive forces would be explored for their influence on the location decision. 1-4. Q: What aspects of the globalization of production and marketing do you expect will benefit your company following the move? A: Students must consider key aspects of the globalization of marketing and production. Sunglasses are a global product and a company should be able to standardize at least some marketing elements depending on the price point of its products. Students should also consider key elements affecting investing in a country. For sunglasses production, there will be a

great deal of production machinery involved. Training may be required so employees can operate the equipment safely and efficiently. Students’ responses could also consider: (1) the presence of investment barriers in the country; (2) resources needed to carry out sunglasses 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. Ethical Challenge You are the CEO of a major U.S. apparel company that contracts work to garment manufacturers abroad. Employees of one contractor report 20-hour workdays, pay below the minimum wage, overcrowded living conditions, physically abusive supervisors, and confiscation of workers’ passports so they cannot quit. Local officials say labor laws are adhered to and enforced, though abuses appear widespread. You send inspectors to the offending factory 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. 1-5. Q: Should you implement a monitoring system to learn the truth about what is happening? A: The implementation of a monitoring system is important. A keener sense of business ethics and social responsibility are critical to success in international business. These concepts serve as the guiding principles that influence the way individuals and organizations behave within society. The issues of personal ethical responsibility and reasoning impact how managers make ethical decisions in specific situations. 1-6. Q: Do you help the factory improve conditions, withdraw your business from the country, or simply do nothing? A: The answer depends on the overall outlook of the production location and opportunities that it presents. If the long-term outlook is good, the company will likely decide to remain engaged and try to resolve the ethical problem. However, if the production advantages are not great, a company may decide to limit potential damage to its reputation and abandon the operation. Social responsibilities

regarding topics such as human rights, fair trade, and sustainable development are extremely difficult for companies to manage. 1-7. Q: How might your actions affect your global corporate reputation, brand image, and brand value? A: Reputation risk is extremely important to corporations in the current age of international business. A company may be held responsible for its supplier’s actions and even the actions of its supplier’s supplier. Individuals worldwide might begin to boycott your company’s products if they learn what is happening. The company’s brand image and market value could potentially be irreparably harmed if the company makes a wrong move. 1-8. Q: How might your actions affect your relations with the factory owner and your ability to do business in the country? A: The company should be thorough and transparent throughout the monitoring process. The monitoring process could seem more impartial by contracting an independent organization to conduct the investigation. You could also have the report made public to all parties simultaneously to eliminate the perception of bias. 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 ethical can be useful in marketing and differentiate the firm in global markets. Practicing Management Case

International

Apple’s Global Strategy 1-11. Q: Why should Apple purchase parts and components that are made outside the United States and subcontract assembly to China and other nations? A: The foundational theory of international business and trade says a country should produce the goods and services in which it is most productive, and then trade with other nations to obtain things it needs but does not produce. For Apple, this means importing components that require labor-intensive processes and

having assembly performed abroad as well. Apple’s parts and components come from a global manufacturing network of firms in dozens of countries where labor costs are lower. Labor costs of Apple’s Chinese subcontractors, for example, account for only about 4 percent of the iPhone’s total cost. The greatest cost is incurred in California, where Apple performs design, engineering, and marketing tasks. 1-12.

Q: Why did the Apple iPhone lose market share in China? What specific actions, if any, do you think Apple could have taken with regard to its presence in China to prevent the loss of market share? A: As China’s economic growth continued and personal incomes grew, Apple began to sell devices there as well as make them. Sales revenue in China grew from $2.8 billion in 2010 to a peak of $59 billion 2015, then fell to around $40 billion in 2020. Several factors contributed to the drop in sales. A trade war began in 2017 between China and the United States as nationalist sentiment grew significantly in both countries. Then the pandemic arrived and the US government actively encouraged a ―supply chain restructuring‖ initiative, or ―decoupling,‖ of the US and Chinese economies. Also, when the US government sanctioned Apple’s Chinese competitor, Huawei, a host of other Chinese smartphone makers rushed in to fill the void. Device makers Xiaomi, Oppo, and Vivo quickly improved their designs and cameras and went head-to-head against Apple with lower-priced phones. The three saw doubledigit growth rates in sales.

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Q: Assume you are part of the top executive team at Apple. How do you personally feel about doing business in China, which appears to have large differences with how business is done in the United States? A: This question essentially presents students with an ethical dilemma because it asks how they personally feel. Students may decide they want Apple to continue doing business in China purely for reasons of maintaining profits. On the other hand, they might want the company to more fully participate in the social and political movement and pull more of its operations out of China. Answers will reflect students’ own beliefs about business objectives and social responsibility.

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previous question about doing business in China, do you recommend that Apple make any changes in its strategy going forward? Explain your answer. A: Students will likely expand upon Apple’s earlier response of moving some iPad production to Vietnam and India, and moving some smart speaker, earphones, and computer assembly to Malaysia. Southeast Asia is where Apple plans to expand production for many core products. In fact, additional action by Apple along these lines is likely its only real option. It is unlikely to abandon China as a key production base for the foreseeable future, yet it is diversifying away from reliance on a single country.

Chapter 2 ETHICS, SOCIAL RESPONSIBILITY, AND SUSTAINABILITY LEARNING OBJECTIVES: 2.1: Summarize the main theories of ethics that are important to international business. 2.2: Explain ways to resolve ethical dilemmas and foster ethical business decisions. 2.3: Describe the main elements of corporate social responsibility and stakeholder theory. 2.4: Explain the importance international firms place on sustainability and climate change. 2.5: Describe several additional issues international managers can face daily in their jobs. CHAPTER OUTLINE: Ethics Theories Utilitarianism Rights Theory Justice Theory Cultural Relativism Business Ethics Resolving Ethical Dilemmas Codes of Ethics Sources of Unethical Behavior Corporate Social Responsibility Efficiency and Profits as Social Responsibility Business Responsibilities to Society Stakeholder Theory Benefit Corporations Sustainability

Carbon Footprints and Climate Change A Circular Economy Greenwashing Environmental, Social, and Governance Funds Additional Key Global Issues Bribery and Corruption Working Conditions and Human Rights Diversity, Equity, and Inclusion DEI Efforts Within Companies 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 INTRODUCTION Multinational companies must comply with laws and regulations both at home and in every jurisdiction in which they operate. They adhere to environmental regulations, antitrust laws, labor laws, securities laws, and more. Today, cross-cultural business brings moral issues to the fore. Although cultures differ in their views of what defines ethical behavior in certain situations, businesses are expected to be model citizens in every country in which they operate. Global competition means it is critical for each firm to have a competitive advantage—an attribute that is difficult to imitate and enables a firm to outperform its competitors in the same industry. Building trust and behaving ethically are essential for business because their activities are grounded in a motivation for profit. Operating in an ethical and socially responsible manner can bolster a firm’s brand and competitive advantage. There is a moral foundation for ethical behavior, corporate social responsibility, and sustainable business practices. 2.1

ETHICS THEORIES Ethics are the moral principles of society that govern human behavior and decision making. Ethical behavior is individual behavior in accordance with principles of good conduct of morality. An ethical dilemma arises when one’s ethics are challenged in a decision-making situation because no available alternative presents a clear moral solution. Ethical theories can serve as a guide for how a manager can make an ethical decision when facing a dilemma.

2.1.1

Utilitarianism This ethics theory advocates actions that foster happiness and oppose actions that cause unhappiness. It says companies should behave in a way that maximizes good outcomes and minimizes bad outcomes. 1. A utilitarian manager asks the question ―What outcome should I aim for?‖ and answers, ―That which produces the best outcome for all affected parties.‖ 2. Example: manager pays a bribe based on calculations that more people will benefit than will be harmed by the outcome. 2.1.2 Rights Theory This theory states that every human being has rights and all governments are obligated to protect them. It views these rights as universal and not culture-specific. 1. The United Nations’ Universal Declaration of Human Rights declares every person’s fundamental right as inherent and inalienable. 2. Recognizes that all humans are born free and equal and in dignity and rights regardless of nationality, residence, gender, ethnicity, race, religion, language, or any other status. 3. Several articles in the Declaration deal explicitly with business dealings. These include the right to own property, the right to work and choose one’s work, the right to paid time off work for leisure, and the right to the fruits of one’s creations. 2.1.3 Theory of Justice Theory that describes a society of free citizens who have equal basic rights and who cooperate within an egalitarian economic system. 1. Desires a social contract that bestows society’s rights, freedoms, and resources equitably and fairly to all. 2. A manger following this theory would work to find solutions to ethical dilemmas that are most equitable and fair to all parties. 2.1.4 Cultural Relativism This theory says the morality of an act depends on how the act is perceived within that specific culture at the time of the act. It says a company should adopt local ethics everywhere because all belief systems are determined within a cultural context.

1. 2. 2.2

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.

BUSINESS ETHICS All company employees should sustain a high standard of ethical behavior. This may be more challenging for companies entering cultures that have value systems that are very different than at home. 2.2.1 Resolving Ethical Dilemmas Executives can employ several concepts to resolve ethical dilemmas. 1. The conflict of relative development recognizes that countries and their populations can differ in their stage of development. A manager asks if the practice would be acceptable in the manager’s home country if it were in a similar stage of development. 2. The conflict of cultural tradition asks if a practice would be acceptable if (1) is it not possible to do business successfully in the country without engaging in the practice, and (2) the practice does not violate a core human value. 3. Managers choosing an ethical path to follow can also look for guidance to the ethics theories presented above, including utilitarianism, rights theory, theory of justice, and cultural relativism. 2.2.2 Codes of Ethics A code of ethics is a formal statement that conveys ethical values and describes baseline professional conduct expected of individuals. 1. Describes how employees are to interact ethically with co-workers, suppliers, customers, and others. It guides employees’ attitudes, demeanor, and judgments while they fulfill duties and can be consulted when employees face ethical dilemmas. 2. Ethical imperialism is when a company attempts to export their home country’s ethical beliefs to other countries. This rarely works because ethics are deeply engrained in a people’s culture. 3. Companies also must be careful not to follow cultural relativism and blindly accept local ethics in their entirety if significant

differences exist with the home country. The Academy of Management identifies three general principles that serve as a guide in determining ethical courses of action, including (1) responsibility, (2) integrity, and (3) respect for people’s rights and dignity. 2.2.3 Sources of Unethical Behavior 1. Two principal sources of unethical behavior are the moral integrity of individuals and a firm’s managerial setting or policies. 2. Individuals differ in their moral integrity. Each person possesses a unique set of values learned throughout their life. 3. It is crucial that leaders set an acceptable example. Managers should behave ethically in official meetings as well as when the spotlight is off. 4. Corporate compliance departments traditionally ensure that their companies abide by the relevant laws and regulations and good corporate practices. CORPORATE SOCIAL RESPONSIBILITY Conscientious business leaders know their company’s future depends on healthy communities and environments worldwide. Probably every international company of at least moderate size has a policy for social responsibility. Issues include child labor, human rights, the environment, and more. 2.3.1 Efficiency and Profits as Social Responsibility 1. Historically speaking, to be considered socially responsible a company was to maximize profits for its owners (or shareholders) while operating within the law, and follow basic ethical guidelines. 2. In the modern corporation, managers are hired to run a business for the owners. These managers are legally obligated to work in the best interests of owners (shareholders). 3. Economic theory argues that the presence of private businesses operating in free and competitive markets maximizes economic efficiency and society’s well-being. This is the view of Adam Smith and Milton Friedman. 4. Utilitarianism would support this view, as would cultural relativism. Yet from a justice perspective one might argue that a business should do more to redistribute wealth and income to the less well-off. And from a rights perspective one might say that firms should also defend people’s basic rights and provide equal opportunity for all. 2.3.2 Business Responsibility to Society 4.

2.3

Another perspective views a business as having social responsibilities beyond efficiency and maximizing profits. This view is known as corporate social responsibility (CSR)—the belief that a company should incorporate social objectives within its goals and policies and contribute positively to society. 1. The pyramid of corporate social responsibilities involves four areas: a. Economic—businesses must create economic value for society. b. Legal—businesses must follow each society’s ―codified ethics.‖ c. Ethical—businesses must follow the norms, values, principles, and expectations of society. d. Philanthropic—businesses must voluntarily give back to society. 2. Some social responsibilities differ depending on their industry. For example, sugary and fast-food companies versus oil and gas companies. Other social responsibilities are common to all industries, including respect for human rights and providing safe working conditions. 2.3.3 1.

2.4

Stakeholder Theory Stakeholder theory is a view of capitalism that stresses the interconnected relationships between a business and those who have an interest or ―stake‖ in the company. These individuals are called stakeholders and include all parties who affect, or are affected by, a company’s activities. These individuals can be either internal or external to the organization. The stakeholder view argues that the purpose of a business is to create as much value as possible for all stakeholders, not only shareholders. It can support development of competitive advantage. Benefit Corporation A benefit corporation is a business entity legally empowered to pursue positive stakeholder impacts alongside profits. a. The Certified B Corporation (B Corp) movement is a community of missiondriven entrepreneurs that is creating companies that balance purpose and profit to use business as a force for good.

SUSTAINABILITY Development that

meets

the

needs

the

present

without compromising the ability of future generations to meet their needs. Net-zero emissions is reached when the amount of greenhouse gases released into the atmosphere and the amount removed are equal. Businesses are embracing the challenge to become net zero. 2.4.1 Carbon Footprints and Climate Change 1. Carbon footprint is the environmental impact of greenhouse gases measured in units of carbon dioxide that are emitted by human activity. 2. A primary footprint are emissions from the burning of fossil fuels used to produce a good or service. A secondary footprint are emissions from the whole life cycle of products from their manufacture to eventual breakdown. 2.4.2 A Circular Economy 1. A circular economy is an approach that designs products and components that can be reused, disassembled, and upgraded to minimize waste (see Figure 2.7). 2. The circular economy attempts to mimic natural systems and differs markedly from a linear economy. It aims to produce the same or better output with less material input and fewer emissions. 3. This resilient system is good for business, people, and the planet. The circular economy is a systems solution framework that tackles global challenges like climate change, biodiversity loss, waste, and pollution. 2.4.3 Greenwashing 1. Greenwashing is providing false or misleading information that presents a business or its products as being environmentally friendly. 2. There are at least four reasons why companies engage in greenwashing. a. Give the appearance of going green when a company is simply complying with environmental regulations. b. Highlight green features that a product may or may not have to appeal to environmentally-minded consumers. c. Internal reward system might encourage executives to pronounce untruthfully that a business has met sustainability targets. d. Personal biases, preferences, or

2.5

thrill-seeking behavior might motivate individuals to try and get away with lying. Environmental, Social, and Governance Funds a. ESG funds are stock or bond investments for which environmental, social, and governance factors are considered during the investment process. b. These funds are supposed to invest in companies that are good stewards of the environment and have strong stakeholder relationships. c. However, some ESG funds are more genuine than others. Companies are being forced to disclose more information on their business activities and ESG funds are being more closely scrutinized.

ADDITIONAL KEY GLOBAL ISSUES This section covers additional issues that are prominent in international business. 2.5.1 Bribery and Corruption 1. Corruption can lead to the misallocation of resources, hurt economic development, distort public policy, and damage national integrity. 2. The president of US-based Lockheed Martin once bribed Japanese officials to obtain a large sales contract. Public disclosure of the incident resulted in the passage of the Foreign Corrupt Practices Act (FCPA), a law that forbids US companies, subsidiaries, or citizens from bribing government officials or political candidates worldwide. 3. Enron’s failure sent a shockwave around the world. Energy trading markets were in chaos and many lost jobs worldwide. 4. In reaction, the US Congress passed the Sarbanes-Oxley Act, which set more stringent accounting standards and reporting practices. 2.5.2 Working Conditions and Human Rights 1. Managers must monitor their own behavior plus that of employees and business partners. 2. Governments, labor unions, consumer groups, and human rights activists forced apparel companies to implement codes of conduct and the monitoring of international production.

2.5.3 1.

Diversity, Equity, and Inclusion Diversity in the workplace means that a firm’s employees represent a limitless variety of social viewpoints, cultural perspectives, experiences, and identities. a. Corporations benefit when they develop a diverse, equitable and inclusive workplace at every level of the organization. b. Diversity includes people of different ages, ethnicities, genders, physical abilities, religions, etc. Equity in the workplace means that a company offers every employee an equal opportunity for work and advancement. a. Equity recognizes and eliminates barriers that reduce opportunity for underrepresented employees. b. An employee must know that people from their social and cultural background will receive equal opportunity for success in the organization. Inclusion in the workplace means that a company welcomes every employee, whatever their identity, and helps them to feel they are an integral part of the organization. a. Inclusion fosters acceptance of and respect for all people and is often defined as diversity in action. b. Employees are encouraged to be their authentic selves without fear of recrimination. DEI Efforts Within Companies a. A DEI statement can establish a company’s commitment to these ideals. This helps form the basis of the overall workplace culture and guides policies with employees, suppliers, customers, and all community stakeholders. b. Diversity, equity, and inclusion goals are increasingly integrated into executive and management compensation structures today. c. Some firms achieve DEI goals through a practice called impact sourcing—a practice that brings marginalized groups into the global business service workforce.

Quick Study Questions Quick Study 2.1 1.

Q: Why is it important for firms to do business with integrity and earn the public’s trust in international business today? A: Although cultures differ in their views of what defines ethical behavior in certain situations, businesses are expected to be model citizens in every country in which they operate. Global competition means it is critical for each firm to have a competitive advantage—an attribute that is difficult to imitate and enables a firm to outperform its competitors in the same industry. Building trust and behaving ethically are essential for business because their activities are grounded in a motivation for profit. Operating in an ethical and socially responsible manner can bolster a firm’s brand and competitive advantage.

Q: Which theory says that an ethical action is one that brings the greatest good to the greatest number of people? A: Utilitarianism advocates actions that foster happiness and oppose actions that cause unhappiness. It says companies should behave in a way that maximizes good outcomes and minimizes bad outcomes. 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: What is the rights theory of ethics and what kinds of rights does it cover? A: Rights theory states that every human being has rights and all governments are obligated to protect them. It views these rights as universal and not culture-specific. The United Nations’ Universal Declaration of Human Rights declares every person’s fundamental right as inherent and inalienable. It recognizes that all humans are born free and equal and in dignity and rights regardless of nationality, residence, gender, ethnicity, race, religion, language, or any other status. Articles in the Declaration that deal explicitly with business dealings include the right to own property, the right to work and choose one’s work, the right to paid time off work for leisure, and the right to the fruits of one’s creations.

Q: What type of justice is the focus of the ethics theory of justice? A: The theory of justice describes a society of free citizens who have equal basic rights and who cooperate within an egalitarian economic system. It desires a fair social contract with moral standing that embodies distributive justice. This social contract would bestow society’s rights, freedoms, and resources equitably and fairly to all. A manger following this theory would work to find solutions to ethical dilemmas that are most equitable and fair to all parties.

Quick Study 2.2 1.

Q: Which two concepts can managers use to resolve ethical dilemmas between the home and host countries? A: Executives can employ two key concepts to resolve ethical dilemmas. First, the conflict of relative development recognizes that countries and their populations can differ in their stage of development. A manager asks if the practice would be acceptable in the manager’s home country if it were in a similar stage of development. Second, the conflict of cultural tradition asks if a practice would be acceptable if (1) is it not possible to do business successfully in the country without engaging in the practice, and (2) the practice does not violate a core human value.

Q: What is a code of ethics and why is it important for an international business to have one? A: A code of ethics is a formal statement that conveys ethical values and describes baseline professional conduct expected of individuals. It becomes an actionable program that supports a strong culture of ethics in all areas of the business. It describes how employees are to interact ethically with co-workers, suppliers, customers, and others. It guides employees’ attitudes, demeanor, and judgments while they fulfill duties and can be consulted when employees face ethical dilemmas.

Q: What are the principal sources of unethical behavior? A: The two principal sources of unethical behavior are the moral integrity of individuals and a firm’s managerial setting or policies. Individuals differ in their moral integrity. Each person possesses a unique set of values learned throughout their life so leaders must set an acceptable example. Managers should behave

ethically in official meetings as well as when the spotlight is off. Quick Study 2.3 1.

Q: How did Adam Smith and Milton Friedman believe companies best served their responsibilities to society? A: Adam Smith and Milton Friedman believed that private companies operating in free and competitive markets maximizes economic efficiency and society’s well-being. They believed that a socially responsible company should maximize profits for its owners (shareholders) while operating within the law and following basic ethical guidelines.

Q: What are the four categories of responsibility identified in the CSR pyramid of corporate social responsibilities? A: The pyramid of corporate social responsibilities involves four areas: (1) Economic—businesses must create economic value for society, (2) Legal— businesses must follow each society’s ―codified ethics,‖ (3) Ethical—businesses must follow the norms, values, principles, and expectations of society, and (4) Philanthropic—businesses must voluntarily give back to society.

Q: Which parties are important stakeholders for an average company? A: Stakeholders are those who have an interest, or stake, in an organization. This includes all parties who affect, or are affected by, a company’s activities. This group includes internal stakeholders (e.g., managers, executives, workers, shareholders) and external stakeholders (e.g., suppliers, customers, creditors, unions, communities, governments, media). An international business has multiple sets of some of these constituents depending on the number of locations in which it is active. Companies must carefully manage their global web of exchange relationships to create the greatest amount of value for their diverse sets of stakeholders.

Quick Study 2.4 1.

Q: How is sustainability and the term Race to Zero relevant to the discussion of climate change? A: Sustainability is development that meets the needs of the present without compromising the ability of

future generations to meet their needs. Corporations, governments, nongovernmental organizations, and consumers worldwide are working toward more sustainable practices and a healthier ecosystem. For their part, companies are pursuing sustainable, or green, initiatives that will help them achieve netzero emissions to thwart climate change. Net-zero emissions (or carbon neutral) is the point at which the amount of greenhouse gases released into the atmosphere equals the amount being removed. Businesses spurred on by the increased competitiveness of clean technologies are embracing the challenge to become net zero. The Race to Zero is a global campaign to rally leadership and support from businesses, cities, regions, and investors for a healthy, resilient, zerocarbon economy that prevents future climate change threats, creates decent jobs, and unlocks inclusive, sustainable growth. 2.

Q: What do we mean by the term carbon footprint and what are its two components? A: Carbon footprint is the environmental impact of greenhouse gases measured in units of carbon dioxide that are emitted by human activity. A primary footprint includes emissions from the burning of fossil fuels used to produce a good or service. A secondary footprint includes emissions from the whole life cycle of products from their manufacture to eventual breakdown.

Q: What are the main differences between a linear economy and a circular economy? A: A circular economy designs products and components that can be reused, disassembled, and upgraded to minimize waste. It minimizes the recycling of products because that process requires large amounts of energy. The idea of a consumer is replaced whenever possible by a user, who leases or rents a durable product for a time and then returns it for someone else to use. A circular economy differs greatly from a linear economy in that it designs waste and pollution out of production from the start. A circular economy attempts to mimic natural systems, where nothing seems to go to waste.

Q: Why might companies and investment funds engage in greenwashing? A: Greenwashing is providing false or misleading information that presents a business or its products as being environmentally friendly. There are at least

four reasons why companies engage in greenwashing. First, it can give the appearance of going green when a company is simply complying with environmental regulations. Second, a firm might highlight green features that a product may or may not have to appeal to environmentally-minded consumers. Third, an internal reward system might encourage executives to pronounce untruthfully that a business has met sustainability targets. And fourth, personal biases, preferences, or thrill-seeking behavior might motivate individuals to try and get away with lying. Quick Study 2.5 1.

Q: What individuals and types of businesses can be charged under the Foreign Corrupt Practices Act (FCPA)? A: The Foreign Corrupt Practices Act forbids US companies, subsidiaries, or citizens from bribing government officials or political candidates worldwide. The primary focus of the FCPA is bribery enforcement against US-based companies and citizens. But the FCPA also can be brought to bear against: (1) a foreign company that has a US subsidiary or that does business in the United States; (2) a company that has transactions going through the US banking system; or (3) a foreign citizen who works for any of these entities.

Q: What consequences might a firm face if it provides poor working conditions or violates human rights? A: Nations try to avoid violating human rights and providing poor working conditions for a host of reasons. Otherwise, a company could find its export permits denied, brand loyalty and brand equity fall, employee loyalty and morale decline, pricing power and profit margins fall, and risk of lawsuits, protests, and boycotts rise.

Q: Why is it important for businesses to promote a diverse, equitable, and inclusive workforce in their operations at home and abroad? A: An international business can improve employee morale, dedication, and retention from its DEI efforts. This can reflect positively on the firm’s brand reputation. A diverse, equitable, inclusive, and multicultural workplace can reward a multinational or global firm with employees who are knowledgeable of other cultures and who have unique perspectives and skills. This can translate into a creative workplace

that generates innovative ideas and solutions. It can also help a company demonstrate its appreciation for customers because its own employees reflect the diversity among its customer base. And employees with a variety of life experiences can understand and relate to a wider range of customers. Teaming Up Imagine that you and several of your classmates form the Csuite (chief executive officer, chief information officer, etc.) of a company that makes semiconductors. Your task is to write a national ―rider‖ that will be added to your home country code of ethics to be implemented at a new fabrication facility built in a Southeast Asian nation of your choosing. 2-4. Q: What are the most important topics and subtopics that your code of ethics will include? A: There is a natural tension between creating a multinational or global code of ethics and the situation in each society. One solution is to include built-in flexibility to allow for some discretion of local subsidiary managers. Each national rider will deal with any issues specific to that market. Students may also reflect on the Academy of Management code of ethics in Figure 2.3 for ideas on what to include. 2-5. Q: How does your team propose to avoid ethical imperialism and make sure it does not follow cultural relativism in its code of ethics rider? A: Companies are said to practice ethical imperialism if they attempt to export their home country’s ethical beliefs to other countries. Companies also must be careful not to follow cultural relativism and blindly accept local ethics in their entirety if significant differences exist with the home country. One solution is to follow Motorola’s guidelines for its employees abroad. Motorola’s code of conduct says an individual cannot engage in any behavior that violates the business ethics of Motorola or US laws related to business ethics, even if that conduct is legal, customary, or accepted in the foreign country. Ethical Challenge You are the newly hired CEO of a business that contracts

with a global social media firm to enforce its community standards. Your employees (content moderators) in a dozen countries earn around $15 per hour to review and purge content that fails to meet your client’s standards. People say the social media firm sends the most controversial content for review to companies like yours. Reviewing one of your firm’s international locations, you find past and present workers’ complaints of filthy workspaces, sexual harassment, physical and verbal abuse, discrimination, and drug use at work. The psychological toll of hours spent watching graphic violence, hate speech, child pornography, and even murder cause employees to be diagnosed with anxiety, depression, and post-traumatic stress disorder (PTSD). 2-6. Q: Why do you think the global social media company contracts this type of work to other companies? A: First, the company likely subcontracts work to companies who hire people in the country whose content is being reviewed for violating its terms. Content moderators should know the language, street slang, and overall culture of the people being monitored for adherence to the content rules. Second, the social media company might be trying to isolate itself (to whatever extent possible) from liability regarding the moderation of content on its website. 2-7. Q: What specific steps can you think of that could be implemented immediately to improve the situation at your company? A: Employees should be interviewed about how they are handling the exposure to sometimes difficult content. They could be given increased rest breaks during working hours. Employees susceptible to depression or anxiety or who are suffering from exposure to violent or otherwise harmful content could be offered mental health services. Some employees might be advised to seek other work inside or outside the company. Mental health professionals could also be hired to assist employees who choose to remain on the job. The company’s and subcontractor’s computer algorithms could be improved to do more of the work currently demanded of people to reduce workers’ stress. 2-8. Q: Do you think the social media company bears any ethical responsibility for the physical and psychological health of your employees, or is it entirely your firm’s responsibility? A: From a strictly legal perspective, the social media company likely bears no direct legal liability for the

toll such work takes on the mental and physical health of the subcontractor’s employees. However, from an ethical perspective, the social media company may want to be sure that the employees are being wellcompensated for their work and see to it that they have a great deal of support from the subcontractor’s management team. 2-9. Q: Do you think the social media company or your firm has any long-term responsibility for your employees’ health once they leave your employment? A: In some cultures, one never knows what lawsuits might one day arise from having been employed doing such content moderation work. It does not seem too far-fetched to think that a talented legal team could pierce the veil of separability and go after the social media company as well as the subcontractor if a former employee brings a lawsuit. Practicing International Management Case Big Chocolate’s Big Problem 2-12. Q: Research whether Big Chocolate set a new deadline for meeting the terms of the Harkin-Engel Protocol. Has it met the deadline? What reasons does it give if it failed to meet it? A: As of mid-2022, it appears that the objectives of the Harkin-Engel Protocol are not yet met. The economics of the industry create conditions for the practice to continue—farmers do not make enough profit to hire adult laborers. Yet there appears to be some progress on the goal of eliminating child labor from cocoa harvesting. Around one-third to one-half of the world’s cocoa beans are now certified as not using child labor. 2-13. Q: Intermediaries and exporters control the sale of cocoa from Ghana and the Ivory Coast. Is there a way Big Chocolate can use its influence to ensure farmers receive a fairer price? A: Most obvious, and immediate, Big Chocolate could pressure intermediaries to pay cocoa farmers an above market price that allows them to hire more costly adult laborers rather than children. If Tony’s Chocolonely, can succeed doing so, Big Chocolate should also be able to do this. It would seem that Big Chocolate has a great deal of power relative to the

intermediaries and the farmers. 2-14. Q: If you were a member of the US Congress, what specific steps could you take to help eliminate the use of child labor in the cocoa industry or any industry? A: Greater transparency and monitoring is an obvious solution yet problems arise in their application. But if the world can monitor and report on sweatshop labor in the textile industry and working conditions in all sorts of other industries around the world, it should be able to do so effectively on the cocoa bean farms of Ghana and the Ivory Coast. 2-15. Q: Can you think of a way technology could be put to use to eliminate child labor in the cocoa industry? A: Tony’s Chocolonely created its Sweet Solution bars following its five sourcing principles: (1) using 100 percent traceable cocoa beans, (2) paying an abovemarket price, (3) supporting farmers, (4) creating long-term partnerships, and (5) focusing on quality and productivity. Tony’s ―Open Chain‖ also created an open-source cocoa bean platform for sourcing beans and makes it available to any chocolate maker that wishes to follow its lead.

Chapter 3 CROSS-CULTURAL BUSINESS LEARNING OBJECTIVES: 3.1: Explain culture and the need for cultural knowledge. 3.2: Summarize the cultural importance of values, attitudes, and behavior. 3.3: Describe the roles of social structure and education in culture. 3.4: Outline how the major world religions can influence business. 3.5: Explain the importance of personal communication to international business. 3.6: Describe how firms and cultures interact in the global workplace. CHAPTER OUTLINE: What Is Culture? Cross Cultural Literacy

Avoiding Ethnocentricity Developing Cross-Cultural Literacy National Culture Subcultures Physical Environment Material Culture Values, Attitudes, and Behavior Values Attitudes Aesthetics Behaviors Manners Customs Social Structure and Education Social Group Associations Types of Groups Family Collectivism and Individualism Social Status Social Mobility Caste System Class System Education The ―Brain Drain‖ Phenomenon Religion Christianity Islam Hinduism Buddhism Judaism Confucianism Personal Communication Spoken and Written Language Implications for Managers Language Blunders Lingua Franca Body Language Culture in the Global Workplace Perception of Time View of Work Cultural Change When Companies Change Cultures When Cultures Change Companies Kluckhohn-Strodtbeck Framework Case: Japanese Culture Hofstede Framework 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 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. 3.1

WHAT IS CULTURE? Culture is the set of values, beliefs, rules, and institutions held by a specific group of people. Main components include: physical environment, material culture, values, attitudes, aesthetics, manners, customs, social structure, education, religion, personal communication. Globalization encouraged cultures to assimilate to some extent. Yet it is enormously unlikely that the world will ever homogenize to a culture in which all people share similar lifestyles, values, and attitudes. 3.1.1. Cross-Cultural Literacy 1. Avoiding Ethnocentricity a. Ethnocentricity is the belief that one’s own ethnic group or culture is superior to that of others. It causes people to view other culture in terms of their own and overlook beneficial aspects of other cultures. b. Ethnocentricity can undermine business can undermine business projects when employees are insensitive to cultural nuances. 2. Developing Cross-Cultural Literacy a. Managers working directly in international business should develop cross-cultural literacy—detailed knowledge about a culture that enables a person to work happily and effectively within it. b. Cross-cultural literacy brings a company closer to customer needs and improves competitiveness. 3.1.2. National culture 1. 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. 2. Companies get involved in supporting culture, in part, for the public relations benefit. 3.1.3 Subcultures 1. 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.

Companies must be mindful of subcultures when formulating business strategies (e.g., China has 50 ethnic groups). 3. Decisions regarding product design, packaging, and advertising must consider distinct cultures. 4. Subcultures also can extend beyond national borders. 3.1.4. Physical Environment 1. Physical environment heavily influences a culture’s development and pace of change. 2. Topography includes all physical features that characterize the surface of a geographic region. Cultures isolated by mountains or large bodies of water are less exposed to the cultural traits of others and change slowly. 3. Topography impacts product needs and personal communication (e.g., mountains and the Gobi Desert consume two-thirds of China). 4. Climate affects where people settle, directs systems of distribution, and plays a large role in lifestyle, clothing, and work habits. 3.1.5 Material Culture 1. This is all technology a culture uses to manufacture goods and provide services. It can measure a culture’s technological advancement. 2. A firm enters a market under one of two conditions: (1) demand for its products has developed, or (2) the market can support its production operations. 3. Changes in material culture can change other aspects of culture. 4. Many nations display uneven levels of material culture across geography, markets, and industries. 3.2

VALUES, ATTITUDES, AND BEHAVIOR People in different nations behave differently and that every culture has segments of people with distinct values and behaviors. 3.2.1 Values Values are ideas, beliefs and customs to which people are emotionally attached. 1. They affect work ethic and desire for material possession. Some cultures value leisure while others value hard work. 3.2.2 Attitudes Attitudes are positive or negative evaluations, feelings, and tendencies that individuals harbor toward objects or concepts. 1. Learned from role models and formed within a cultural context. They are more flexible over time than values.

3.2.3

Aesthetics 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. 1. Appropriate colors for advertising, product packaging, and even work uniforms can enhance success (e.g., Green in Islam). 2. Blunders can result from selecting inappropriate colors and symbols for advertising, product packaging, and architecture. 3. It is also an important consideration in marketing over the internet. 3.2.4 Behaviors An understanding of manners and customs can help one avoid mistakes abroad. In depth knowledge improves the abilities of managers. 1. Manners are appropriate ways of behaving, speaking, and dressing in a culture. 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 and Popular Customs Folk customs are behaviors, dating back generations, practiced within a homogeneous group of people. A popular custom is behavior practiced by a heterogeneous group or by several groups. b. Gift-Giving Customs Although giving token gifts to business and government associates is customary, the proper type of gift varies. Cultures differ in their legal and ethical rules regarding bribery. US law prohibits companies from giving large gifts to win business favors.

3.3

SOCIAL STRUCTURE AND EDUCATION Social structure embodies a culture’s fundamental organization, including groups and institutions, social positions and relationships, and resource distribution. 3.3.1 Social Group Associations A social group is a collection of two or more people who identify and interact with one another. Social groups contribute to identity and self-image. 1. Type of Groups a. A primary group is a small group of people who share close personal relationships that form early in life and endure through time (e.g., family,

close friends) A secondary group is a larger, less personal, and less enduring than a primary group. They develop later in life and are established to achieve a specific goal (e.g., company employees). c. A reference group is one that people use as a standard (or reference) for their own preferences, beliefs, attitudes or behaviors (e.g., influencers and followers). 2. Family a. Nuclear family consists of immediate relatives, including parents, brothers, and sisters. Prevails in Australia, Canada, United States, and in Europe. b. Extended family includes grandparents, aunts and uncles, cousins, and relatives through marriage. Mostly found in Asia, Middle East, North Africa, and Latin America. 3. Collectivism and Individualism a. Identifies the extent to which a culture emphasizes the individual versus the group. b. Collectivist cultures have a tendency toward groups, including family and work units. Goals include maintaining group harmony and working toward collective, rather than personal, accomplishments. c. Individualist cultures stress individual rights, entrepreneurial risk taking, and a focus on personal goals. 3.3.2 Social Status Social stratification is the process of ranking people into social layers, or classes. 1. An objective social status ranking is a direct determination of social class based on socioeconomic variables. Such factors normally are family heritage, income, wealth, power, behavior, and occupation. 2. A subjective social status ranking is one in which people place themselves into various categories, relying mostly on income and to a lesser extent, education as powerful determinants. 3. Social status rankings are fairly stable over time in a culture but they can and do b.

3.3.3 1. 2. 3.

3.3.4 1.

3.4

change. Social Mobility Social mobility is the ease with which individuals can move up or down a culture’s ―social ladder.‖ Caste system: people are born into a social ranking, with little or no opportunity for social mobility. Class system: personal ability and actions determine social status and mobility. Highly class-conscious cultures can offer less mobility but experience more class conflict. 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. Excellent basic education attracts high-wage industries that invest in training and increase productivity. A skilled and welleducated workforce attracts high-paying jobs; a poorly educated one attracts lowpaying jobs. The ―Brain Drain‖ Phenomenon a. Brain drain is the departure of highly educated people from one profession, geographic region, or nation to another. b. Reverse brain drain is when those professionals return to their homelands.

RELIGION Human values often originate in religious beliefs. Different religions take different views of work, savings, and material goods. Beliefs can influence competitiveness, economic development, and business strategies. 3.4.1 Christianity 1. Founded in Palestine 2,000 years ago among Jews who believed that Jesus of Nazareth was their savior. With 2 billion followers, it is the world’s single largest religion. 2. More than 300 denominations but most are Roman Catholic, Protestant, or Eastern Orthodox. 3. Roman Catholics are to refrain from placing materialism above God and people. Protestants believe that salvation comes

4. 3.4.2 1.

2. 3. 3.4.3 1. 2.

3. 3.4.4 1.

3.4.5 1.

from faith in God and that hard work gives glory to God. Christian organizations sometimes get involved in social causes that affect business policy. Islam 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.‖ Religion strongly affects the goods and services acceptable to Muslim consumers (e.g., alcohol, pork, interest on loans). Hinduism Founded 4,000 years ago in present-day India, where more than 90 percent of its nearly 900 million adherents live. Some say it is a way of life rather than a religion. 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. Cows considered sacred animals so eating beef is not allowed (e.g., McDonald’s replaces beef with lamb). Buddhism Founded 2,600 years ago in India by a Hindu prince named Siddhartha Gautama. About 380 million followers, mostly in Asia, including China, Tibet, Korea, Japan, Vietnam, and Thailand. Promotes a life centered on spiritual rather than worldly matters. Buddhists seek nirvana (escape from reincarnation) through charity, modesty, compassion for others, and general self-control. Judaism Founded more than 3,000 years ago and has 18 million followers. Was the first religion to teach belief in one God. Orthodox Jews make up 12 percent of Israel and constitute an increasingly important economic segment. 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). The Sabbath lasts from sundown on Friday to

3.4.6 1.

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sundown on Saturday so work schedules might need adjustment. 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. Confucianism Founded 2,500 years ago by exiled politician and philosopher Confucius. Confucian thought is ingrained in the cultures of China, Japan, South Korea, and nations with large numbers of ethnic Chinese, including Malaysia, Singapore, Indonesia, and Thailand. Some observers contend that the Confucian work ethic and a commitment to education helped spur East Asia’s phenomenal economic growth. Others say Chinese leaders distrusted Confucian ideas for centuries because they believed it stunted economic growth. Moreover, the primary objective of merchants (to earn profits) goes against Confucian beliefs.

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 us understand people’s thoughts and behaviors. 3.5.1 Spoken and Written Language Spoken and written language is the most obvious difference we notice when traveling in another country. Linguistically different segments of a population are often culturally, socially, and politically distinct. 1. Implications for Managers a. Language proficiency is crucial in production facilities where non-native managers are supervising local employees. b. Marketers prize insights into the interests, values, attitudes, and habits of consumers to better target promotions. 2. Language Blunders a. Companies have made language blunders in their international business dealings. b. Advertising slogans and company

3.5.2 1.

2. 3. 4.

3.6

documents must be translated carefully so that the messages are received precisely as intended. Lingua Franca a. A lingua franca is a third or ―link‖ language that is understood by two parties who speak different languages. b. Although only 5 percent of the world’s population speaks English as a first language, it is the most common lingua franca used in international business, followed closely by French and Spanish. Body Language Body language is communicated through unspoken cues, including hand gestures, facial expressions, physical greetings, eye contact, and the manipulation of personal space. Communicates information and feelings and differs among cultures. It can be quite subtle and takes time to interpret. Proximity is an element of body language. Standing too close may invade personal space and appear aggressive. Physical gestures can easily cause misunderstanding between people of different cultures because they can convey very different meanings.

CULTURE IN THE GLOBAL WORKPLACE The workplace holds a prominent position in a culture. It provides a way to earn a living and supplies people with an avenue to give their lives meaning, structure, and identity. 3.6.1 Perception of Time 1. People in different culture often perceive time differently. People in polychronic time (P-time) cultures tend to engage in less advance planning and tend to do things according to their own schedule. 2. People in monochronic times (M-time) cultures tend to prefer well-defined advance schedules for deadlines, meetings, and so forth. 3.6.2 View of Work 1. Some cultures have a strong work ethic, others stress a balanced pace in work and leisure (e.g., a work to live versus a live to work mentality). 2. Many European nations are trying to foster

an entrepreneurial spirit to achieve the job growth realized in the United States. 3.6.3 Cultural Change Cultural trait is anything that represents a culture’s way of life including gestures, material objects, traditions, and concepts. Cultural diffusion is the process whereby cultural traits spread from one culture to another. 1. When Companies Change Cultures a. Globalization and technology increased the pace of cultural diffusion and encouraged cultural convergence in some market segments for some products. b. Cultural imperialism is the replacement of one culture’s traditions, folk heroes, and artifacts with substitutes from another. 2. When Cultures Change Companies a. Culture can force companies to adjust business policies and practices. Managers can encounter cultural differences that force changes in how they motivate employees in other countries, for example. b. Managers can use situational management to walk an employee through every step of a task and monitor the results at each stage. This helps employees understand the scope of their jobs and clarifies their responsibilities. 3.6.4 Kluckhohn–Strodtbeck Framework The Kluckhohn–Strodtbeck Framework compares cultures along six dimensions by 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?

Do people prefer to conduct most activities in private or in public? a. CASE: 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 – not necessarily for themselves, but for their 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. 3.6.5 Hofstede Framework The Hofstede Framework grew from a study of more than 110,000 people working in IBM subsidiaries in 40 countries by Dutch psychologist Geert Hofstede. He developed five dimensions for examining cultures. Later research included more people in additional countries, and he expanded the framework to a total of six dimensions. 1. Individualism versus Collectivism: Identifies the extent to which a culture emphasizes the individual versus the group. a. Individualist cultures value hard work, entrepreneurial risk-taking, 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 goals. 2. Power Distance: Identifies the degree to which a culture accepts social inequality among its people. a. A large power distance can cause inequality between superiors and subordinates. Organizations are hierarchical and power flows from prestige, force, and inheritance. b. A small power distance translates to greater equality, with prestige and

rewards equally shared between superiors and subordinates. Power derives can be seen as more legitimate. 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, have formal rules for employee behavior, and more difficulty implementing change. b. Low uncertainty avoidance cultures are more open to change and new ideas. Masculinity versus Femininity: Identifies the extent to which a culture emphasizes ―masculinity‖ versus ―femininity.‖ a. High ―masculinity‖ cultures are characterized by personal assertiveness, wealth accumulation, and entrepreneurship. b. Low ―masculinity‖ cultures have more relaxed lifestyles and place a concern for others over material gains. Long-Term Orientation: Indicates a society’s time perspective and an attitude of overcoming obstacles with time. a. This dimension attempts to capture differences between Eastern and Western cultures. b. Cultures scoring high (strong long-term orientation) value respect for tradition, thrift, perseverance, and a sense of personal shame. c. Cultures scoring low are characterized by individual stability and reputation, fulfilling social obligations, and reciprocation of greetings and gifts. Indulgence versus restraint: Captures the extent to which a society allows free expression. a. An indulgent society (one scoring high on this dimension) allows people to rather freely satisfy human needs related to enjoying life and having fun. b. A restrained society uses varying degrees of social norms to suppress the free satisfaction of such needs.

Quick Study Questions Quick Study 1 1.

Q: What is the term for detailed knowledge about a culture that enables a person to work happily and effectively within it? A: Cross-cultural literacy is detailed knowledge about a culture that enables a person to work happily and effectively within it. Cross-cultural literacy improves people’s ability to manage employees, market products, and conduct negotiations in other countries.

2. Q: How might a subculture differ from the dominant culture? A: A subculture can differ from the dominant culture in language, race, lifestyle, values, attitudes, or other characteristics. Subcultures can also extend across national borders. 3.

Q: What is the difference between physical environment and material culture? A: The physical environment includes surface features such as rivers, plains, mountain ranges, and bodies of water. These features might facilitate or impede travel and contact with others. The physical environment affects consumers’ product needs, where people settle, and distribution systems for products. Material culture is all the technology that a culture uses to manufacture goods and provide services. It is often used to measure the technological advancement of a nation’s markets or industries. It often displays uneven development across a nation’s geography, markets, and industries.

Quick Study 2 1.

Q: What are examples values? A: Values are ideas, beliefs, and customs to which people are emotionally attached. Examples include concepts such as honesty, individual freedom, group consensus, and responsibility, work ethic, and the desire for material possessions.

Q: What type of custom might a conservative group oppose in a culture? A: Popular customs from other countries can be resisted by a conservative group within a culture that believes it threatens traditional practices.

Contemporary clothing, music, TV and films, drugs and alcohol, and video games from more liberal cultures can be included in this category. Popular foods from other cultures (such as ―burgers ’n’ fries‖ born in the United States) that threatens to replace folk and traditional food can also face resistance. Perhaps even a folk custom from another culture can be resisted by very conservative groups. 3.

Q: How might the practice of gift giving differ across countries? A: Although giving token gifts to business and governments associates is customary in many countries, the proper type of gift varies. A knife, for example, should not be offered to associates in Russia, France, or Germany, where it signals the severing of a relationship. In Japan, gifts must be wrapped in such a delicate way that it is wise to ask someone trained in the practice to do the honors. Yet cultures differ in their legal and ethical rules against giving or accepting bribes. The U.S. Foreign Corrupt Practices Act prohibits companies from giving large gifts to government officials, to win business favors.

Quick Study 3 1.

Q: Social structure embodies a culture’s fundamental organization, including what? A: Social structure embodies 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.

Q: People and their immediate relatives, including parents and siblings, are called a what? A: A nuclear family consists of a person’s immediate relatives, including parents, brothers, and sisters. This is in contrast to an extended family, which includes grandparents, aunts and uncles, cousins, and relatives through marriage.

Q: What do we call the departure of highly educated people from one profession, region, or nation to another? A: The brain drain phenomenon refers to the departure of highly educated people from one profession, geographic region, or nation to another. If and when these individuals return is referred to as reverse brain drain.

Quick Study 4 1.

Q: Which denomination of Christianity has a ―work ethic‖ named after it? A: Protestants believe that salvation comes from faith in God and that hard work gives glory to God—a tenet which is widely known as the Protestant work ethic.

Q: How might practicing Islam affect a person’s consumption choices? A: Islam prohibits the consumption of alcohol and pork. Popular alcohol substitutes are soft drinks, 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). Markets for hot coffee and tea are quite extensive in Muslim cultures because they often play ceremonial roles. And because usury (charging interest for money lent) violates the laws of Islam, credit card companies instead collect management fees and limit each cardholder’s credit line to an amount held on deposit.

3. Q: India is home to more than 90 percent of the adherents of which religion? A: Hinduism formed around 4,000 years ago in present day India, where more than 90 percent of Hinduism’s 900 million adherents live. Quick Study 5 1.

Q: Every culture has a communication system that it uses to convey what? A: People in every culture have a communication system to convey thoughts, feelings, knowledge, and information through speech, writing, and actions.

Q: What is a name for a special language understood by two parties who speak different native languages? A: A lingua franca is a third, or link, language that is understood by two parties who speak different native languages. The original lingua franca arose to support ancient trading activities and contained a mixture of Italian and French, along with Arabic, Greek, and Turkish. Although only 5 percent of the world’s population speaks English as a first language, it is the most common lingua franca used in international business, followed closely by French and Spanish.

Q: What are some interesting facts about body language? A: Body language communicates through unspoken cues, including hand gestures, facial expressions, physical

greetings, eye contact, and the manipulation of personal space. Similar to spoken language, body language communicates both information and feelings and differs greatly from one culture to another. Italians, French, Arabs, and Venezuelans, for example, tend to animate conversations with lively hand gestures and other body motions. Japanese and Koreans can communicate just as much information through their own more reserved body languages; a look of the eye can carry as much or more meaning as an animated gesture. Most body language is subtle and takes time to recognize and interpret. Proximity is an important element of body language. Finally, physical gestures can easily cause misunderstanding between people of different cultures because they can convey very different meanings. Quick Study 6 1.

Q: What is the difference between P-Time and M-Time cultures? A: People in different cultures often perceive time differently. People in polychronic time (P-time) cultures tend to engage in less advance planning and to do things according to their own schedule. Businesspeople, for example, might arrive after the scheduled meeting time and prefer to build personal trust before discussing business. Conducting business in these parts of the world may take longer than in other cultures. P-time cultures are found in Africa, Latin America, Eastern Europe, and South East Asia. People in monochronic times (M-time) cultures tend to prefer well-defined advance schedules for deadlines, meetings, and so forth. People typically arrive promptly for meetings and keep tight schedules. M-time cultures are found in Northern Europe, Western Europe, Japan, and the United States.

Q: What is an example of cultural imperialism? A: Cultural imperialism is the replacement of one culture’s traditions, folk heroes, and artifacts with substitutes from another. Fears of cultural imperialism drive politicians in Russia to decry the Snickerization of their culture—which refers to the popularity there of the Snickers candy bar made by Mars Incorporated. When the Miss World Pageant was held in India, conservative groups criticized Western corporate sponsors for spreading the message of consumerism and portraying women as sex objects. And some consumers worldwide oppose US films and TV

programs for their perceived westernization of their culture.

influence

the

Q: The Kluckhohn-Strodtbeck frameworks studies culture along what dimensions? A: The Kluckhohn-Strodtbeck Framework compares cultures along six dimensions by 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?

Q: What are the six main cultural dimensions analyzed in the Hofstede framework? A: The Hofstede framework for studying cultural differences also examines cultures along six dimensions, including: 1. Individualism versus Collectivism: Identifies the extent to which a culture emphasizes the individual versus the group. 2. Power Distance: Identifies the degree to which a culture accepts social inequality among its people. 3. Uncertainty Avoidance: Identifies the extent to which a culture avoids uncertainty and ambiguity. 4. Masculinity versus Femininity: Identifies the extent to which a culture emphasizes “masculinity” versus “femininity.” 5. Long-Term Orientation: Indicates a society’s time perspective and an attitude of overcoming obstacles with time. 6. Indulgence versus Restraint: Captures the extent to which a society allows free expression.

Teaming Up 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 will question the opponent’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 on which team has offered the more compelling argument. A: Students should be sure to support their arguments with the theories, concepts, and examples presented in this chapter. They should 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. Ethical Challenge You are vice president of operations for a US–based global food company that sources fruit from suppliers worldwide. News reports say the authoritarian government of a developing nation from which your firm purchases a relatively rare fruit is repressing a religious and ethnic minority within its borders. Reports say the government is violating the group’s human rights by forcing them to harvest fruit that is then sold to your company. They say the fruit is, therefore, the outcome of forced labor. The government denies the charges but provides no evidence. Consumers from developed nations that purchase your products are on social media calling for your firm to cut all ties with the country. Your company calls a crisis videoconference to discuss the matter. 3-4. Q: Your firm’s crisis management strategy is to first issue a statement on an issue in hopes of controlling it. What, if any, statement could your company issue that would appease all parties in this matter? A: First of all, any statement by the company is doubtful to appease all parties. To minimize the odds of it becoming more embroiled in controversy, management will need to craft a delicate statement to its stakeholders. This statement could reiterate the company’s commitment to ethical sourcing and production policies. It could also link to the company’s code of conduct that clearly states its philosophy and its policies. Executives could announce that it will immediately launch an internal investigation into the matter and could, if possible and at least temporarily, source from other locations. The company might also obtain the services of a public relations firm, at least for the near term. 3-5. Q: As VP of operations, what course of action do you

advise your company to take? Explain. A: The company should begin obtaining the fruit from other sources, if possible, yet not burn bridges with local suppliers if the claims turn out to be false. Meanwhile, it should launch a full investigation into the matter to determine the authenticity of the claims. Based on its findings, the company should make any required changes to where it obtains the fruit. Executives might also want to learn if company personnel were aware of these potential allegations beforehand. If yes, why was the issue not addressed earlier? The company may need to review its sourcing policies and perform a review of the staff involved in procuring this ingredient. 3-6. Q: Do you think it is possible to continue to import fruit from the country? Why? A: The company might choose to continue sourcing the fruit from the country for now while it investigates, especially if the evidence of those making the claims is dubious. However, it will need to be prepared for any potential backlash from customers. It should have responses and a strategy prepared for how it will move forward under different outcomes. The company might wish to obtain the services of a professional public relations firm at least for the near term. 3-7. Q: How do you think each of your firm’s stakeholders will react if your company chooses your suggested course of action? A: If handled properly, the firm’s stakeholders should understand the situation and what the company is doing to remedy matters. This is one reason why proper, ongoing communication with a firm’s stakeholders is so important and help form a competitive advantage. A long-term relationship built on mutual trust and respect allows a company to take the time it needs to take the measure of a situation and communicate thoughtfully with stakeholders. Knee-jerk reactions in such situations are often misguided and can result in lost brand equity.

Practicing Management Case

International

“Off The Wall” with Vans® and VF Corporation 3-10. Q: Identify all the chapter topics and concepts you can within the case. How is each one illustrated in the case? A: Vans embraced the values and attitudes of the skateboarder subculture within the dominant US culture. That subculture lifestyle differs in many ways from the dominant culture in its fashion, art, music, and its vernacular. The company appealed to the subculture’s core values of creative self-expression, authenticity, and individuality. Actor Sean Penn wore Vans shoes in the popular teen film, Fast Times at Ridgemont High. The film’s cast of characters was a strong reference group for teens both inside and outside the skater subculture. The company creates activities and venues for the superstars of skateboarding to become important influencers for teens. Vans nurtures future generations of customers by educating them on the original spirit and creativity of skateboarding pioneers. The lifestyle and popular customs of the skateboarder subculture then made its way to other countries. 3-11. Q: In what ways has Vans and its parent company, VF Corporation, benefitted from globalization? A: Vans benefitted enormously from the globalization of markets. US film and social media promoted the skater/surfer subculture to the world. Vans benefitted from being able to market its shoes worldwide to members of the skater/surfer subculture and also to these who just wanted to wear a hip pair of Vans sneakers. Vans benefitted later from producing its shoes where costs were lower and then shipping them to markets worldwide. Vans was eventually purchased by a global holding company comprising some of the best-known global apparel brands. 3-12. Q: Vans employs professional athletes in the design and marketing of its products. What are the benefits and potential drawbacks of this marketing strategy? A: Vans benefits from well-known skaters such as Stacy Peralta and Tony Alva through their endorsement of its products. This also benefits the brand as professional athletes form a strong reference group for those in skateboard competitions and those belonging to the skater/surfer subculture. The potential drawbacks are that any damaging behavior by an athlete, in their private or public life, reflects on the company and brand. This can affect the brand both positively or negatively. 3-13. Q: What other reasons, besides those that VF Corporation gave, might have influenced its decision to move operations out of Hong Kong, China? A: The geopolitical environment is once again front and center in international business. Vans moved operations out of Hong Kong most likely because of mainland China’s growing influence in Hong Kong. Namely, China’s 2020 crackdown on political demonstrations in Hong Kong. Furthermore, relations worsened between China and the United States (and others) with the arrival of the Covid-19 pandemic. There is a decoupling to some extent going on whereby US companies are moving some production out of China and to other nations, such as Vietnam. Some companies are engaging in what is called ―friend-shoring,‖ moving production to countries that share similar values. Another issue is the supply chain problems that arose when pandemic-caused economic lockdowns exposed the weaknesses of just-

in-time inventory practices. Companies are tending to increase inventories to more easily weather supply shocks caused by unpredictable events.

CHAPTER 4 POLITICAL ECONOMIC AND LEGAL SYSTEMS LEARNING OBJECTIVES: 4.1 Describe the key features of each form of political system. 4.2 Explain how the three types of economic systems differ. 4.3 Summarize the main elements of each type of legal system. 4.4 Outline several key legal issues important for international business. CHAPTER OUTLINE: Political Systems Totalitarianism Theocratic Totalitarianism Secular Totalitarianism Doing Business in Totalitarian Countries Democracy Representative Democracy Doing Business in Democracies Economic Systems Centrally Planned Economy Origins of the Centrally Planned Economy Decline of Central Planning Mixed Economy Origins of the Mixed Economy Progress of Mixed Economies Market Economy Origins of the Market Economy Features of a Market Economy Government’s Role in a Market Economy Economic Freedom Legal Systems Common Law Civil Law Theocratic Law Global Legal Issues Intellectual Property Industrial Property

Copyrights Product Safety and Liability Antitrust Regulations Taxation A comprehensive set of specially designed PowerPoint slides is available for use with Chapter 4. These slides and the lecture outline below form a completely integrated package that simplifies the teaching of this chapter’s material. Lecture Outline INTRODUCTION This chapter considers the basic differences between political and legal systems around the world. Disputes grounded in political and legal matters affect business activities. Companies should be aware of how to manage the associated risks. Individualism is a belief that individual rights and responsibilities should be placed above the group’s welfare. Collectivism stresses the relative importance of a group’s welfare over that of the individual. The legal, political, and economic systems of every nation display a unique blend of individual and group values. 4.1

POLITICAL SYSTEMS A political system includes the structures, processes, and activities by which a nation governs itself. A nation’s political system derives from its history and culture, and includes such factors as population, age, race composition, and per capita income. 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. The political system also allows for Participation, which occurs when people voice opinion, vote and show general approval or disapproval of the system. 4.1.1 Totalitarianism is a political system in which individuals govern regardless of the people’s support, tightly control people’s lives, and do not tolerate opposing viewpoints. 1. These governments share three features: imposed authority, lack of constitutional guarantees, and restricted participation. 2. Theocratic totalitarianism is a political system under the control of totalitarian religious leaders. 3. Secular totalitarianism is a political system in which leaders maintain control

through military and bureaucratic power. It takes three forms: Communist, tribal and right wing. a. Communism is a system that says social and economic equality can only by establishing an all-powerful Communist Party, violently gaining control over economic resources, and eliminating political opposition. b. Socialism is a political system in which government owns and controls all types of economic activity to achieve social and economic equality. c. Tribal totalitarianism is a system in which one ethnic group imposes its will on others with whom it shares a national identity. d. Right-wing totalitarianism is when government grants few (if any) political freedoms and endorses private ownership of property and a marketbased economy. Leaders strive for economic growth and oppose left-wing totalitarianism, or communism. 4. Doing Business in Totalitarian Countries a. 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. 4.1.2 Democracy is a political system in which government leaders are elected directly by wide participation of the people or their representatives. 1. In representative democracies, citizens elect individuals from their groups to represent their political views. 2. Representative democracies strive to provide freedom of expression, periodic elections, full civil and property rights, minority rights, and nonpolitical bureaucracies. 3. In a parliamentary democracy, the nation divides itself into geographic districts and people in each district vote for competing parties rather than individual candidates. a. Absolute majority: the number of representatives the party gets elected exceeds the number of representatives elected by all other parties.

4.2

Coalition government: if the party with the largest number of representatives lacks an absolute majority it can join with one or more parties to share responsibilities. Examples include Italy, Israel, the Netherlands. Doing Business in Democracies Democracies tend to maintain stable business environments through laws protecting individual property rights. Participative democracy, property rights, and free markets tend to encourage economic growth.

ECONOMIC SYSTEMS An economic system is the structure and processes that 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. 4.2.1 Centrally Planned Economy Land, factories, and other economic resources are owned by the government, which plans nearly all economic activity. 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. Based on the belief that group welfare is more important than individual wellbeing, 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 the economic law in lands stretching across Central and Eastern Europe, Asia, Africa, and Latin America. 2. Decline of Central Planning a. In the late 1980s, after the former Soviet Union implemented its twin policies of glasnost (political openness) and perestroika (economic reform), its totalitarian government collapsed. Other nations began to dismantle communist central planning in favor of market-based economies. b. Failure to create economic value: Central planners failed to produce quality products efficiently.

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 behind other nations due to a lack of innovation. e. Failure to satisfy consumer needs: Consumers’ basic needs were not being met. f. China experimented with market economics before the former Soviet Union began its reform programs. Today, China practices state capitalism, whereby the government is the leading economic actor and uses markets for political gain. China continues to experience strong economic growth. 4.2.2 Mixed Economy Economic system in which land, factories, and other economic resources are rather equally split between private and government ownership. Government controls economic sectors important to national security and long-term stability. Generous welfare systems support the unemployed and provide health care. 1. Origins of the Mixed Economy A successful economy is efficient and innovative, but also protects society. Its goals are low unemployment, low poverty, steady economic growth, and an equitable distribution of wealth. 2. Progress of Mixed Economies Mixed economies believe they should not dismantle their social welfare institutions but should modernize them so they contribute to national competitiveness. a. Somewhat slow economic growth caused many mixed economies to want to increase economic efficiency, boost productivity, and raise living standards. This led nations to pursue privatization—the sale of governmentowned economic resources to private operators. 4.2.3 Market Economy Economic system in which 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 It Places individual concerns 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. b. Free enterprise: Companies can decide what to produce and which markets to compete in. c. Price flexibility: Prices rise or fall reflecting supply and demand. 3. Government’s Role in a Market Economy It has 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. Encourage competition and innovation that lower prices and increase product choices. iii. Prevent trade-restraining monopolies from price-fixing, sharing markets and gaining unfair advantages. 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

4.3

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. Reduces political risk for companies. Economic Freedom a. Connection between political freedom and economic growth is uncertain. b. Greater economic freedom tends to coincide with higher living standards. But the economic success of autocratic state capitalism complicates this subject.

LEGAL SYSTEMS A legal system is a country’s set of laws and regulations, including how its laws are enacted and enforced, and how its courts hold parties accountable. It is influenced by cultural variables, including class barriers, religious beliefs, emphasis on individualism or conformity, and the political system. The legal system can also be influenced by political moods and upsurge in nationalism, the devotion of a people to their nation’s interests and advancement. Totalitarian governments favor public ownership and enact laws limiting entrepreneurial behavior. Democracies encourage entrepreneurial activity and protect businesses with property-rights laws. 4.3.1 Common Law  Tradition: Country’s legal history  Precedent: Past cases that have come before the courts  Usage: How laws are applied in specific situations 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

3. 4.3.2 1.

4.3.3 1. 2.

4.4

account particular situations and circumstances. Practiced in Australia, Britain, Canada, Ireland, New Zealand, the United States, and some nations in Asia and Africa. Civil Law Based on a detailed set of written rules and statutes that constitute a legal code. Can be traced to Rome in the fifth century BCE and is the oldest and most common legal tradition. 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 directly from the relevant code. Practiced in Cuba, Puerto Rico, Quebec, all of Central and South America, most of Western Europe, and parts of Asia and Africa. Theocratic Law Legal tradition based on religious teachings (e.g., Islamic, Hindu, and Jewish law). 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. Firms operating in countries with theocratic legal systems 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. There is a movement toward standardizing the interpretation and application of laws in more than one country, but this does not involve standardizing entire legal systems. Enduring differences, therefore, can force companies to continue the costly practice of hiring legal experts in each country where they

operate. 4.4.1 1.

4.4.2. 1.

Intellectual Property This results from intellectual talent and abilities such as graphic designs, novels, computer software, machine-tool designs, and secret formulas. The move to cloud computing and increased sales of subscription software are lowering prices and reducing the incidence of unlicensed software. Cloud computing is the delivery of computing services over the internet, or the cloud. Industrial Property a. 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. b. Industrial property is intellectual property and often a firm’s most valuable asset. Laws protecting industrial property reward innovative and creative activity. c. A 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. d. 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., Apple’s logo). Copyrights give creators of original works the freedom to publish or dispose of them as they choose. a. The 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. b. Protected under the Berne Convention and the 1954 Universal Copyright Convention and are granted for the creator’s lifetime plus 70 years. Product Safety and Liability Product liability is the responsibility of manufacturers, sellers, individuals, and others for damage, injury, or death caused by defective products.

Developed nations have the toughest product liability laws compared to developing and emerging countries. 4.4.3 Antitrust Regulations 1. Antitrust (antimonopoly) laws are designed to prevent companies from fixing prices, sharing markets, and gaining unfair monopoly advantages. They help ensure a variety of products at fair prices. 2. The United States and the European Union have strict antitrust regulation and are strict enforcers. 3. In strict antitrust countries, companies are at a disadvantage if competitors’ home countries condone market sharing, whereby competitors agree to serve only designated market segments. 4.4.4 Taxation 1. Tax revenues needed to pay government salaries, build military capacity, and shift earnings from people with high incomes to those with low incomes. 2. Consumption taxes help pay for the consequences of using a particular product and to make imports more expensive. 3. Value added tax (VAT) is levied on each party that adds value to a product throughout its production and distribution. Supporters of the VAT system contend that it distributes taxes on retail sales more evenly between producers and consumers. Yet consumers ultimately pay the tax because producers and distributors usually increase prices to compensate for their tax burden. Quick Study Questions Quick Study 1 1.

Q: How are anarchism, totalitarianism and pluralism different? A: An anarchist views public government as unnecessary and unwanted because it tramples on personal liberty. At the other extreme lies totalitarianism, a political system in which individuals govern regardless of the people’s support, tightly control people’s lives, and do not tolerate opposing viewpoints. Between these two extremes lies pluralism, which is a belief that both private and public groups play important roles in a

nation’s political activities. 2.

Q: What are the main characteristics of the political system known as communism? A: A communist government has sweeping political and economic powers. In this type of system, private business is virtually non-existent. Government ownership and control covers all means of production (such as capital, land, and factories) and the power to decide what is produced and the prices of the products.

Q: What five things does a representative democracy strive to provide for its people? A: Representative democracies strive to provide some or all of the following: (1) freedom of expression, (2) periodic elections, (3) full civil and property rights, (4) minority rights, and (5) nonpolitical bureaucracies.

Q: How does doing business in a totalitarian country differ from doing business in a democracy? A: Democracies tend to encourage entrepreneurial activity and protect business with strong property rights laws, while totalitarian government favor public ownership of economic resources and enact laws liming entrepreneurial behavior.

Quick Study 2 1.

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

Q: Why do mixed economies split ownership of land, factories, and other economic resources rather equally between private and government ownership? A: The government controls economic sectors considered important to national security and stability. Mixed economies tend to assist these key industries with special subsidies, maintain generous unemployment support and provide subsidized or free healthcare.

Q: What are three key features of a market economy that make it run smoothly and properly? A: Free choice, free enterprise, and price

flexibility. 4.

Q: What feature do countries with the greatest amount of economic freedom tend to have? A: Countries with the greatest economic freedom tend to have the highest standard of living.

Quick Study 3 1.

Q: Which legal system decides cases by interpreting the law based on tradition, precedent, and usage? A: Under common law, the judicial system decides cases by interpreting the law based on tradition, precedent, and usage.

Q: Which legal system is based on a detailed set of written rules and statutes that constitute a legal code? A: Civil law is a system based on a detailed set of written rules and statutes that constitute a legal code.

Q: What do we call a legal tradition based on faith? A: A legal tradition based on religious teaching is called theocratic law.

Quick Study 4 1.

Q: What are some examples of intellectual property? 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 is protected by copyrights, patents, and trademarks. Examples include graphic designs, novels, computer software, machinetool designs, and secret formulas, such as that for making Coca-Cola.

2. Q: What are the different types of industrial property? 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. 3.

Q: What are laws called that hold parties responsible

for damage, injury, or death caused by defective products? A: 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. Developed nations have the toughest product liability laws compared to developing and emerging countries. Enforcement of such laws also varies from nation to nation, with highly developed countries being the strictest enforcers. Teaming Up 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 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 arguing in favor of entering countries with totalitarian governments should consider the perspective of companies based in similar countries, not just democratic ones. Many students will overlook the fact that many companies based in totalitarian countries do business in similar countries. Trying to view business from this perspective might challenge students’ logic who do not come 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 not investing will hinder political change. 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. Ethical Challenge 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) to download or use online. But with an income of just over $5,000 a year, you cannot afford to buy the original graphics software for your business. An associate has offered to get you all the software you need, and more, for only $30. Yet you have financially strapped friends who code software for the global software companies that make the very programs you

need. 4-3. Q: Do your personal circumstances make it morally acceptable for you to purchase the pirated software? A: Entrepreneurs who have just started a company with limited resources may turn to pirated software to keep cost down. Is the use of the pirated software justified? Is it ethical to assume that this software is available over the internet for free or from colleagues at reduced prices ethical? I think most would conclude that software piracy is not only illegal, but completely unethical. However, student responses will vary. 4-4.

Q: Do you feel guilty that you are harming the company that employs your friends? A: Many students will likely agree with the logic that says it is acceptable to use pirated software because of the inherent inequality between the company in a developed country and a working-class individual in an emerging market. They do not likely see taking advantage of the discounted, illegal software as a threat to the software company.

4-5. Q: What would you do if you were told of a new government effort to actively punish users of pirated software? A: Many students will probably hold the belief that online software piracy is not a serious offense. However, with the government actively exerting an effort to punish users, the possibility of criminal punishment may make them reconsider. 4-6. Q: Does a software company bear any responsibility for subcontracting work to low-wage markets where its finished product is unaffordable for the same coders who helped create it? 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, thus earning pirates a huge profit. Another is the precedent that is set for other markets—all consumers would only need to start an underground market for companies to lower prices. Students sometimes argue for multinationals to fight piracy but be less forceful in lowerincome markets. Practicing International Management Case TikTok and the Big Tech Crackdown

4-9. Q: Do you believe China’s political, economic, and legal systems will one day operate more similarly to those of the United States? Why or why not? A: Some years ago, an ideological line of reasoning took root across the Western world, particularly in the United States. This line of thinking believed that as China grew wealthier, its people would demand greater political freedom, China’s government would eventually evolve into some type of democracy, and China would strengthen existing institutions that support global business. As a result, the West engaged with China and welcomed it into the World Trade Organization, promoted FDI into China, and helped advance its economy. In recent years, the West has viewed this as a strategic error. The Chinese Communist Party has made it clear that it desires a new, or revised, world order embedded with far more Chinese characteristics and decreased influence of the United States. The future will reveal whether China will continue along that path or alter its strategy. 4-10.

Q: Do you believe China is following the right course of action by reducing the political and market power of its biggest technology firms? Explain. A: This question will get students to consider how they personally feel about the competing economic systems of capitalism, socialism, and communism. Students read here the power that China’s government has over its businesses. Companies can see their initial public offerings of stock canceled, greater government regulation imposed, its corporate structure modified, and large fines imposed, all by the Communist Party leadership. Students should also consider whether such moves will negatively impact the global competitiveness of China’s technology firms.

4-11.

Q: While China’s government took antimonopoly steps against its big technology companies, the US government was considering something similar against big US technology firms. Do you see any differences in the motives between the two countries for their antimonopoly efforts? A: China wanted to reign in the political power of its technology companies and have their financial success contribute more to Chinese society, among other things. Jack Ma’s criticism of the government was likely the proverbial straw that broke the camel’s back. The Party simply could not allow business leaders to publicly criticize the government. Antimonopoly forces within the United States were more focused on encouraging competition, lowering prices, spurring innovation, and increasing consumer data protection. US technology leaders can criticize government leadership without experiencing overt government action against them like China’s government did to its tech titans.

4-12. Q: Do you believe TikTok was treated unfairly by certain governments of the world? Are Facebook, Twitter, and other social media firms not in possession of sensitive user data as well? Explain. A: This gets to the distrust some nations feel toward China because they question its long-term goals and agenda. For example, the European Union continues to

fight what it sees as the overreach and violation of consumer privacy by US tech firms. Still, the EU and the US are accustomed to and familiar with the business operations of each other’s companies because both govern based on democratic principles. They use and rely on the familiar rules of the international institutional framework to settle their disputes. But Communist China has exploded onto the world stage as an economic superpower in unprecedented fashion. Some countries fear the long-term intentions of China’s Communist Party and its global corporate champions. Some of this has to do with an unfamiliarity with China’s way of conducting business. Some of it has to do with decades of distrust of communism. And some of it has to do with the political rhetoric out of China and its military buildup and desire to carve out its sphere of influence in Asia, thereby forcing Western nations into retreat from the region.

Chapter 5 ECONOMIC DEVELOPMENT OF NATIONS LEARNING OBJECTIVES: 5.1 Explain economic development and how it is measured. 5.2 Outline the various sources of political risk. 5.3 Explain how companies can manage political risk. 5.4 Describe economic transition and the experiences of China and Russia. CHAPTER OUTLINE: Economic Development Classifying Countries Advanced Countries Emerging Markets Developing Countries National Production Uncounted Transactions Question of Growth Problem of Averages Pitfalls of Comparison Purchasing Power Parity Human Development Political Risk Conflict and Violence Property Seizure

Government Policies Managing Political Risk Adaptation Information Gathering Political Influence International Relations The United Nations Economic Transition Transition Obstacles Managerial Expertise Shortage of Capital Cultural Differences China’s Economic Transition Chinese Patience and Guanxi China’s Challenges Russia’s Economic Transition Russia’s Challenges 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 I.

INTRODUCTION National culture can have a strong impact on a nation’s economic development. In turn, the development of a country’s economy can dramatically influence many aspects of its culture. Economic systems in individualist cultures tend to provide incentives and rewards for individual business initiatives. Collectivist cultures tend to offer fewer such incentives and rewards.

5.1

ECONOMIC DEVELOPMENT Economic development refers to an increase in the economic well-being, quality of life, and general welfare of a nation’s people. It reflects economic output (agricultural and industrial); infrastructure (power and transportation facilities); physical health, safety, life expectancy, environmental sustainability, level of education; and cultural, political, legal, and economic differences. 5.1.1 Classifying Countries Classifications normally based on indicators such as figures on national production, portion of the economy devoted to agriculture, volume of exports in the form of industrial goods, and overall

economic structure. 1. Advanced Countries (also called 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. 2. Emerging Markets (also called Newly industrialized countries) 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. Depending on the classification criteria, the group can include Argentina, Brunei, Chile, the Czech Republic, Hungary, Indonesia, the Philippines, Poland, Russia, Slovakia, Turkey, and Vietnam. 3. Developing Countries a. A nation that has a low-quality infrastructure and low personal incomes. Mainly in Africa, the Middle East, and the least affluent nations in Eastern Europe and Asia. b. Rely on one or a few sectors of production—agriculture, mineral mining, or oil drilling. They may lack key resources and skills. c. 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. 5.1.2 National Production Can classify countries by gross domestic product per capita, but there are problems using GDP and GNP as indicators of development. 1. Uncounted Transactions a. Volunteer work, unpaid household work, illegal activities, shadow economy transactions, and unreported cash transactions. b. The shadow economy (also called the hidden, gray, cash or informal economy) includes economic activities that have

5.1.3 1.

5.1.4 a.

b. c. 5.2

market value but are not formally registered. The shadow economy can be so large and prosperous that official statistics are almost meaningless. Question of Growth a. GDP and GNP figures are a snapshot of one year’s economic output, and do not indicate whether an economy is growing. Problem of Averages b. Per capita figures are averages. Urban areas can be more developed than rural areas and have higher per capita income. Pitfalls of Comparison a. To compare gross product per capita, each currency must be translated into a single currency. b. Official exchange rates do not show what the local currency can buy in its home country. Purchasing Power Parity 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. Using purchasing power parity to compare the wealth of nations, for example, Mexico’s GDP/capita is $9,489 (in US dollars at current exchange rates) and that of the United States is $65,134. If we adjust Mexico’s GDP/capita for purchasing power in Mexico, we obtain a figure of $20,944. Human Development Human development index (HDI) measures extent to which a government equitably provides its people with a long and healthy life, an education, and a decent standard of living. There is often disparity between wealth and HDI. HDI demonstrates that high national income alone does not guarantee human progress.

POLITICAL RISK Political risk is the likelihood of political action that positively or negatively affect a business. It can threaten an exporter’s market, manufacturing facilities, and the ability to repatriate profits. Political risk levels vary from nation to nation. Two broad categories of political risk reflect the range of companies they affect. Macro risk threatens the

activities of all domestic and international companies in every industry. Micro risk threatens companies within a particular industry or even smaller groups. The main sources of political risk include: 5.2.1 Conflict and Violence 1. Local conflict discourages investment. Violence hinders manufacturing, obtaining materials and equipment, and recruiting talented personnel. 2. It can arise from resentment toward government, territorial disputes, and disputes over ethnic, racial, and religious differences. 5.2.2 Property Seizure 1. Confiscation is the forced transfer of assets from a company to the government without compensation. There is no framework for legal appeal, and compensation tends to be far below value. 2. Expropriation is the forced transfer of assets from a company to the government with compensation. 3. 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 so they cannot be transferred to low tax-rate countries, and (4) invest in industries (such as public utilities) that private companies cannot afford. 5.2.3 Government Policies 1. Policy changes can result from newly empowered political parties, pressure from special interests, and civil or social unrest. 2. One policy tool restricts ownership to domestic companies or limits ownership by nondomestic firms to a minority stake. 3. Other policies relate to investments made across borders. 4. Local content requirements are laws stipulating that a specified amount of a good or service be supplied by producers in the domestic market. These laws can 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.

5.3

MANAGING POLITICAL RISK Companies manage political risks that threaten operations and future earnings. 5.3.1 Adaptation: Incorporate risk into business strategies, often with the help of local officials. 1. Partnerships can be used to leverage expansion plans through informal arrangements or joint ventures, strategic alliances, and cross-holdings of company stock. 2. Localization entails modifying operations, the product mix, or other elements to suit local tastes and culture. 3. 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. 4. Insurance can be used to protect companies against losses and can provide project financing. The US International Development Finance Corporation insures US companies that invest abroad against loss and can provide project financing. 5.3.2 Information Gathering: Sources include employees with information and political risk agencies. 1. Current employees with relevant information: people who worked in the country and have valuable contacts and knowledge. 2. Agencies specializing in political-risk services: such as banks, political consultants, news publications, and riskassessment services. 5.3.3 Political Influence: Deal with local lawmakers and politicians directly or by lobbying–a policy of hiring people to represent a company’s views on political matters. 5.3.4 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. 5.3.5 The United Nations

5.4

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, medical supplies, educational supplies and training, and financial resources to lower-income member nations. Receives funding from member contributions based on gross national product (GNP). Entire world is involved with the UN in some manner. UN system consists of six main segments: (1) General Assembly; (2) Security Council; (3) Economic and Social Council; (4) Trusteeship Council; (5) International Court of Justice; and (6) the Secretariat. 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.

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.  Encourage innovation through investment and entrepreneurship. 5.4.1 Transition Obstacles: Transition from central planning to free market economies generates tremendous international business opportunities. Yet difficulties arising from decades of centrally planned economic principles can impair development efforts. Several key obstacles for countries in transition. 1. Managerial Expertise a. Central planners had little need for management skills in production, distribution, pricing, or marketing strategies. b. Some managers from former communist

nations can now rival the abilities of the best managers. 2. Shortage of Capital Transition is expensive, requiring spending to: a. Develop a telecommunications and infrastructure system. b. Create financial institutions, including stock markets and a banking system. c. 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 made in welfare, unemployment benefits, and guaranteed government jobs. 5.4.2 China’s Economic Transition China’s system is ―Socialism with Chinese characteristics,‖ and the nation has undergone great economic reform over the past two decades. 1. Early Years a. 1949: Communes planned all agricultural and industrial production and schedules. Rural families owned their homes and land and produced particular crops which could be consumed by the family or sold for profit. b. 1979: Government reforms allowed families to grow crops they chose and sell produce at market prices. c. 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. d. Mid-1980s: Foreign companies were allowed to form joint ventures with Chinese partners. In 1988, China relaxed government controls over private property. China began selling ―land-use rights‖ for residential, commercial, and other uses to raise capital. e. 1994: China formalized the practice of ―land-use rights" into law. In a capitalist economy this would be called private land ownership.

Chinese Patience and Guanxi a. If there is one trait that all private companies need in China, it is patience. An interesting facet of doing business there is guanxi, the Chinese term for personal relationships. 3. China’s Challenges a. China’s economy continues to grow following the Covid-19 pandemic. b. Increased democratic reform is not supported by the government and protests arise whenever citizens grow impatient with political issues. c. Uncertainty surrounds Taiwan’s eventual reunification with the Chinese mainland. 5.4.3 Russia’s Economic Transition 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. Russia’s Challenges a. In the 1980s, Russia entered a new era of freedom of thought, freedom of expression, and economic restructuring. b. People could now speak freely, and vented frustration over lack of consumer goods, poor quality products, and long lines at banks and grocery stores. c. Transition away from government ownership and central planning was sudden and turbulent. Politicians and bureaucrats looked out for themselves and most made out fine in the transition. But most people had difficulty maintaining their standard of living and affording many basic items. d. Russia invaded Georgia in 2008 over two of Georgia’s restive republics that wanted to draw closer to Russia. In 2014, Russia annexed the Ukraine’s peninsula of Crimea and two eastern provinces away from Ukraine. Many nations swiftly rebuked Russia’s actions and some, including the United States, imposed political and economic sanctions. Then, in 2022 Russia invaded the rest of Ukraine. Western nations fled Russia, sanctioned its politicians and oligarchs, and decoupled from its economy. Quick Study Questions Quick Study 1

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

Q: What are the drawbacks of using national production to measure economic development? A: There are several 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 among 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.

Q: The human development index measures which aspects of a nation’s 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.

Quick Study 2 1.

Q: What is political risk and how might it affect companies? A: Political risk is the likelihood of political action that will positively or negatively affect a business. The two broad categories of political risk reflect the range of companies they affect. Macro risk threatens the activities of all domestic and international companies in every industry, Examples include a general threat of violence against corporate assets in a nation and a rising level of government corruption. Micro risk threatens companies only within a particular industry or a more narrowly defined group. For example, an international trade war in steel affects the operations of steel producers and companies that require steel as an input to their business activities.

Q: What danger does conflict abroad present to companies? 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. 3.

Q: What are the three forms of property seizure that nations might pursue? A: The forced transfer of assets from a company to the government without compensation is called confiscation. The forced transfer of assets from a company to the government with compensation is call expropriation. Whereas expropriation involves one or several companies, in an industry, nationalization means government takeover of an entire industry.

Quick Study 3 1.

Q: How can situational awareness help keep a company ahead of political risks? A: Companies should take a proactive approach to political risk and be prepared for the possibility of something going wrong. Situational awareness involves setting up a warning system that scan for political risk information. There are two sources that companies use to conduct accurate political risk forecasting. Current employees who have worked in a country long enough to gain insight into local culture and politics are often a good source of information. Second, agencies specialized in providing political risk services which include banks, political consultants, news publications, and risk assessment services.

Q: What are the three main approaches to managing political risk? A: 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. Information gathering involves monitoring and even trying to predict political events that could threaten local operations and future earnings. Political influence involves proposing changes that positively affect their local activities, often through lobbying.

Q: How might international relations among countries affect political risk? A: Unfavorable political relations among countries will foster an unstable business environment, decreasing business opportunities, increasing risk,

and hindering economic development. Quick Study 4 1.

Q: What does the economic transition process involve? 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.

2. Q: What are the key obstacles for countries in transition? 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 hampered progress. 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 presented special problems because of the high cost of economic transition. Governments of nations in transition could often afford only a portion of the required investment. These nations lacked 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. 3.

Q: What are the main characteristics of China’s experience with economic transition? A: China has done more for its people economically over the past two decades than perhaps any other nation on earth. China’s leaders describe its economic philosophy as ―socialism with Chinese characteristics.‖ The country’s immense population, rising incomes, and expanding opportunities attracted huge sums of investment. The purpose is to promote regional integration, increase trade and stimulate economic growth.

Q: How has Russia managed its economic transition from central planning? A: Transition away from government ownership and central planning was sudden and turbulent. Politicians and bureaucrats looked out for themselves and most made out fine in the transition. But most people had difficulty maintaining their standard of living and affording many basic items. But Russia had done well fostering managerial talent. Years of central planning delayed the development of managerial skills needed in a marketbased economy. But Russian managers advanced their skills in every facet of management practice including financial control, research and development, human

resource management and marketing strategy. But today instability threatens Russia’s progress. Russia invaded Georgia in 2008 and annexed the Ukraine’s peninsula of Crimea and two eastern provinces away from Ukraine in 2014. Many nations rebuked Russia’s actions and some imposed political and economic sanctions. Then, in 2022 Russia invaded the rest of Ukraine. Western nations fled Russia, sanctioned its politicians and oligarchs, and decoupled from its economy. Teaming Up Debate Project. Two groups of four students each will debate the ethics of political lobbying activities in a foreign country where a company does business. 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. The 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 ideas and topics 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 time to do research outside of class to prepare for the debate. Ethical Challenge You are managing director of your U.S. firm’s subsidiary in southern France. The social welfare states of Western Europe were founded 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. In recent decades, many countries in Western Europe have trimmed social welfare provisions, privatized businesses, and increased their reliance on market forces. Now many European countries are contemplating moving to a mandatory four-day workweek. You are asked to research the impact this could have on your company and the region’s economic development. 5-3. Q: Do you think the cultures of Western Europe have

changed over the years and that ethical concerns at their founding are a remnant of the past? A: Here are some more things that Western European cultures have in common and that US culture does not have in common: (a) Christianity has less fervor; fewer political decisions are influenced by religion. (b) the government supports a lot of theaters, opera houses, museums, art galleries etc. (c) at least in the UK, France and Germany, social interactions with strangers are generally less openly friendly, wait staff will affect less interest and so on. 5-4. Q: Do you think that free-market reforms will simply re-create the conditions that gave rise to the welfare state in the first place? A: Welfare states in Europe share several broad characteristics. These generally include a commitment to full employment, social protections for all citizens, social inclusion, and democracy. Examples common among European countries include universal health care, free higher education, strong labor protections and regulations, and generous welfare programs in areas such as unemployment insurance, retirement pensions, and public housing. On the other hand, a free-market system is one in which the prices of goods and services are determined by the open market and consumers, in which the laws of supply and demand are free from any government intervention. It is possible that the political mood will once again swing away from free-market economics and a return to a concern for increasing the welfare state. 5-5. Q: What can governments do for workers who become displaced in an open and competitive economy? A: Workers understand 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 reduced welfare benefits was because they believed market forces to be more efficient at allocating resources in a market context. Governments can return to and expand the wide variety of government programs they have in place to support people who have lost work or need training for new jobs. 5-6.

Q: What do you think are the primary reasons behind the drive for a four-day workweek? How might such a change impact national economic development? A: One reason for support of a four-day workweek is that some studies show productivity rises when reducing work from a five-day week. Also, it can be fairer to parents (especially mothers) of children who have difficulty juggling work and family life. This can increase workplace equality. Fewer people commuting on

any given day also helps reduce carbon emissions. The practice may also help reduce employee turnover and burnout. If all of these benefits would indeed flow from implementation of a four-day workweek, national economic development and human development would both likely improve. Practicing International Management Case Paytm Pays Off for India 5-9. Q: List as many reasons as you can for why the two biggest emerging markets of India and China followed different paths of economic development? A: India’s economic history is one of organic growth and homegrown startups in knowledge-based industries. India’s focus on education in medicine, mathematics, and engineering turned out to be essential in today’s knowledge-based world economy. Other factors aiding India’s economic development include a history of having a market economy, a legal system based on property rights and private enterprise, and a functioning democracy. China developed its economy and grew its homegrown businesses following a different approach. It used its abundant supply of natural resources and inexpensive factory labor to fuel its economic development. China threw open its doors to manufacturing investment and its companies gained knowledge of the production processes and technologies used by foreign partners. Chinese companies then began supplying the growing worldwide demand for all sorts of merchandise made in China. Countries historically relied on a strong manufacturing base to begin their economic development. India appears to be the first developing nation to begin its economic advance with its white-collar service sector rather than blue-collar manufacturing. The best growth strategy—the organic-led path of India versus the in-vestment-led path of China—depends on a nation’s circumstances. The fact that China follows a top-down approach to development while India pursues a bottom-up approach reflects their opposing political systems: India has a functioning democracy and China is ruled by the Chinese Communist Party. 5-10.

Q: Conduct an internet search on Paytm. Has the company been a takeover target of a global financial institution? Has the company increased its user base and product offerings since its initial public offering of stock? A: Paytm was not the target of a takeover attempt despite its share price having fallen significantly after its IPO. However, the drop in share price is at least in part related to the struggling global economy related to supply chain problems and a shortage of critical components for many products. More recently, share prices of tech companies were brought down by high interest rates. High interest rates for young tech companies often spell lower future cash flows (and thus lower share prices) because these firms often carry significant debt and rising interest rates mean higher debt repayments.

5-11.

Q: How many unicorns does India have now? In what industries are the unicorns? Has India kept up with developing its technology infrastructure? A: As of July 2022, India had 103 unicorns while China had 217 and the United States had 806. India has more unicorns in the financial technology (fintech) sector than it has in any other segment. Meanwhile, unicorns are increasing in India’s telecoms sector and ―deeptech‖ segment (companies doing engineering and scientific research in areas such as artificial intelligence, robotics, blockchain). India is not slowing down whatsoever in developing its technology infrastructure and, if anything, is accelerating its pace.

CHAPTER 6 INTERNATIONAL TRADE THEORY LEARNING OBJECTIVES: 6.1: Describe the nature of international trade. 6.2: Explain how mercantilism worked and identify its inherent flaws. 6.3: Detail the theories of absolute advantage and comparative advantage. 6.4: Summarize the factor proportions theory of trade. 6.5: Explain the international product life cycle theory. 6.6: Outline the new trade theory and the first-mover advantage. 6.7: Describe the national competitive advantage theory and the Porter diamond. CHAPTER OUTLINE: The Nature of International Trade Benefits of Trade Economic Importance of Trade Top Trading Nations Global Trade and Output Trade Interdependence Mercantilism How Mercantilism Worked Trade Surpluses Government Intervention Colonialism Flaws of Mercantilism Theories of Absolute and Comparative Advantage

Absolute Advantage Case: Riceland and Tealand Gains from Specialization and Trade Comparative Advantage

Gains from Specialization and Trade Assumptions and Limitations Factor Proportions Theory Labor Versus Land and Capital Equipment Evidence on Factor Proportions Theory: The Leontief Paradox International Product Life Cycle Stages of the Product Life Cycle Limitations of the Theory New Trade Theory First-Mover Advantage National Competitive Advantage Factor Conditions Advanced Factors Demand Conditions Related and Supporting Industries Firm Strategy, Structure, and Rivalry Government and Chance 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 INTRODUCTION This chapter explores international trade in goods and services, examining its benefits, volume, and patterns as well as the main theories of why nations trade. Trade theory tells us that if a refrigerator can be made more cheaply in Mexico and exported to Canada, it should be. The same reasoned logic tells us that if a US credit card inquiry can be equally processed for less money in India, it should be. In both cases, the country that imports the service benefits from a less-expensive product, and the country that exports the service benefits from inward-flowing investment and jobs. 6.1

THE NATURE OF INTERNATIONAL TRADE International trade is the purchase, sale, or exchange of goods and services across national borders. This is in contrast to domestic trade, which occurs between different states, regions, or cities within a country. Differences in national culture and system of politics, economics, and law are just some features of international trade that make it more complicated than domestic trade. 6.1.1 Benefits of International Trade

Countries obtain three primary benefits from international trade: (1) Trade provides people with a greater choice of goods and services, (2) International trade is an engine for job creation, and (3) Trade allows for greater consumption possibilities and raise people’s standard of living. 6.1.2 Economic Importance of Trade We can measure the importance of trade to a nation by examining the value of its trading activity relative to its gross domestic product. Trade as a share of GDP is equal to the sum of exports and imports (for goods and services) divided by GDP (see Map 6.1). 6.1.3 Top Trading Nations World merchandise exports are valued at $17.6 trillion, which is more than three times the value of service exports at $4.9 trillion. Table 6.1 shows the world’s largest exporters of both merchandise and services. The United States ranks first in commercial services exports and second in merchandise exports behind China (see Table 6.1). 6.1.4 Global Trade and Output Trade volume and world output provide insight into the international trade environment (see Figure 6.1). Total global exports lagged global output until 2007 when they became equal. Global trade then surpassed output for the first time in 2008, dipped below output in 2009, but then quickly rebounded and has exceeded output in about three-fourths of the years since 2008. But the US–China trade war starting in 2018 and the global pandemic in 2020 slowed both global trade and output. 6.1.5 Trade Interdependence Trade between most nations is characterized by a degree of interdependency. The level of interdependency between pairs of countries often reflects the amount of trade that occurs between a company’s subsidiaries in the two nations. Emerging markets that share borders with developed countries are often dependent on their wealthier neighbors. Trade dependency can be a blessing and benefit a nation or harm the nation if companies suddenly pull out in difficult economic times. 6.2

MERCANTILISM Theory that nations should accumulate financial wealth, usually in the form of gold, by encouraging exports and discouraging imports. Viewed other measures of a nation’s well-being, such as living standards or human development, as irrelevant. It was practiced from around 1500 to the late 1700s by European nations, including Britain, France, the Netherlands, Portugal, and Spain. 6.2.1 How Mercantilism Worked

Trade was to benefit mother countries and colonies in Africa, Asia, and North, South, and Central America were exploitable resources. 1. Trade Surpluses Nations increased wealth through a trade surplus—the value of a nation’s exports exceeds the value of imports. Trade deficits were to be avoided at all costs. 2. 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. 3. Colonialism Mercantilist nations acquired colonies as sources of inexpensive raw materials and markets for higher-priced finished goods. Trade among mercantilist nations and their colonies expanded wealth and created armies and navies to control colonial empires and protect shipping. 6.2.2 Flaws of Mercantilism The main problem with mercantilism is that it viewed international trade as a zero-sum game—a nation benefits only at the expense of other nations. But if all nations barricade their markets from imports and push their exports onto others, international trade would be severely restricted. It also kept colonial markets poor— they received little money for raw materials but were charged high prices for finished goods. This severely limited their purchasing power. 6.3

THEORIES OF ABSOLUTE AND COMPARATIVE ADVANTAGE 6.3.1 Absolute Advantage 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 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. 2. 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 6.3). 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. 6.3.2 Comparative Advantage 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

6.4

tea. In Tealand, 6 resource units still produce a ton of rice, and 3 units are still needed to produce a ton of tea. Thus, Riceland has absolute advantages in producing both goods. 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 6.4). Assumptions and Limitations a. Assumes countries are only driven by the maximization of production and consumption. Yet governments get involved in trade for many reasons. b. Assumes only two countries engaged in the production and consumption of two goods. yet there currently are more than 180 countries and countless products are produced, traded, and consumed. c. Assumes that there are no costs for transporting traded goods from one country to another. Yet 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 (also known as Heckscher– Ohlin theory) states that countries produce and export goods that require resources (factors) that are abundant and import goods that require resources that are in short supply. Thus, the theory focuses on the productivity of the production process.

6.4.1

Labor versus Land and Capital Equipment 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 abundant (low cost) relative to land and capital, and vice versa. 2. Factor proportions theory is conceptually appealing. Australia has much land relative to its population. Its exports consist of products that require land whereas imports consist of manufactured and consumer goods. 6.4.2 Evidence on Factor Proportions Theory: The Leontief Paradox 1. Theory not supported by studies that examine trade flows. 2. 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 laborintensive production than its imports; called the Leontief Paradox. 3. 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. 1.

6.5

INTERNATIONAL PRODUCT LIFE CYCLE The international product life cycle theory states that a company begins by exporting its product and later undertakes foreign direct investment as the product moves through its life cycle (a country’s export eventually becomes its import). 6.5.1 Stages of the Product Life Cycle 1. 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 6.5). Although initially there is virtually no export market, exports increase late in the new product stage. 2. 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

6.5.2 1.

2. 3.

6.6

time. Near the end of the maturity stage, the product generates sales in developing nations, and perhaps manufacturing is established there. 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. Limitations of the Theory 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. Companies today design new products and make product modifications at a very quick pace. Companies introduce products in many markets simultaneously to recoup a product’s research and development costs before sales decline. The theory is challenged by the fact that more companies are operating in international markets from their inception. The Internet has made this easier particularly for small and midsize companies. Also, small companies are more often teaming up with companies in other markets to develop new products or production technologies. Yet the theory retains explanatory power when applied to technology-based products that are eventually mass-produced.

NEW TRADE THEORY New trade theory argues: (1) there are gains to be made from specialization and increasing economies of scale; (2) the 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, and is in line with the theory of comparative advantage but as odds with factor proportions theory. 6.6.1 First-Mover Advantage4 1. As specialization and output increase, companies realize economies of scale, and unit production costs decline. Then companies expand, lower prices, and force

6.7

competitors to produce at a similar level of output to be competitive. 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. Some make a case for government assistance; by working together to target new industries, a government and its home-based 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 (see Figure 6.6). 6.7.1 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. 1. 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. 6.7.2 Demand Conditions 1. 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. 6.7.3 Related and Supporting Industries 1. 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. 2. Exporting clusters are those that export

6.7.4 a.

6.7.5 a. b. c.

products or make investments to compete outside the local area and can lead to longterm prosperity. Firm Strategy, Structure, and Rivalry Strategic decisions of firms have lasting effects on future competitiveness, but equally important is industry structure and rivalry among companies. 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. Government and Chance Government policies toward industry and export and import regulations can hurt or help competitiveness. Chance events also can influence national competitiveness because they can support competitiveness or threaten it. 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.

Quick Study Questions Quick Study 1 1.

Q: What are the benefits of international trade? A: Countries obtain three primary benefits from international trade: (1) Trade provides people with a greater choice of goods and services, (2) International trade is an engine for job creation, and (3) Trade allows for greater consumption possibilities and raise people’s standard of living.

Q: How do we measure the importance of trade to a nation, and why does it vary among countries? A: We can measure the importance of trade to a nation by examining the value of its trading activity relative to its gross domestic product. Trade importance among nations varies greatly. Some countries trade a great deal but have a relatively small economy. This nation will have a high ratio of trade to GDP. The ratio depends on both a nation’s level of trade (high or low) and its GDP (high or low).

Q: World merchandise exports are valued at how many times the value of worldwide service exports?

A: World merchandise exports are valued at more than $17.6 trillion, which is more than three times the value of service exports at $4.9 trillion. 4.

Q: What positive and negative effects can trade have on a country? A: Trade between nations is characterized by a degree of interdependency. The level of interdependency between pairs of countries can reflect the importance of trade that occurs between a company’s subsidiaries in two nations. Moreover, emerging markets that share borders with advanced countries are often dependent on their wealthier neighbors. Trade dependency can have some drawbacks, when some companies relocate to other low-cost production locations, leaving empty factories and unemployed workers behind.

Quick Study 2 1. Q: What was required for the successful implementation of mercantilism? A: The practice of mercantilism requires three key essentials: (1) trade surpluses, (2) active government intervention, and (3) practicing colonialism. 2. Q: What was it that mercantilist nations wished to acquire from their colonies? A: It was a source of a nation’s economic power that in turn increased political power relative to other countries (accumulation of wealth in the form of gold). Mercantilist nations acquired colonies as sources of inexpensive raw materials and markets for higher-priced finished goods. 3.

Q: What are the flaws of mercantilism? A: Mercantilist nations believed that the world’s wealth was limited. They believed that a nation could increase its share of wealth only at the expense of others (zero-sum game) The main problem with mercantilism is that if all nations were to barricade their markets from imports and push their exports onto other, international trade would be severely restricted, and trade in all nonessential goods would likely cease altogether. Moreover, mercantilist nations used their colonies as sources of inexpensive raw materials and markets for higher-priced finished goods. But this kept colonial markets poor as they received little money for raw materials but were charged high prices for finished goods. This severely limited their purchasing power and restrained consumption and the eventual size of the market for goods.

Quick Study 3

Q: What type of advantage does a nation have when it is able to produce a good more efficiently than other nations? A: An absolute advantage is the ability of a nation to produce a good more efficiently than any other nation.

Q: What type of advantage does a nation have when it is unable to produce a good more efficiently than other nations but it can produce the good more efficiently than it can any other good? 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. 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.

Q: Why do nations benefit from specialization and trade? A: Absolute advantage and comparative advantage both translate into gains for trading partners. Both nations benefit from a trade because each obtains the efficiency gains from specialization. So a country that is more efficient at producing both goods still benefits from specialization and trade versus producing both goods on its own.

Quick Study 4 1.

Q: Factor proportions theory divides a nation’s resources into what two categories? A: The theory states that a nation has two types of resources at its disposal: labor on one hand, and land and capital equipment on the other. The theory predicts that a country will specialize in products that require labor if the cost of labor is low relative to the cost of land and capital, and vice versa.

Q: What is meant by the term Leontief paradox? A: The Leontief Paradox reflects the gap between the predictions using the Factor Proportions theory and the actual trade flows in the world economy.

Quick Study 5 1.

Q: The international product life cycle theory says that a company will begin by exporting its product and

later undertake ―what‖ as the product moves through its life cycle? A: The international product life cycle theory states that a company begins by exporting its product and later undertakes foreign direct investment as the product moves through its life cycle. 2.

Q: List the three stages that a product goes through according to the international product life cycle theory.

A: 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. 3.

Q: What are some of the limitations of the international product life cycle theory? A: The theory has the following limitations: (1) Innovative products spring up across the world from both entrepreneurs and established global competitors, (2) Companies design new products and make product modifications at a quick pace, (3) More companies are operating in international markets from inception.

Quick Study 6 1.

Q: What is the main thrust of new trade theory? A: The new trade theory argues that: (1) There are gains to be had from specialization and increasing economies of scale; (2) Companies first to market can create barriers to entry; and (3) Government may have a role to play in assisting its home-based companies.

Q: What benefit might a company obtain by being a first mover in an industry? A: A first-mover advantage is the economic and strategic advantage gained by being the first company to enter an industry. This first-mover advantage can create a formidable barrier to entry for potential rivals and help a country dominate the market for a certain product.

Quick Study 7 1.

Q: What is the national competitive advantage theory? 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.

Q: What are the components 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. 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.

Q: What do we call a group of related industries that spring up in a geographic area to support a nation’s internationally competitive industry? A: Cluster is a group of related industries that spring up in a geographic area to support a nation’s international competitive industry. Each industry in the cluster serves to reinforce the productivity, and therefore, competitiveness of every other industry within the cluster.

Teaming Up Debate Project. Two groups of four students each 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. Ethical Challenge You are a member of a World Trade Organization task force that is reviewing the classic nine-year banana conflict between the United States and the European Union. Your job is to identify lessons that can be applied to future potential agricultural trade disputes. The EU was giving preferential treatment to banana exporters from Africa, the Caribbean, and the Pacific-island nations. It was supporting struggling economies for which bananas make up a large portion of their income. The United States challenged the policy as unfair trading and the World Trade Organization agreed. The US action gained support from global fruit companies Dole, Chiquita, and Del Monte, which account for nearly two-thirds of the fruit traded worldwide. 6-3. Q: Should international trade be left to private enterprise only, or should governments openly manage it to benefit developing nations? A: Free trade is an economic practice whereby countries can import and export goods without fear of government intervention. Government intervention includes tariffs and import/export bans or limitations. Free trade offers several benefits to countries, especially those in the developing stage, a country with low levels of economic resources and/or low standard of living. Developing countries can often advance their economy through strategic free trade agreements. This can be accomplished by improved access to economic resources, an improved quality of life (importing goods not readily available and at cheaper prices), and better foreign relations. On the other hand, you can have the infant industry argument, which involves government intervention. This is an argument normally used by developing or less than developed countries in the implementation of trade restrictions. This protection is meant to be temporary, as the firms will need protection from imports until the labor force is trained. 6-4. Q: Would you have argued on behalf of the United States or the European Union? Explain. A. Student responses will vary but all positions should be supported by logical explanations.

6-5. Q: 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 to align it 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 US 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 US 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. Then, the WTO ruled in April 1999 that the EU’s banana import program violated international trade law and must 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. Bananas are the world’s most produced fruit crop, generating an estimated $8 billion annually worldwide. The most efficient producers include Ecuador, Colombia, Panama, Costa Rica, Guatemala, and Honduras. The EU’s system had helped sustain the economies of Caribbean countries, including Jamaica, Dominica, Saint Kitts and Nevis, Saint Lucia, and Saint Vincent and the Grenadines, for which bananas were a main export. The loss of the EU system harmed these nations’ economies. Chiquita filed for bankruptcy protection in 2001 but restructured and reemerged soon afterward. Other issues students might discuss include job creation, setting international trade precedents, political strategies of companies, industrial policies of nations, government corruption, and the WTO’s effectiveness. Practicing Management Case

International

Tesla Drives EV Market Growth 6-8. Q: What forces do you think were behind Tesla’s firstmover advantage and market dominance?? A: Tesla was formed by two business partners in 2003 in San Carlos, California. The town is just north of Palo Alto and Cupertino where many high-tech businesses were headquartered. Elon Musk invested in the company a year later and eventually gained control with large infusions of capital. The company’s location was nearby all sorts of innovative software companies and had easy access to software engineers to write the computer code on which its vehicles operated. Introduction of Tesla’s vehicles coincided with enormous concern over

climate change. It’s electric vehicles with large air filters in the front grill actually cleaned the air as people drove, rather than polluting it. 6-9. Q: Do you think the Porter diamond can help explain the success of Tesla, which began operations in the Palo Alto region of California? Explain. A: Yes. Nearby industry clusters that boasted many advanced factors certainly benefitted Tesla in its early years. Clusters of high-tech companies of all types developing all sort of new products and the availability of software engineers were a huge benefit. The forward-looking, sophisticated, and well-off consumer market of the area also helped encourage Tesla to produce the highest quality product it could. Tesla knew that the competitiveness of the automobile market (although not for EVs in its early years) meant the company had to create an amazing product. Tesla needed to overcome buyer skepticism and industry rivalry to encourage additional investment in the company’s efforts. 6-10.

Q: Is there anything else that Tesla can do to ensure it has the semiconductors it needs for its EV production? Is there anything Tesla can do to ensure it has enough lithium for its battery production? A: Tesla might one day invest in a chip-making facility of its own or continue to develop strong relationships with its current chipmakers. Moreover, Tesla is already striking deals with suppliers of minerals and investing in mines that produce the nickel and lithium that it needs for its EV batteries. Beyond past and potential future direct investments in minerals and chips, Tesla, like producers of practically everything, will need to reexamine its global value chain. Relying on just-in-time inventory methods while sourcing from suppliers in other countries is problematic, as the global pandemic and subsequent supply shortages demonstrated. Obtaining products from closer suppliers and stockpiling critical components will need to be evaluated. This may perhaps work to encourage the formation of regional clusters of economic activities.

CHAPTER 7 GOVERNMENTS AND TRADE

LEARNING OBJECTIVES: 7.1 Explain why governments sometimes intervene in trade. 7.2 Outline the instruments that governments use to promote trade. 7.3 Describe the instruments that governments use to restrict trade. 7.4 Summarize the main features of the global trading system. CHAPTER OUTLINE:

Why Do Governments Intervene in Trade? Political Motives Protect Jobs Preserve National Security Imports and National Security Exports and National Security Respond To ―Unfair‖ Trade Gain Influence Economic Motives Protect Young Industries Pursue Strategic Trade Policy Benefits of Strategic Trade Policy Drawbacks of Strategic Trade Policy Cultural Motives Instruments of Trade Promotion Subsidies Drawbacks of Subsidies Export Assistance Foreign Trade Zones Special Government Agencies Instruments of Trade Restriction Tariffs Protect Domestic Producers Generate Revenue Quotas Import Quotas Export Quotas Voluntary Export Restraints Tariff-Quotas Other Nontariff Barriers Embargoes Local Content Requirements Administrative Delays Currency Controls Global Trading System 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 Recent Issues Dumping and the WTO Subsidies and the WTO WTO and the Environment 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 INTRODUCTION This chapter explores business–government trade relations, considers why nations implement 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. 7.1

WHY DO GOVERNMENTS INTERVENE IN TRADE? Free trade is the pattern of imports and exports that occurs in the absence of trade barriers. Governments impose restrictions on free trade for political, economic, and cultural reasons. 7.1.1 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 review requests to export technologies or products that have dual uses— meaning they have both civilian uses and military applications. 3. 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. 4. Gain Influence Governments of the largest nations may become involved in trade to gain influence

7.1.2 1.

over smaller nations. The United States wishes to maintain control over Central, North, and South America and the Caribbean basin. For example, in 1962, the United States banned all trade and investment with Cuba in the hope of exerting political influence against its communist leaders. Economic Motives Protect Young 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. Pursue Strategic Trade Policy New trade theorists believe government intervention helps firms take advantage of economies of scale and enjoy first-mover advantages. First-mover advantages result because economies of scale limit the number of companies in an industry. Strategic trade policy attempts to affect the outcomes of strategic competition among companies in favor of domestic firms. a. Benefits Companies earn profits if they obtain first-mover advantages and solidified market positions. The chaebol (South Koran family-owned conglomerates) helped companies survive poor economic time 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 support specific industries, can be subject to political lobbying and special-interest

groups could capture gains with no benefit for consumers. 7.1.3 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 imperialism. 3. The United States is seen as a threat to national cultures because of its global strength in consumer goods, entertainment, and media. 7.2

INSTRUMENTS OF TRADE PROMOTION A government may intervene in trade if it believes that another nation is restricting foreign companies from entering its domestic market. Managed trade refers to government efforts to achieve trade objectives pertaining to market shares or quantities of specific products. 7.2.1 Subsidies A subsidy is financial assistance to domestic producers in the form of cash payments, lowinterest loans, tax breaks, product price supports, or other form. Subsidies are 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, they may benefit companies but harm consumers. Although subsidies provide short-term relief, their helpfulness in the long term is questionable. 7.2.2 Export Assistance 1. Governments promote exports by helping companies finance their export activities through low-interest-rate-loans or loan guarantees. 2. Two agencies help U.S. companies to obtain export financing: Export-Import Bank and the International Development Finance Corporation. This agency insures up to $1 billion of losses due to currency inconvertibility, government interference, and political violence including terrorism. 3. Financing is often crucial to small businesses just beginning to export. 7.2.3 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

4. 5.

7.2.4 1.

7.3

duties (taxes) or fewer customs procedures. Increased employment is often the intended purpose of FTZs, with a by-product being increased trade. 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. A common purpose of such zones is final product assembly. Lower customs duties are offset by the jobs created in the United States. China established very large foreign trade zones to reap the benefits. 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 Governments have trade-promotion 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. Governments not only promote exports but also may encourage imports of product that the nation does not or cannot produce.

INSTRUMENTS OF TRADE RESTRICTION 7.3.1 Tariffs A tariff is a government tax levied on a product as it enters or leaves a country. 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. 1. 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. 2. Generate Revenue Tariffs are a source of revenue for many

developing nations. Some of these nations have less formal economies that do not track all domestic transactions accurately. Nations sometimes compensate for this shortfall by raising revenue through import and export tariffs. As countries develop, they tend to obtain revenue from taxes on income, capital gains, and other economic activities. Tariffs exact a cost on countries because they lessen the gains from trade. 7.3.2 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. 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 restraining 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. 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. 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. Voluntary Export Restraints Unique version of export quota that a nation imposes on its exports, usually at the

7.3.3 1.

request of an importing nation. If domestic producers do not curtail production, consumers benefit from lower prices due to a greater supply. Tariff Quotas A tariff quota (tariff-rate quota) is a lower tariff rate for a certain quantity of imports and a higher rate for quantities that exceed the quota. These are allowed by the WTO (Figure 7.1). Other Nontariff Barriers Embargoes 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. Embargoes can be decreed by individual nations or by supranational organizations such as the UN. Local Content Requirements Laws stipulating that a specified amount of a good or service be supplied by domestic producers in a market. Designed to force companies from other nations to employ local resources in their production processes— particularly labor. May protect domestic producers from the price advantage of companies based in lower-wage countries. Developing countries use them to boost industrialization. Administrative Delays Administrative delays are regulatory controls or bureaucratic rules designed to impair the rapid flow of imports into a country. Can include government actions such as requiring international air carriers to land at inconvenient airports, inspections that damage the product, understaffing customs offices, and requiring special licenses that take time to obtain. Currency Controls Currency controls are restrictions on the convertibility of a currency into other currencies. Governments can require a license to obtain currency, restrict who is allowed to convert the nation’s currency, and stipulate an exchange rate that is unfavorable to potential importers.

Alternatively, a country can allow exporters to exchange home currency for an international currency at favorable rates to encourage exports. 7.4

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 global trade wars crippled industrialized nations and helped spark the Great Depression. 7.4.1 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 (Table 7.3 lists the completed Rounds of GATT). 1. Uruguay Round of Negotiations The Uruguay Round made significant progress in reducing trade barriers by revising and updating GATT. a. Agreement on Services The General Agreement on Trade in Services (GATS) extended the principle of nondiscrimination to cover trade in services. The GATS identifies four forms of services: cross-border supply, consumption abroad, commercial presence, and presence of natural persons. b. Agreement on 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 created the Agreement on Trade-Related Aspects of Intellectual Property (TRIPS) to standardize intellectualproperty rules. c. Agreement on 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 but places no requirements on least-developed economies. 7.4.2 World Trade Organization The World Trade Organization (WTO) is the international organization that regulates trade among nations. The WTO replaced the institution of the GATT but absorbed the GATT agreements (such as on services, intellectual property, and agriculture) into its own agreements. The three main goals of the WTO are to help free trade, negotiate opening of markets, and settle trade disputes. A 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. 1. Dispute Settlement in the WTO a. WTO’s power to settle trade disputes set 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. Offenders must realign policies according to WTO guidelines or suffer financial penalties and perhaps trade sanctions. 2. Recent Issues Over the years the WTO has done a good job encouraging fair trade among its members. Later on, powerful nations started to grow impatient with the WTO, disagreeing with its rulings and sometimes flagrantly continuing practices that caused another nation to bring a case to the WTO in the first place. 3. 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.

Because dumping is an act by a company, not a country, the WTO cannot punish the country in which dumping is based. c. The WTO allows a nation to retaliate against dumping if it proves dumping charges, calculates the damage, and can show the 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. 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 alongside existing 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. The 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.

Quick Study Questions Quick Study 1 1.

Q: How would you define free trade? A: It is the pattern of imports and exports that occurs in the absence of trade barriers.

Q: For what political reasons does a government intervene in trade? 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) Nations restrict exports containing high technology and those with ―dual uses.‖ (4) For reasons of unfair trade by another nation, a government may threaten to restrict imports coming from a nation that restricts its own imports. (5) The largest nations may get involved in trade to gain influence over smaller nations.

Q: What are some economic reasons why a government intervenes in trade? A: One economic motive for a nation to intervene in trade is protection of young (infant) industries from competition. This argument says a country’s emerging industries need protection from international competition during their development phase until they become sufficiently internationally competitive. 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.

Q: What cultural motives cause governments to intervene in 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 did 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: What are the intentions and the drawbacks of subsidies for various parties? 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 taxes on sales and income, critics charge that they amount to corporate welfare on behalf of consumers. 2.

Q: What are some of the ways that governments provide export assistance? 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.

3. Q: What are the hoped-for outcomes of a foreign trade zone? 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. Increased employment is often the intended purpose of FTZs, with a by-product being increased trade. FTZs promote the most trade when they are established as low-cost assembly points for companies manufacturing products that will then be shipped to other international markets. Quick Study 3 1.

Q: Why might a government impose a tariff on a product, and who benefits from tariffs? A: There are two main reasons why countries impose tariffs, and they are: (1) to protect domestic producers and (2) to generate revenue. The benefits of tariffs are questionable. Domestic buyers of a product receiving tariffs may pay a higher price as a direct result of the tariff. There is also a danger that tariffs will create inefficient domestic producers that may go out of business if protective tariffs are removed. The key point is to know that tariffs tend to exact a cost on countries because they lessen the

gains that a nation obtains from trade. 2.

Q: Why do government impose quotas on products, and who benefits from this practice? A: A government may impose an import quota to protect domestic producers by placing a limit on the amount of goods allowed to enter the country. This helps domestic producers maintain their market shares and prices because competitive forces are restrained. In this case, domestic producers win because their market is protected. Consumers lose if this results in higher prices and limited selection attributable to lower competition. Other potential losers include domestic producers whose own production requires the import that is subjected to a quota. Companies relying on the importation of so-called intermediate goods might need to raise the final cost of their own products. There are at least two reasons why a country imposes export quotas on its domestic producers. First, it may wish to maintain adequate supplies of a product in the home market. This motive is most common among countries that export natural resources that are essential to domestic business or the long-term survival of a nation. Second, a country may limit the export of a good in order to restrict its supply and increase its price on world markets. Consumers in the country that imposes an export quota benefit from lower-priced products (due to their greater supply) as long as domestic producers do not curtail production. Producers in an importing country benefit because the goods of producers from the exporting country are restrained. But consumers in the importing nation will be harmed by a possibly reduced selection and potentially higher prices. Yet export quotas might allow these same consumers to retain their jobs if imports were threatening to put domestic producers out of business.

Q: What do we call a stipulation that requires a portion of a product be sourced domestically? 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.

Quick Study 4 1.

Q: What was the first system of multilateral agreement

to promote free trade called? A: The General Agreement on Tariffs and Trade (GATT) was designed to promote free trade by reducing both tariff and nontariff barriers to trade. It was formed in 1947 and achieved early success. Between 1947 and 1988, the GATT helped 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. It was clear that a revision of the treaty was necessary and a new round of trade talks concluded in 1994. 2.

Q: What are the three main goals of the World Trade Organization (WTO)? A: The World Trade Organization (WTO) is the international organization regulating trade among nations. The three main goals of the WTO are to help the free flow of trade, to help negotiate further opening of markets, and to settle trade disputes among its members. One key component of the WTO that was carried over from the GATT is the principle of nondiscrimination (formerly ―most favored nation status‖) called normal trade relations. WTO agreements are essentially contracts among 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.

Q: What is it called when companies sell products in markets abroad at unfairly low prices, and what can be done about it? A: 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 the 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. Teaming Up Imagine that the United States applies an antidumping duty of 200 percent on aircraft parts imported from China that it believes are being dumped in the US market. Imagine that China then applies a 300 percent countervailing duty on US auto imports that it believes are receiving unfair subsidies. 7-3. Q: What political, economic, or cultural motives do you think are behind the US antidumping duty against China’s aircraft parts? A: Not being a cultural product, aircraft parts are most probably protected for political and economic reasons in this hypothetical scenario. This includes protecting US jobs and businesses. Aircraft parts also likely fall within the national security category that require domestic production. The antidumping duty could also be simply a response to what the US side considers unfair trade and product dumping. Potential economic motives would include a possible infantindustry argument if US aircraft parts makers are young. There could also be strategic trade policy reasons for the purpose of supporting the domestic US industry. 7-4. Q: What motives do you think are behind China’s countervailing duty against US autos? A: In this hypothetical scenario, the Chinese government is likely retaliating because it believes the competitiveness of its own firms is being threatened. No country is likely to admit openly to dumping. It is more likely to apply antidumping duties, ratchet up the pressure on the other side to respond, and then seek an understanding from all sides that they need to return to a level playing field. 7-5. Q: Should countries experiencing economic difficulties be allowed to erect temporary tariff and nontariff barriers? Explain. A: International trade occurs primarily because of differences in production costs, which in turn result from differences in factor endowments, technologies, productivity, and exchange rates. Nations can increase consumption possibilities and achieve a higher standard of living by specializing in products in which they possess a comparative advantage and

importing other products. In other words, they benefit by exporting their strengths and importing their weaknesses. Trade restrictions stop this free flow of goods and may harm national welfare in the long run. Students might say that perhaps countries should be allowed to impose temporary trade restrictions to allow a country time to remedy an unusual and temporary problem. Ethical Challenge The National Foreign Trade Council (NFTC), a nonprofit group that represents trade and industry, won its court battle against the state of Massachusetts. In a unanimous decision, the US 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. In fact, the US Constitution states that ―foreign policy is exclusively reserved for the federal government.‖ The NFTC said that it shared concern over human rights abuses in Myanmar but believed that a coordinated, multinational effort would be most effective at instilling change in the nation. 7-6. Q: Do you think that companies should be penalized domestically (e.g., denied state contracts) based on where they do business abroad? Explain. A: There already are US laws that govern the conduct of activities of US companies in foreign countries. The Foreign Corrupt Practices Act (FCPA) prohibits directly or indirectly paying of offering money or anything of value to a foreign official to obtain an improper advantage in securing or retaining business. The Anti-Boycott Laws prohibit US companies from participating in a boycott that is not approved or sanctioned by the US government. The Export Control Statutes—US Department of Commerce Export Administration Regulations (EAR) and US Department of State International Traffic in Arms Regulations (ITAR)—control the export of research-related materials and information. The Office of Foreign Assets Control (OFAC) administers and enforces economic and trade sanctions to protect against threats to national security, foreign policy, or the economy. The Bureau of Industry and Security (BIS) maintains separate lists of individuals and entities with which one may not engage.

7-7. Q: How might domestic firms react if each state were to punish firms based on its own 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 in countries deemed bad actors. Even then, companies could create holding companies in offshore locations that have strict secrecy laws so that governments would be unable to find out whether they are dealing with countries having questionable human rights records. 7-8. Q: What potential problems can you foresee if the WTO were to begin punishing businesses with which it does not agree on political matters? A: The WTO is first and foremost a promoter of world trade and an arbiter of trade disputes. Economic principles, not politics, should guide its policies. If the WTO were to involve itself in political issues, charges of political favoritism for powerful industrialized countries would likely increase. The WTO would be going outside its mandate if it were to begin taking political positions on matters. The organization would likely cease to be effective. A political stance on other situations and events within and between nations are better managed through international relations or within the framework of the United Nations. Practicing Management Case

International

Netflix and Trade in Digital Services 7-11.

Q: What specific economic, political, and cultural reasons might a government cite to block content of a global digital streaming media company like Netflix? A: Section 7.1 of the text presents all the various economic, political, and cultural reasons for government involvement in trade. A possible political reason includes a nation protecting domestic jobs. Economic motives include protecting companies in a fledgling domestic entertainment industry and protecting an industry targeted for strategic trade policy. Cultural motives are likely the strongest in this scenario. Countries block unwanted media coming into their nation in digital form if they fear its content undermines local culture or government authority.

7-12.

Q: What instruments do you think countries can

use to promote or restrict international trade in digital media streaming? A: Countries can first of all communicate with streaming media companies about their displeasure with certain content. If that does not work, they can employ technological tools to block unwanted media. They can also place tariffs on products of entertainment importers. They could also force them to use local companies and actors or film in the country. They can also require media companies to obtain licenses if they want to stream their content in the country. Countries encouraging exports of digital media can offer their domestic firms export assistance, subsidies, and other governmental help to export. 7-13.

Q: Why do you think Netflix does not mention an interest in entering the Chinese market given its enormous population? A: As of mid-2022, Netflix remains unavailable in China, Crimea, North Korea, and Syria. Netflix was denied access by the Chinese government several years ago and the company is not prioritizing the market. China is likely restricting any potential influence of Western culture and Western ideas. It could also be protecting its domestic film industry. Netflix says it is not focused on China because it has such great growth potential throughout the rest of Asia, including India, South Korea, Japan, and Indonesia.

7-14. Q: Can Netflix and other global media giants do anything to promote crosscultural understanding worldwide? A: Netflix and other global media streamers could create films that foster crosscultural understanding and an interest in learning about other cultures. It could minimize films that stereotype people, cultures, and races and those that reinforce biases or distrust between people of different cultures that harbor serious political differences. But, as a private company, this is something Netflix would need to decide to do under its own volition. If students mention that perhaps Netflix should be instructed to do these things by government, then this opens the topic up to what extent should government be involved in the product decisions of companies.

CHAPTER 8 FOREIGN DIRECT INVESTMENT LEARNING OBJECTIVES: 8.1 Describe the nature of foreign direct investment (FDI). 8.2 Summarize each theory that attempts to explain why FDI occurs. 8.3 Identify the important management issues involved in the FDI decision.

8.4 Explain why governments intervene in FDI. 8.5 Describe the policy instruments governments promote and restrict FDI.

use

CHAPTER OUTLINE: The Nature of Foreign Direct Investment Forms of Foreign Direct Investment Worldwide Flows of FDI Recipients and Sources of FDI Theories for Foreign Direct Investment International Product Life Cycle Market Imperfections 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 Cost of Research and Development Customer Knowledge Following Clients Following Rivals Why Governments Intervene in FDI Balance of Payments Reasons for Intervention by the Host Country Control Balance of Payments Technology, Skills, and Employment Reasons for Intervention by the Home Country Influence Balance of Payments Protect Jobs Improve Competitiveness Government Policy Instruments and FDI Host Countries: Promotion Financial Incentives Infrastructure Improvements Host Countries: Restriction Ownership Restrictions Performance Demands Home Countries: Promotion Home Countries: Restriction 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 material.

simplifies

the

teaching

this

chapter’s

Lecture Outline INTRODUCTION Foreign direct investment (FDI) is the purchase of physical assets or significant stock ownership of a company in another country to obtain 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. 8.1

THE NATURE OF FOREIGN DIRECT INVESTMENT Trade and foreign investment are related to one another. Historically, to circumvent trade barriers, companies accessed promising markets by investing directly in foreign markets. After the Uruguay Round of negotiations of GATT, countries lowered trade barriers. Businesses then realized they could now establish their business in the most efficient and productive locations almost anywhere and export to markets worldwide. 8.1.1 Forms of Foreign Direct Investment Foreign direct investment takes two main forms: 1. Greenfield investment is the purchase of land in another country and construction of new facilities or an entire subsidiary from the ground up. 2. Companies may also merge with or acquire an existing company abroad. Companies from developed countries historically were the main participants behind cross border mergers and acquisitions. However, firms from emerging markets are accounting for an even greater share of the global M&A activity. Many cross-border M&A deals are done to: a. Get a foothold in a new geographic market b. Increase a firm’s global competitiveness c. Fill gaps in companies’ product lines in a global industry d. Reduce costs in R&D, production, distribution, etc. 8.1.2 Worldwide Flows of FDI 1. FDI inflows grew around 20 percent per year in the first half of the 1990s, then around

40 percent annually in the second half of the decade. FDI inflows measured a little more than $1.3 trillion in 2000 (see Figure 8.1), then slowed as internet-related investments suffered a downturn, and recession ensued. FDI then benefitted from strong global growth and high corporate profits between 2004 and 2007, reaching a high of around $1.9 trillion. 2. The global financial crisis in 2008 resulted in a global recession and lower FDI in 2008 and 2009. The crisis reduced FDI by onethird and flows took 2.5 years to recover. FDI then increased in 2015 and 2016 on strong economic growth. It then declined through 2020. 8.1.3 Recipients and Sources of FDI (see Figures 8.2 and 8.3) 1. Developed nations have been the biggest recipients of FDI. But since 2014 they are attracting a smaller share of the world’s total FDI flows. 2. In 2014, developing countries attracted a greater amount of FDI than developed countries, accounting for about 55% of the total. 3. Developing nations then attracted nearly as much FDI as developed nations did in 2018 and 2019 and attracted far more in 2020. 4. Developed nations are the historic sources of FDI but developing countries are increasingly becoming sources of FDI. Their outflows are rising as the strong, homegrown competitors in these nations, seek growth and market share worldwide. 5. See Table 8.1 for a listing of the top ten countries for FDI inflows and outflows. 8.2

THEORIES OF FOREIGN DIRECT INVESTMENT 8.2.1 International Product Life Cycle 1. States that a company begins by exporting its product and later undertakes foreign direct investment as the 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. 8.2.2 Market Imperfections 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 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 form of market imperfection. b. Firms undertake FDI when market imperfections are present. 2. Specialized Knowledge a. A unique competitive advantage may consist of specialized knowledge, which could be technical expertise or the special abilities of engineers or managers. b. 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. 8.2.3 Eclectic Theory 1. States that firms undertake foreign direct investment when the features of a location combine with ownership and internalization advantages to make a location appealing for investment. When each advantage is present, a company will undertake FDI. 2. A location advantage is the advantage of locating a particular economic activity in a specific location because of the characteristics (natural or acquired) of the location. 3. An ownership advantage is the advantage that a company has due to its ownership of some

8.2.4 1.

8.3

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 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 better able to dictate the cost of its inputs or the price of its output. Companies can gain market power through vertical integration—the extension of activities into production that provide a firm’s inputs (backward integration) or that absorb its output (forward integration).

MANAGEMENT ISSUES AND FOREIGN DIRECT INVESTMENT 8.3.1 Control Many companies invest abroad because they wish to control activities in the local market, such as the firm’s production costs. Other reasons are related to the market and the industry in which a firm competes. Examples include customer preferences or ensuring 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. 8.3.2 Purchase-or-Build Decision 1. The purchase-or-build decision entails deciding whether to purchase an existing business or build a subsidiary abroad from the ground up—called a greenfield investment. 2. An acquiring firm may benefit from the goodwill the existing company has built over the years and, perhaps, brand recognition of the existing firm. The purchase of an existing business also may allow for alternative methods of financing, such as an exchange of stock ownership. 3. Factors that reduce the appeal of purchasing existing facilities are obsolete equipment, poor labor relations, and an unsuitable location. 4. If adequate facilities are unavailable, a company might need to go ahead with a greenfield investment. These can require obtaining necessary permits and financing. Also, hiring local personnel can be difficult in some markets. 8.3.3 Production Costs Local labor regulations can 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 system in which each component is produced where the cost of producing that component is lowest. b. The components are brought together at one location for assembly into a final product. c. Potential problem is that a work stoppage in one country can halt the entire production process. 2. Cost of Research and Development a. Cost of developing new technologies has led to cross-border alliances and acquisitions. b. One indicator of the significance of technology in FDI 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. 8.3.4 Customer Knowledge 1. Buyer behavior 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. 8.3.5 Following Clients 1. FDI can place companies near the firms they supply. Following clients occurs in industries in which component parts are obtained from suppliers with whom a manufacturer works closely. 8.3.6 Following Rivals 1. FDI decisions resemble a follow-the-leader scenario in industries with a limited number of large firms. 2. Firms may believe that not making a move parallel to that of the first mover might result in being shut out of a lucrative market. 8.4

WHY GOVERNMENT INTERVENE IN FDI Nations can 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 a variety of practical reasons. 8.4.1 Balance of Payments 1. National accounting system that records all receipts coming into a nation and all payments to entities in other countries. 2. International transactions that result in outflows to entities in other nations are reductions in the balance of payments accounts. 3. International transactions that result in inflows from other nations are additions to the balance of payments accounts. 4. Current account a. National account that records transactions involving the export and import 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

8.4.2 1.

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. 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 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-ofpayments boost from initial FDI flows. Local content requirements can lower imports, providing an added balance-ofpayments boost. Exports from the FDI can further help the balance-ofpayments position. c. When companies repatriate profits, they deplete the foreign exchange reserves of their host countries; these capital outflows decrease the balance of payments. Thus, a host nation may prohibit or restrict nondomestic firms from removing profits. d. But host countries conserve their foreign exchange reserves when international companies reinvest their earnings in local manufacturing facilities. This improves the competitiveness of local producers, boosts a host nation’s exports, and improves its balance-of-payments position. Technology, Skills, and Employment a. Nations encourage FDI in technology because it increases its productivity and competitiveness. b. Encouraging FDI into a country can allow talented foreign managers to train local personnel in how to operate the local facilities. Some of these managers will also go on to establish

their own businesses. 8.4.3 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. Influence Balance of Payments 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. 2. Protect Jobs a. An outgoing FDI might cause job losses at home. Yet FDI abroad might create jobs at home if they are needed to support the operations created by the FDI. 3. Improve Competitiveness a. Outward FDI can increase long-run competitiveness as companies grow to become global industry leaders. b. Nations may encourage FDI in industries that use obsolete technology or employ low-wage workers with few skills. 8.5

GOVERNMENT POLICY INSTRUMENTS AND FDI 8.5.1 Host Countries: Promotion 1. Financial Incentives a. Host governments commonly offer tax incentives such as lower tax rates or offers to waive taxes on local profits for a period of time. Or they may offer low-interest loans to attract investment. b. But incentives can create bidding wars between locations vying for investment. The cost to taxpayers of attracting 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 telecommunications systems. 8.5.2 Host Countries: Restriction 1. Ownership Restrictions

8.5.3 1. 2. 3. 4. 8.5.4 1. 2.

Governments may 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. 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 Offer insurance to cover the risks of investments abroad. Grant loans to firms wishing to increase their investments abroad. Offer tax breaks on profits earned abroad or negotiate special tax treaties. Apply political pressure on other nations to get them to relax their restrictions on inbound investments. Home Countries: Restriction Impose differential tax rates that charge income from earnings abroad at a higher rate than domestic earnings. Impose sanctions that prohibit domestic firms from making investments in certain nations.

Quick Study Questions Quick Study 1 1.

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

Q: What is the pattern of annual worldwide foreign direct investment inflows over the years?

A: FDI inflows grew around 20 percent per year in the first half of the 1990s, then around 40 percent annually in the second half of the decade. FDI inflows measured a little more than $1.3 trillion in 2000 (see Figure 8.1), then slowed as internet-related investments suffered a downturn, and recession ensued. FDI then benefitted from strong global growth and high corporate profits between 2004 and 2007, reaching a high of around $1.9 trillion. The global financial crisis in 2008 resulted in a global recession and lower FDI in 2008 and 2009. The crisis reduced FDI by one-third and flows took 2.5 years to recover. FDI then increased in 2015 and 2016 on strong economic growth. It then declined through 2020. 3.

Q: How is the makeup of FDI recipients changing with respect to developed and developing nations? A: Historically, developed nations have been the biggest recipients of FDI. Although they still dominate the existing stock of FDI worldwide, they now attract a smaller share of the world’s total FDI flows. In 2014, for the first time ever, developing countries attracted a greater amount of FDI than developed countries, accounting for about 55% of the world total (see Figure 8.2). FDI inflows reverted in 2015 with the developing nations attracting less then developed nations. Developing nations then attracted nearly as much FDI as developed nations did in 2018 and 2019 and attracted far more in 2020.

Q: How is the composition of FDI sources changing with respect to developed and developing nations? A: Developing countries are increasingly becoming important sources of FDI. Their outflows are rising as the strong, homegrown competitors in these nations seek growth and market share worldwide.

Quick Study 2 1.

Q: What is the role of exporting and FDI in the international product life cycle theory? A: The international product life cycle theory states that a company begins by exporting its product and later undertakes foreign direct investment as the product moves through its life cycle. 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 and exports to markets around the world.

Q: What imperfections are relevant to the discussion of market imperfections theory?

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 may undertake FDI when they want to lessen the risk of giving away a competitive advantage to other companies through licensing agreements. 3.

Q: Location, ownership, and internalization advantages combine in which FDI theory? 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: Which FDI theory depicts a firm establishing a dominant market presence in an industry? A: The market power theory states that a firm tries to establish a dominant market presence in an industry by undertaking foreign direct investment. The benefit of market power is greater profit because the firm is far better able to dictate the cost of its inputs or the price of its output.

Quick Study 3

Q: Why might 100 percent ownership of a subsidiary not give a company complete control? A: The local government might intervene and require a company to hire some local managers rather than bringing them all in from the home office. Governments might also require all goods produced in the local facility be exported so that they do not compete with products of the country’s domestic firms.

Q: What type of production system makes components where the cost of producing each is lowest? A: 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: Why would a company engage in FDI when the firms it supplies invested abroad? A: Firms commonly engage in FDI when the firms they supply have already invested abroad. The practice of ―following clients‖ is common in industries in which producer source component parts from suppliers with who they have close working relationships.

Quick Study 4 1.

Q: What is the purpose of the national accounting system known as the balance of payments? A: A country’s balance of payments is a national accounting system that records all receipts coming into the nation and all payments to entities in other countries. The balance of payments helps a country monitor the flows of goods, services, income, and transfer of assets between itself and other nations. International transactions that result in outflows to entities in other nations are reductions in the balance of payments accounts. International transactions that result in inflows from other nations are additions to the balance of payments accounts.

2. Q: Why might a host country intervene in foreign direct investment? 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-of-payments boost. (3) Exports generated by production resulting from FDI can help the balance-of-payments position. (4) A host nation might also want to obtain resources and benefits, such as technology to increase the

productivity and competitiveness. (5) A host country 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. Some of these managers will go on to establish their own businesses, thereby expanding the economy and employment opportunities within the nation. 3. Q: Why might a home country intervene in foreign direct investment? 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 longrun competitiveness. (2) Nations may encourage FDI in industries that they have determined to be declining, low-skill industries with low pay. Quick Study 5 1.

Q: What policy instruments can host countries use to promote FDI? A: Host countries promote FDI by giving tax incentives, low-interest loans, and infrastructure improvements.

Q: What policy instruments can home countries use to promote FDI? A: To promote FDI home countries can offer insurance, low-interest loans, tax breaks, and apply political pressure.

Q: What goals are ownership restrictions and performance demands designed to accomplish? A: Host nations restrict FDI through ownership restrictions and performance demands.

4. Q: What is the intended purpose of differential tax rates and sanctions? A: Home countries may try to restrict FDI by using

differential tax rates and sanctions. Teaming Up Companies undertake FDI for many reasons and evaluate a host of factors in any FDI decision. Imagine that you work for an electric vehicle manufacturer and your team is charged with evaluating the viability of a greenfield auto assembly plant in Mexico. 8-3. Q: What management issues should your team consider in making its evaluation? A: This Teaming Up exercise is somewhat of an integrative case for Chapters 1 through 8. This can be made into as small or as large an exercise as the instructor likes. It can even be folded into the Market Entry Strategy Project that accompanies the text. A greenfield electric vehicle manufacturing facility is a massive undertaking. For example, how might existing global value chains impact the proposed operation and how can the company best mitigate potential disruptions (local or global) to its business activities? Students will want to review and include elements from earlier chapters in their answer. They should examine features of the cultural, political, and economic environments that will impact the decision and the eventual operations. They will need to keep in mind potential ethical, social responsibility and sustainability matters in their evaluation. And they should address the international trade and investment environment and how the company might have to negotiate with the governments of the US and Mexico. 8-4. Q: For each FDI theory in this chapter, create a brief, hypothetical scenario in which the theory explains why the company should invest in Mexico. A: Students should review the international product life cycle theory, market imperfections theory, eclectic theory, and theory of market power in this chapter. They should then explain how each one may, or may not, help explain the decision to invest in a manufacturing facility in Mexico. 8-5. Q: What policy instruments might Mexico use to attract additional FDI inflows? A: Mexico can provide financial incentives to encourage inward FDI flows. It can offer tax incentives such as lower tax rates or even waive taxes for a period of time. It can also offer low-interest loans to entice investors. Finally, it can offer to make infrastructure improvements (such as improved roads or telecom systems) that can lower the cost of doing business there or increase efficiency and

productivity. Ethical Challenge You are a US senator deciding whether to vote yes or no on new legislation. The potential new law places restrictions on the practice of outsourcing work to lower-wage countries and is designed to protect US workers’ jobs. Companies commonly promise manufacturing contracts to overseas suppliers in exchange for access to that country’s market. Labor union representatives at home argue that these kinds of deals cost jobs as factories close and parts are made in lower cost countries. They also say that the transfer of technology will breed strong competitors in other nations and thereby threaten even more jobs at home in the future. Others argue that market access abroad will translate to increased sales of products made at home and create additional future new jobs at home. 8-6.

Q: Do you think companies bear an ethical burden when they contract production to factories abroad and reduce jobs at home? A: Students should revisit Chapter 2, which covers the topics of personal ethics and social responsibility in great detail. They can use the frameworks discussed in that chapter to present their thoughts on such FDI abroad. These frameworks include the ethics theories of utilitarianism, rights theory, theory of justice, and cultural relativism; the conflict of relative development and the conflict of cultural tradition; as well as stakeholder theory. Students can explore the personal ethics of executives who make the decision as well as the social responsibilities of companies.

8-7. Q: As senator, will you vote yes or no on the pending legislation? Explain. A: Students now have the opportunity to place themselves in the position of senator and make a decision based on their personal ethics. Students may qualify their decision, saying they would approve such a move if it was required out of competitive necessity and the needs of the employees will be looked after. 8-8. Q: What policy instruments might you your government develop to encourage re-shoring, the opposite of offshoring? A: Students will likely approach this issue from a variety of perspectives ranging from a free-market ideology to a protectionist one and to a socialist one. Students must consider 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 old or more. Students must also

consider social issues of lost jobs due to manufacturing going abroad and the strong competitors arising from transferring technologies abroad. Practicing Management Case

International

Taking Local Sounds Global 8-11.

Q: Do you think Spotify will be able to continue buying companies through foreign direct investment to fuel its future growth in music and podcasting? A: The ability of Spotify to continue its strategy of growth through acquisition largely depends on the innovativeness of the social-media and streaming markets. As long as innovation in these economic sectors is encouraged and successful, there will undoubtedly be some new businesses that Spotify would benefit from having in-house. Spotify can also expand its strategy of buying strong national competitors in markets globally to quickly garner local footholds. The strategy also depends on the growth of antimonopoly forces in various national markets and globally if Spotify were to eventually gain monopoly status through its acquisition strategy.

8-12.

Q: Who are Spotify’s primary competitors in the areas of music, podcasting, and perhaps video today? A: The main competitors of Spotify (approximately 35 percent share) in music streaming include Apple Music (20 percent approx.), Amazon Music (15 percent approx.), and YouTube Music (10 percent approx.). Smaller music streaming services that compete with Spotify include Pandora, Sirius, Sound Cloud, and Deezer.

8-13.

Q: What business area(s) might be good options for Spotify to target next if it were to expand its product offerings? A: Video streaming is an area that Spotify has not invested in as of this writing. The company could perhaps compete with the likes of TikTok and YouTube with its ―Shorts‖ class of videos. Listeners could upload and share their own singing, dancing, or other antics to music from Spotify’s streaming platform. It might be a stretch, but Spotify could also perhaps compete in the movie streaming business. But that is an already crowded marketspace and seems to become increasingly competitive, which could drive down financial returns in that sector.

8-14. Q: If the company were to expand in the areas you mentioned, could it do so through foreign direct investment or would it need to develop products internally? A: The company could expand through acquisition if suitable targets exist or it could grow organically using its existing talent in-house.

CHAPTER 9 REGIONAL ECONOMIC INTEGRATION LEARNING OBJECTIVES: 9.1 Outline the nature of regional integration efforts. 9.2 Describe regional integration efforts in Europe. 9.3 Describe regional integration efforts in the Americas. 9.4 Summarize integration efforts in Asia and Africa. CHAPTER OUTLINE: The Nature of Regional Integration Efforts Levels of Regional Integration Free Trade Area Customs Union Common Market Economic Union Political Union The Case for Regional Integration Trade Creation Greater Consensus Political Cooperation Employment Opportunities Corporate Savings The Case Against Regional Integration Trade Diversion Shifts in Employment Loss of National Sovereignty Integration in Europe European Union Early Years Single European Act Maastricht Treaty Management Implications of the Euro The UK Exits the EU Trade and Cooperation Agreement Future EU Enlargement Structure of the EU European Parliament European Council Council of the EU European Commission Court of Justice European Central Bank Court of Auditors

European Free Trade Association (EFTA) Integration in the Americas United States-Mexico-Canada Agreement (USMCA) Record of NAFTA Creation of USMCA Key Provisions Central American Free Trade Agreement (CAFTA-DR) Andean Community (CAN) Southern Common Market (MERCOSUR) Central America and the Caribbean Integration in Asia and Africa Comprehensive and Progressive Agreement for TansPacific Partnership (CPTPP) Association of Southeast Asian Nations (ASEAN) Regional Comprehensive Economic Partnership (RCEP) Asia Pacific Economic Cooperation (APEC) The Record of APEC Africa’s Integration Effort 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 INTRODUCTION This chapter focuses on regional efforts to encourage free 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. The goal is greater cross-border trade and investment and higher living standards. Specialization and trade allow more choice, lower prices, and increased productivity. 9.1

THE NATURE OF REGIONAL INTEGRATION EFFORTS Regional economic integration is a process by which countries in a geographic region cooperate 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. Regional trade agreements help nations accomplish economic growth objectives and perhaps even eventual political union. 9.1.1 Levels of Economic Integration

There are five levels of economic integration. 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 (see Figure 9.1). 1. Free Trade Area a. Countries remove all barriers to trade among members, but each country determines its own barriers against nonmembers. b. Countries in a free trade area also may establish a process to resolve trade disputes among members. 2. Customs Union a. Countries remove all barriers to trade among members but erect a common trade policy against nonmembers. b. Countries might also negotiate as a single entity with other supranational organizations such as the WTO. 3. Common Market a. Countries remove all barriers to the free movement of trade, labor, and capital among themselves but erect a common trade policy against nonmembers. b. Can be difficult for nations to cooperate on economic and labor policies. 4. Economic Union a. Countries remove barriers to the free movement of trade, 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. Nations thus concede some amount of sovereignty to the supranational organization. 5. Political Union a. Countries coordinate aspects of economic and political systems. Members accept a common stance on economic and political policies regarding nonmember nations. b. Nations are allowed a degree of freedom in setting certain political and economic policies within their territories. 9.1.2 The Case for Regional Integration

Debates continue over the effects of regional trade agreements on people, jobs, companies, culture, and living standards. Nations engage in specialization and trade to benefit from 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 the level of trade between nations that results from regional economic integration. b. Gives consumers and industrial buyers a wider selection of goods and services than was previously available. c. Buyers can acquire goods and services at lower prices due to lower trade barriers such as tariffs. Lower costs can lead to higher aggregate consumption because people have more money after a purchase to buy other products. 2. Greater Consensus a. Eliminating trade barriers in smaller groups of countries may make it easier to gain consensus as opposed to working in the far larger WTO. 3. Political Cooperation a. A group of nations can have significantly greater political weight than nations have individually. Integration involving political cooperation can reduce the potential for military conflict among members. 4. Employment Opportunities a. Regional integration can expand employment by enabling people to move from country to country for work, or to earn a higher wage. 5. Corporate Savings a. Trade agreements allow companies to alter their strategies. Companies that do business throughout the region could save money from the removal of tariffs and potentially from supplying entire regions from fewer factories. 9.1.3 The Case Against Regional Integration 1. Trade Diversion a. Diversion of trade away from nations not belonging to a trading bloc and toward member nations. This can occur after formation of a trading bloc

9.2

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. Shifts in Employment a. Because trading blocs reduce or eliminate barriers to trade, the preferred producer will be decided by relative productivity. Industries requiring unskilled labor shift production to lower-wage nations within a trading bloc. b. Job dislocation allows a nation to upgrade its economy toward higher-wage jobs and greater competitiveness from a more educated and skilled workforce. 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. 9.2.1 European Union 1. Early Years a. Europe in 1945 faced two challenges: (1) rebuild itself and avoid further conflict, and (2) 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. c. Members of the European Coal and Steel Community signed the Treaty of Rome in 1957, creating the European Economic Community (EEC), which outlined a future common market. d. In 1967 the Community’s scope was broadened to include additional industries, notably atomic energy, and

changed its name to the European Community. Enlargement continued and in 1994 the bloc changed its name to the European Union (EU). e. Today the 27-member European Union has a population of about 450 million people and a GDP of around $16 trillion. f. Single European ACT (SEA) This removed remaining barriers, increased harmonization, and enhanced the competitiveness of EU companies. Mergers and acquisitions swept Europe as large firms combined their understanding of European needs, capabilities, and cultures with economies of scale. g. Maastricht Treaty The Treaty (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. There are 19 member nations using the single currency, comprising the ―eurozone.‖ h. Management Implications of the Euro The euro reduces transaction costs by eliminating the need to exchange currencies. It eliminates exchange-rate risk for business deals among member nations using the euro. And transparency in prices harmonizes prices across markets. 2. The UK Exits the EU a. The UK became a member of the EU in 1973. Yet citizens of the UK became unhappy with the EU because of fear of loss of sovereignty and other reasons. The UK government held a referendum and the voters decided to leave the EU. b. Trade and Cooperation Agreement (TCA) This agreement governs the UK-EU relationship going forward. 3. Future EU Enlargement Albania, North Macedonia, Serbia, and Turkey remain official candidates for EU membership. Potential members must show that they meet the Copenhagen Criteria: (1) Stable institutions, (2) Has a functioning market economy, (3) Able to assume the obligations of membership, and (4) Ability to adopt the rules and regulations of the community. 4. Structure of the EU

European Parliament i. Members elected by popular vote within each 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. European Council i. Not to be confused with the Council of the EU, it is the highest level of political cooperation among EU countries. ii. Consists of the heads of each EU country, the European Council President, and the European Commission President. Council of the EU i. The legislative body of the EU. Council members change depending on the topic under discussion. 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. European Commission i. The executive body of the EU. Commissioners are appointed by each country. ii. Drafts legislation, manages and implements policy, and monitors members’ compliance with EU law. Court of Justice i. Acts as the EU court of appeals. One type of case heard is when a member nation is accused of not meeting its treaty obligations. ii. Justices are required to act in the interest of the EU as a whole, not in the interest of their own countries. European Central Bank (ECB) i. The central bank of the EU eurozone. Its primary objective is to stabilize prices and safeguard the value of the euro, thereby supporting economic growth and job creation.

9.2.2 1.

9.3

Court of Auditors i. Composed of one individual from each member nation who are appointed for six-year terms. ii. Audits EU accounts and implements the EU budget. Also aims to improve EU financial management and report to member nations’ citizens. European Free Trade Association (EFTA) Some nations wanted the benefits of a freetrade area but were wary of a full common market. The European Free Trade Association (EFTA) formed in 1960 to focus on trade in industrial goods. Today members are Iceland, Liechtenstein, Norway, and Switzerland and has 13.6 million people and a combined GDP of $990 billion. 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 North America has made major progress toward economic integration. Latin America began forming regional trading arrangements in the early 1960s and made substantial progress in the 1980s and 1990s. 9.3.1 United States-Mexico-Canada Agreement (USMCA) The North American Free Trade Agreement (NAFTA) sought to eliminate most tariffs and nontariff trade barriers on most goods originating from North America. This was later replaced by the USMCA. 1. Record of NAFTA a. Liberalized rules regarding government procurement practices, the granting of subsidies, and the imposition of countervailing duties. b. Other provisions dealt with trade in services, intellectual property rights, and standards of health, safety, and the environment. c. Trade among Canada, Mexico, and the US grew from $297 billion in 1993 to around $1.6 trillion. i. Mexico’s exports to the US rose to about $280 billion, and US exports to Mexico grew to more than $226

billion. Canada’s exports to the US more than doubled to approximately $332 billion, and US exports to Canada grew to $300 billion. iii. Canada’s exports to Mexico grew to $3.9 billion, and Mexico’s exports to Canada grew from $1.5 billion to $5.2 billion. d. NAFTA’s effect on employment and wages is not as easy to determine. The US Trade Representative Office and the AFL-CIO group of unions debate NAFTA’s effect on jobs. Creation of USMCA a. Disagreement over the effects of NAFTA on each economy and growing discontent with it enticed the parties to begin renegotiating its terms in 2017. Mexico, Canada, and the US created the United States-Mexico-Canada Agreement (USMCA), which came into effect July 1, 2020. Key Provisions a. The USMCA tightened standards and rules in NAFTA by (a) raising North American content from 62.5 percent to 75 percent for preferential tariff treatment, (b) requiring at least 70 percent of its steel and aluminum content to be from North America, and (c) requiring 40 percent of a passenger car and 45 percent of a truck to be built by workers earning at least $16 an hour. b. Guarantees workers rights to collective bargaining and the right to vote on their contracts. This will improve wages and working conditions in Mexico and give US producers less reason to move or outsource to Mexico. c. Guarantees the free flow of data internationally and says a company cannot be forced to keep data within the country in which it was gathered. It also prohibits customs duties on digital products and promotes cybersecurity cooperation. d. Maintains the zero-tariff structure in the dairy industry and opens markets further. ii.

Commits over $600 million to environmental initiatives. f. The USMCA is set to terminate 16 years after it goes into effect unless the parties agree to extend its life following a review period in year 6 of the agreement. 9.3.2 Central American Free Trade Agreement (CAFTA-DR) 1. Established in 2006 between the United States and Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, and later the Dominican Republic. 2. Average tariffs have been cut from 45 percent to around 7 percent. 3. The value of goods traded among the United States and the six other members equals around $57 billion. 4. The CAFTA-DR aims to (1) lower tariff and nontariff barriers; (2) ensure US companies are not disadvantaged by Central American nations’ trade agreements with other countries; (3) require Central American nations and Dominican Republic to encourage competition and investment, protect intellectual property rights, and promote transparency and the rule of law; and (4) support US national security interests by advancing regional integration, peace, and stability. 9.3.3 Andean Community (CAN) 1. Formed in 1969 and today includes Bolivia, Colombia, Ecuador, and Peru. It comprises a market of around 101 million consumers and a combined GDP of about $900 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. Delays mean it has yet to create a customs union. 9.3.4 Southern Common Market (MERCOSUR) 1. MERCOSUR was established in 1988 between Argentina and Brazil but expanded to include Paraguay and Uruguay in 1991. Venezuela joined in 2006 but was suspended in 2017. 2. Today MERCOSUR acts as customs union with a market of more than 295 million consumers (nearly half of Latin America’s total population) and a GDP of around $4.6 trillion.

9.3.5 1. (CARICOM)

It is progressing on trade and investment liberalization and is emerging as the most powerful trading block in all of Latin America. Latin America’s large consumer base and its potential as a low-cost production platform for worldwide export appeal to companies in the European Union and the United States. Central America and the Caribbean Caribbean Community and Common Market a.

Formed in 1973 and today has 15 members. Bahamas is a member of the Community but does not belong to the common market. Has a combined GDP of nearly $30 billion and a market of almost 16 million. b. The goal is a single market that permits the free movement of goods services, capital, and labor. But the main difficulty CARICOM continues faces is that members tend to trade more with nonmembers than they do with each other because members do not produce the imports others need. 2. Central American Common Market (CACM) a. Intends a common market between Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua. Comprises a market of 30 million and combined GDP of $200 billion. b. Not yet a customs union and cooperation is tentative. But officials are aiming for closer integration, political ties, and a single currency—likely the US dollar. El Salvador adopted the dollar as its official currency in 2000, and Guatemala already uses the dollar alongside its own currency, the quetzal. 9.4

INTEGRATION IN ASIA AND AFRICA 9.4.1 Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) 1. Arose after the United States pulled out of negotiations for creation of the TransPacific Partnership (TPP) in 2017. 2. The 11 remaining nations forged a revised agreement (2018) and left the door open for the US to join. Fears of more lost manufacturing jobs is why the US left the agreement. 3. Member nations comprise a combined GDP of $14 trillion. 4. Aims to eliminate and reduce trade barriers, create rules to allow for freer foreign investment and digital commerce, and

increase protections for labor, intellectual property, and the environment. 9.4.2 Association of Southeast Asian Nations (ASEAN) 1. Indonesia, Malaysia, the Philippines, Singapore, and Thailand formed the Association of Southeast Asian Nations (ASEAN) in 1967. Brunei, Vietnam, Laos, Myanmar, and Cambodia joined later. The 10 ASEAN countries comprise a market of nearly 670 million consumers and GDP of nearly $ 3.4 trillion. 2. Goals: (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. 9.4.3 Regional Comprehensive Economic Partnership (RCEP) 1. Free trade agreement launched in January 2022. Grouping includes the ten members of ASEAN plus six additional countries: Australia, China, India, Japan, New Zealand, and South Korea. 2. RCEP creates a market of 2.3 billion consumers with a GDP of around $26 trillion (about 30 percent of global GDP). All 16 members will account for around 25 percent of world trade and roughly 30 percent of global FDI inflows. 3. RCEP aims to increase market access, strengthen economic integration, and support free and fair trade. In addition, they expect to expand business and employment opportunities. 9.4.4 Asian Pacific Economic Cooperation (APEC) 1. APEC has 21 members and comprises more than 47 percent of world trade and 61 percent of global GDP valued at more than $53 trillion. 2. Aims to strengthen the multilateral trading system and expand the global economy by simplifying and liberalizing trade and investment procedures. 3. Record of APEC a. Halved members’ tariffs from an average of 15 to 7.5 percent. The early years saw the greatest progress. b. Is a political body as much as it is a movement toward free trade and thus encourages open dialogue and cooperation. 9.4.5 Africa’s Integration Efforts 1. The Economic Community of West African

States (ECOWAS) intends to form a customs union and an eventual common market and monetary union. ECOWAS nations comprise a large portion of the economic activity in sub-Saharan Africa. a. Slow progress on market integration, but some progress in the free movement of people, construction of international roads, and development of international telecom links. b. Improvement is needed in political stability, infrastructure, and economic policies. The African Union (AU) is a group of 55 nations joined forces in 2002 to create the African Union. a. Goals: (1) develop and promote common policies on trade, defense, and foreign relations; (2) promote cooperation in all fields of human activity to raise living standards; (3) accelerate political and socioeconomic integration of the continent; (4) defend the sovereignty, territorial integrity, and independence of members. The African Continental Free Trade Area (AfCFTA) is the most recent effort at economic integration. a. Fifty-four African Union members (all except Eritrea) signed the agreement and free trade began January 1, 2021. The agreement establishes a single market of 1.2 billion people and a combined GDP of $3 trillion. b. It intends to increase intra-African trade by creating a single market, slashing tariffs 90 percent, and reducing nontariff barriers. It also aims to encourage industrialization across Africa, create jobs, and boos incomes. c. Too early to judge the success of AfCFTA. But Africa has a young, entrepreneurial population and seems poised to be a strong component of the global economy.

Quick Study Questions

Quick Study 1 1.

Q: What is it called when countries in a region cooperate to reduce or eliminate barriers to the international flow of products, people, or capital? A: Regional economic integration is the process by which countries in a geographic region cooperate 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 names of the lowest and highest levels of regional economic integration? A: The first (and lowest) level of regional integration is a free trade area—economic integration by which countries remove all barriers to trade among themselves but where each country determines its own barriers against nonmembers. The second level is a customs union—economic integration by which countries remove all barriers to trade among themselves and set a common trade policy against nonmembers. The third level is a common market—economic integration by which countries remove all barriers to trade and to the movement of labor and capital among themselves set a common trade policy against nonmembers. The fourth level is an economic union—economic integration by which countries remove barriers to trade and the movement of labor and capital among members, set a common trade policy against nonmembers, and coordinate their economic policies. The fifth (and highest) level is a political union—economic and political integration by which countries coordinate aspects of their economic and political systems.

Q: What is it called when regional economic integration results in an increase in trade between nations? A: Trade creation is the increase in the level of trade between nations that results from regional economic integration.

Q: What is it called when trade shifts away from nations not belonging to a trading bloc and toward member nations? A: Trade diversion is the diversion of trade away from nations not belonging to a trading bloc and toward member nations.

Quick Study 2

1. Q: What is the name of the official single currency of the European Union? A: The Euro is the name of the official single currency of the European Union. 2.

Q: Why did the people of the United Kingdom want to exit the European Union? A: One belief held among those wanting to leave the EU was that it was becoming too political. People feared that the UK was losing its sovereignty to bureaucrats in Brussels, Belgium. They believed that their lives should be governed by UK laws, not those created by Brussels. And some individuals felt the EU regulations were becoming too burdensome and imposing unnecessary costs on the UK economy.

3. Q: What are the seven institutions that play particularly import roles in the EU? A: The European Parliament, European Council, Council of the EU, European Commission. Court of Justice, European Central Bank and the Court of Auditors. 4.

Q: Why did nations belonging to the European Free Trade Association not want to join the European Union? A: Certain nations were reluctant to join in the ambitious goals of the EU fearing destructive rivalries and a loss of national sovereignty. They did not want to be part of a common market but instead wanted the benefits of a free trade area only.

Quick Study 3 1.

Q: What is the name of the trading block that encompasses Canada, Mexico, and the United States? A: These three nations belong to the free trade agreement known as the United States-Mexico-Canada Agreement (USMCA).

2. Q: Which countries belong to the regional trading bloc called CAFTA-DR? A: The Central American Free Trade Agreement (CAFTA-DR) was established in 2006 between the United States, Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, and, later, the Dominican Republic. 3.

Q: What is the name of Latin America’s most powerful regional trading bloc? A: The Southern Common Market (MERCOSUR) is the most powerful trading bloc in all of Latin America. It acts as a customs union and boasts a market of more than 295 million consumers (nearly half of Latin America’s total population) and a GDP of around $4.6 trillion.

Quick Study 4 1.

Q: What are the stated aims of the Association of Southeast Asian Nations (ASEAN)? A: Main objectives of the Association of Southeast Asin Nations (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: The stated aims of which organization is not to build a trading bloc but instead to strengthen the multilateral trading system? 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 name of the most recent trade agreement among 54 nations across the continent of Africa? A: A group of 54 African Union members (all except Eritrea) are members of the African Continental Free Trade Area (AfCFTA). It intends to increase intraAfrican trade by creating a single market, slashing tariffs 90 percent, and reducing nontariff barriers. It also aims to encourage industrialization across Africa, create jobs, and boos incomes.

Teaming Up Debate Project. Two groups of four students each will debate the merits of extending the United States-MexicoCanada Agreement (USMCA) to more advanced levels of economic (and even 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 on which team offered the more compelling argument. A: There would be many economic and political obstacles in expanding USMCA to more advanced levels of integration (and perhaps to include other countries). First, there is the problem of unequal levels of development of the three

existing members’ economies. It might be some time before Canada (and to a lesser extent the United States) would allow Mexican workers to travel freely to their countries to find work. The disparity in wages between them and Mexico could cause a flood of workers to flee northward. Second, the problem facing political integration is a fear among countries that must surrender their national sovereignty to the bloc. The United States through its enormous economic and political muscle could sway the bloc’s political position on matters. It is not an impossibility, but would take an extended period of time to accomplish. At any rate, students should be prepared to defend their positions with conceptual information and facts from countries and companies affected by regional integration. Ethical Challenge The Caribbean nations do not participate in USMCA and CAFTA-DR. Some people say that these regional agreements are unfair to people living on the Caribbean islands. They say such agreements are really ―preferential‖ trade agreements that offer free trade only to members and protection against nonmembers. They argue that these trade agreements mean lost jobs, market share, and revenue for small businesses, including apparel factories in Jamaica and sugar cane fields in Trinidad. 9-3. Given the potential economic impact on nonmembers, do such trade agreements have ethical implications? A: The key issues to be included in students’ answers is whether the trade agreement pays adequate attention to the quality of the jobs created? What impact do these jobs have on workers’ rights and working conditions? Are they set up mainly for the benefit of business, government, or the people? How does the agreement require countries and businesses to protect and respect human rights? 9-4. Why do you think the Caribbean islands are not members of USMCA or CAFTA-DR? A: Some Caribbean nations may be excluded because they lack sufficient economic and/or political development to ensure that they will meet the rules and requirements of being a member of the free trade agreement. Others simply may not have products that are desired by the other members. 9-5. What arguments would you make for including Caribbean nations in an expansion of USMCA or CAFTA-DR?

A: One question to be addressed here is the United States’ responsibility to its neighbors. The ―free trade‖ versus ―preferential trade‖ ethical debate is not new. Perhaps there is no practical way to create a regional trading bloc that does not cause displacement of some workers. However, governments would want to do all they can to minimize this impact. If more countries were allowed to join the USMCA or CAFTA-DR, each country would surely want time to ensure a smooth transition for its economy. For example, they could establish a quota system that limits the quantity of a specific good allowed to pass from Mexico to the US and Canada, while guaranteeing market access for a certain quantity of the product from Caribbean nations. Moreover, people emigrating to the United States from some of these nations are searching for work, a better life for themselves, and a chance to send funds home to improve the lives of relatives as well. Practicing International Management Case Nestlé Adapts to Regional Integration 9-8. Q: In what ways might regional economic integration help and harm companies like Nestlé to compete globally? A: Regional free trade agreements and the reduction of trade barriers can allow Nestlé and similar companies to take advantage of centralized production in a single or a few locations. This allows companies to take advantage of economies of scale and reduce the cost of manufacturing, then transport products to markets within the bloc. This strategy helps boost competitiveness. Nestlé and other food companies also benefit if members of the trade agreement harmonize standards for food quality, ingredients, inspections, regulations, and so forth. Companies would be able to standardize product ingredients for the entire bloc. The company benefits even more from cost savings if the members also harmonize aspects of marketing standards and regulations. These are just several ways in which Nestlé and similar firms would benefit from such agreements. 9-9. Q: Do you think regional economic integration helps or harms smaller companies compete against their global competitors? Explain. A: Students must consider the many topics presented in this chapter. For example, might a smaller country benefit from trade creation or be harmed by trade diversion? Will its people benefit from higher living standards or see quality of life slip? Will integration increase, decrease, or have no effect on inequality within the nation and between member nations? Will larger nations pressure smaller countries into accepting the terms of economic integration? If political integration is being pursued, are safeguards in place to protect smaller nations? As an example, the European Union seems to have been quite successful in bringing together very large and very small countries. These are just some issues students should address in their answers.

9-10.

Q: Do you support the efforts of environmental activists in embedding sustainability clauses into regional trade agreements? Explain. A: This question asks students to convey their personal views on this matter. Due to currently increasing sustainability efforts globally, these issues could possibly be embedded in all regional integration agreements going forward.

CHAPTER 10 INTERNATIONAL FINANCIAL MARKETS LEARNING OBJECTIVES: 10.1 Describe the nature and main components of the international capital market. 10.2 Outline the main functions and risks of the foreign exchange market. 10.3 Explain the different types of currency exchange rates and instruments. 10.4 Describe the foreign exchange market structure and currency convertibility. CHAPTER OUTLINE: The International Capital Market Benefits of the International Capital Market Expands Opportunities for Borrowers Reduces Risk for Lenders International Bond Market Types of International Bonds Bonds and Interest Rates International Equity Market Privatization Emerging Markets Investment Banks Electronic Trading Eurocurrency Market Appeal of the Eurocurrency Market The Foreign Exchange Market Functions of the Foreign Exchange Market Currency Conversion Currency Hedging Currency Arbitrage Currency Speculation Exchange-Rate Risk

Transaction Exposure Translation Exposure Economic Exposure Managerial Implications Currency Rates and Instruments Spot and Forward Rates Forward Contracts, Swaps, and Options Market Structure and Convertibility Financial Centers Currency Trading Centers Offshore Financial Centers Interbank Market Currency Convertibility Goals of Currency Restrictions Instruments for Restricting Convertibility 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 INTRODUCTION This chapter explores the two interrelated systems that comprise the international financial markets—the international capital market and the foreign exchange market. 10.1 THE 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. Capital markets provide companies two primary means to obtain external financing: debt and equity: 1. Debt a. Loans in which borrower repays borrowed amount (the principal) plus interest. Company debt normally takes the form of bonds—debt instruments specifying the timing of principal and interest payments. b. Holder of a bond (the lender) can force the borrower into bankruptcy if payment is not made on a timely basis. Bonds to fund investments are issued by private-sector companies and by municipal, regional, and

national governments. Equity a. Equity is part ownership of a company in which the equity holder participates with other 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 earnings. 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. 10.1.1 Benefits 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 Opportunities for Borrowers a. Joins lenders and borrowers in different nations and expands opportunities for borrowers. They have the option of seeking funds outside the home nations. b. Essential for firms in countries with small or developing capital markets or emerging stock markets. 2. Reduces Risk for Lenders a. The international capital market expands the available set of lending opportunities. Lenders (who are essentially investors) can reduce portfolio risk by spreading their money over many debt and equity instruments. b. Lenders also benefit from international securities because some economies are growing while others are in decline. 10.1.2 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. For example, a bond issued by an Australian company, denominated in US dollars, and sold in Britain, France, Germany and the Netherlands (but not available in 2.

the US or to its residents). The Australian borrower receives its loan and pays interest in US dollars. Eurobonds are not regulated, which 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. An example is a yendenominated bond issued in Japan’s domestic bond market by a foreign company. Foreign bonds are regulated like domestic bonds in the country where issued. 2. Bonds and Interest Rates a. Borrowers from newly industrialized and developing countries borrow money from nations where interest rates are lower. b. Lenders in developed countries buy bonds in newly industrialized and developing nations to obtain a higher return (yet greater risk). c. Many emerging countries see the need to develop their own national bond markets. Volatility in currency market hurts projects that earn funds in those currencies and pay debts in dollars. 10.1.3 International Equity Market Consists of all stocks bought and sold outside the issuer’s home country. Companies and governments issue equity. Buyers include other companies, banks, mutual funds, pension funds, and individuals. 1. Privatization a. A single privatization often places billions of dollars of new equity on stock markets. b. Peru’s government raised $1.2 billion when it sold its 26 percent share of national telephone company, Telefonica del Peru. 2. Emerging Markets a. Growth in newly industrialized and developing countries contributes to growth in the international equity market. b. Companies in emerging markets require greater investment as they succeed and expand operations. 3. Investment Banks a. Global banks facilitate the sale of stock worldwide by bringing together sellers and buyers. b. Listing outside one’s home country is becoming an increasingly common. 4. Electronic Trading a. Proliferation of electronic trading and computer automation encourage growth in the international equity market.

Technological innovations encourage global trading activities that are conducted instantly over the internet. 10.1.4 Eurocurrency Market All the world’s currencies banked outside their countries of origin are Eurocurrency and trade on the Eurocurrency market (e.g., Eurodollars, Europounds, Euroyen, etc.). It involves large transactions by the largest companies, banks, and governments. Eurocurrency sources are: (1) Governments with excess funds from prolonged trade surplus, (2) Commercial banks with large deposits of excess currency, (3) international companies with excess cash, and (4) Extremely wealthy individuals. 1. Appeal of the Eurocurrency Market a. Complete absence of regulation lowers costs. b. Low transaction costs because transactions are large. Banks can charge borrowers less and pay investors more but still earn profit. c. Interbank interest rates are those 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. 10.2 THE FOREIGN EXCHANGE MARKET Market in which currencies are bought and sold and in which currency prices are determined. Financial institutions convert currencies using an exchange rate. For example, the exchange rate between the Japanese yen and the US dollar is stated as ¥110/$. We read this as ―110 yen are needed to buy one dollar.‖ 10.2.1 Functions of the Foreign Exchange Market 1. Currency Conversion Companies use the foreign exchange market to convert one currency into another. They must convert to local currencies when they undertake foreign direct investment. When a firm’s international subsidiary earns a profit and the company wants to return some of it to the home country, it must convert the local money into the home currency. 2. Currency Hedging The practice of insuring against potential losses that result from adverse changes in exchange rates. Companies use it to: (1) lessen the risk of international transfers; and (2) reduce exposure in transactions where a time lag exists between billing and receipt of payment.

Currency Arbitrage 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 profitmotivated 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. Riskier than arbitrage because the value, or price, of currencies is quite volatile over time. 10.2.2 Exchange-Rate Risk Potential for adverse changes in exchange rates that could harm a business. 1. Transaction Exposure Risk that an exchange rate change will affect the value of a business transaction. Usually arises when a company orders a product in advance from a supplier in a country that uses another currency. 2. Translation Exposure Risk that an exchange rate change will affect a company’s financial statements. Situation arises when a company consolidates financial statements of international subsidiaries into those of the parent company in the home country. 3. Economic Exposure Risk that an exchange rate change will affect a company’s long-term earnings potential from international operations. This has to do with exchange rate changes that can influence sales, expenses, and investments abroad. 4. Managerial Implications The exchange rate between two countries has implications for their economies and business. For example, should the value of the euro fall relative to the Japanese yen, a Dutch buyer will have to pay more euros to

obtain products from its Japanese supplier. The Dutch company can raise the price of Japanese products it sells, or keep prices steady and accept reduced profits. 10.3 CURRENCY RATES AND INSTRUMENTS 10.3.1 Spot and Forward Rates 1. Spot Rate Exchange rate that requires delivery of a traded currency within two business days. The spot market helps companies: a. Convert income from sales abroad into the home currency b. Convert funds into the currency of a supplier c. Convert funds into a currency of a nation it will invest in 2. Forward Rates Exchange rate at which two parties agree to exchange currencies on a specified future date. Represents expectations of a currency’s future spot rate. Reflects a country’s social and political situation as well as its present and future economic conditions. Companies use forward rates to insure against unfavorable changes in exchange rates. 10.3.2 Forward Contracts, Swaps, and Options Three other types of currency instruments are used in the forward market. 1. Forward Contract Requires the exchange of an agreed-on amount of a currency on an agreed-on date at a specified exchange rate. All conditions are fixed and not adjustable and are commonly signed for 30, 90, and 180 days into the future. 2. Currency Swaps The simultaneous purchase and sale of a currency for two different dates. This allows a company to reduce exchange-rate risk and lock in a future exchange rate. 3. Currency Options Right, or option, to exchange a specified amount of a currency on a specified date at a specified rate. Companies use currency options to hedge against exchange rate risk. 10.4 MARKET STRUCTURE AND CONVERTIBILITY The foreign exchange market is an electronic network that connects the world’s foreign exchange traders, currency trading banks, and investment firms residing in

the major financial centers. Single-day trading volume on the foreign exchange market (spot exchanges, forward contracts, and currency swaps) is $6.6 trillion. 10.4.1 Financial Centers Much of the global trade in currencies occurs in the European Union euro, Japanese yen, and the US dollar. Each of these currencies is called a vehicle currency, which is a currency is used as an intermediary to convert fuds between two other currencies. 1. Currency Trading Centers Four locations account for 75 percent of global foreign exchange trading. London accounts for 43 percent while New York City, Singapore, and Hong Kong account for 32 percent among them. 2. Offshore Financial Center 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. Booking centers see relatively little financial activity and funds usually pass through on their way to large operational centers. 10.4.2 Interbank Market Market in which the world’s largest banks exchange currencies at spot and forward rates. Act as agents for clients and turn to foreign exchange brokers for seldom-traded currencies. 1. Clearing mechanisms aggregate currencies that one bank owes another and then carry out that transaction. Today, clearing is a mostly digital, computerized affair, whereas in the past it meant physically delivering currencies from one bank to another. 10.4.3 Currency Convertibility A convertible currency is one that trades freely in the foreign exchange market, with its price determined by the forces of supply and demand. Some countries do not permit the free convertibility of their currencies. 1. Goals of Currency Restriction a. Preserve a nation’s hard currencies to repay debts owed to other nations. b. Preserve hard currencies to pay for imports and to finance trade deficits. c. Protect a currency from speculators. d. Keep individuals and businesses from

investing in other nations. Instruments for Restricting Convertibility a. Demand that the nation’s central bank performs all foreign exchange transactions. b. Issue import deposit requirements that require a business to deposit a portion of its foreign exchange holdings in a special account before being granted an import license. c. Issue quantity restrictions that limit the amount of foreign currency that individuals can take out of the country when traveling abroad. d. Implement a system of multiple exchange rates that specifies higher rates on imports of certain goods or on imports from certain nations. e. Countertrade The practice of selling goods or services that are paid for, in whole or part, with other goods or services. Companies can circumvent currency convertibility restrictions and yet conduct business. A simple form of countertrade is barter, in which goods are exchanged for others of equal value.

Quick Study Questions

Quick Study 1 1. Q: What are the purposes of the international capital market? 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 risk for lenders. The international capital market expands the available set of lending opportunities from which investors can choose. Investors 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. 2.

Q: What financial instruments are traded in the international bond market? A: The international bond market consists of all bonds sold by issuing companies, governments, or other organizations outside their own countries. One instrument used to raise capital in the international bond market is a Eurobond, a bond issued outside the country in whose currency it is denominated. A company can also issue a foreign bond, a bond sold outside the borrower’s country and denominated in the currency of the country in which it is sold.

Q: What is the name for the market of all stocks bought and sold outside the issuer’s home country? A: The international equity market consists of all stocks bought and sold outside the issuer’s home country.

Q: What is the appeal of the Eurocurrency market? A: The main appeal of the Eurocurrency market is a complete absence of regulation, which lowers the cost of banking yet increases potential risk. Still, Eurocurrency transactions tend to be safe because the banks involved are large and have well established reputations.

Quick Study 2 1.

Q: What is the market in which currencies are bought and sold and their prices are determined? A: The foreign exchange market is a market in which currencies are bought and sold and their prices are determined. Financial institutions convert currencies using an exchange rate.

Q: What are the four main functions of the foreign exchange market? A: The four main functions of the foreign exchange market are currency conversion, currency hedging, currency arbitrage, and currency speculation.

Q: What are the three main exposures that exchangerate risk creates for companies? A: Exchange-rate risk makes a business susceptible to three types of exposure. Transaction exposure is the risk that an exchange rate change will affect the

value of a business transaction. Translation exposure is the risk that an exchange rate change will affect a company’s financial statements. Economic exposure is the risk that an exchange rate change will affect a company’s long-term earnings potential from international operations. Quick Study 3 1.

Q: What do we call an exchange rate requiring delivery of a traded currency within two business days? A: A spot rate is an exchange rate that requires delivery of the traded currency within two business days.

Q: What is the purpose of a forward contract? A: The purpose of a company entering into a forward contract is to decrease exchange-rate risk. For example, it allows an importer to lock in a forward exchange rate and protect itself against a possibly less favorable spot rate in 90 days. But such a contract also prevents the importer from benefitting from a potential increase in the value of their currency in 90 days that would reduce what the company owes its supplier. Still, the certainty it affords allows the importer to move forward knowing its future financial position regarding a transaction.

Q: How does a currency swap work? A: A currency swap is the simultaneous purchase and sale of a currency for two different dates. For example, a Swedish company imports parts from a subsidiary in Mexico. The Swedish company agrees to pay the subsidiary in Mexico pesos for parts when they are delivered today. The company also expects to receive Mexican pesos for equipment sold in Mexico in 90 days. The Swedish company exchanges kroner (its currency) for pesos in the spot market today to pay its subsidiary. It also agrees to a forward contract to sell Mexican pesos (and buy Swedish kroner) in 90 days at the forward rate for pesos. In this way, the Swedish company reduces its exchange-rate risk and locks in the future exchange rate.

Q: What is the purpose of a currency option? A: A currency option is a right, or option, to exchange a specified amount of currency on a specified date at a specified rate. Companies often use currency options to hedge against exchange-rate risk.

Quick Study 4 1.

Q: In which trading centers does 75 percent of all foreign exchange trading take place? A: The world’s four main foreign exchange trading centers account for 75 percent of global foreign exchange trading. London alone accounts for 43 percent, while New York City, Singapore, and Hong Kong account for another 32 percent among them.

Q: What is the purpose of the interbank market? A: The interbank market consists of the world’s largest banks that exchange currencies at spot and forward rates. In addition to locating and exchanging currencies, banks commonly provide business customers with advice on trading strategy, a variety of currency instruments, and other risk-management services.

Q: What is the definition for the term convertible currency? A: A convertible currency is one that trades freely in the foreign exchange market, with its price determined by the forces of supply and demand.

Q: Why do governments sometimes engage in currency restrictions? A: Nations sometimes restrict currency conversion to: (1) Preserve a nation’s hard currencies to repay debts owed to other nations, (2) Preserve hard currencies to pay for imports and to finance trade deficits, (3) Protect a currency from speculators, and (4) Keep individuals and businesses from investing in other nations.

Teaming Up Suppose your firm has $10 million in excess cash to invest for one month. You are a member of the team that your manager assembled 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 currency 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 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. Ethical Challenge The goal of government regulation of financial-services industries is to maintain the integrity and stability of financial systems. Regulations include prohibitions against insider trading, lending by management to itself or to closely related entities (called ―self-dealing‖), and transactions in which there is a conflict of interest. In less than two decades deregulation transformed the world’s financial markets. Competition rose, financial sectors grew, and economies of advanced and emerging countries alike expanded. Deregulation also helped bring the international financial system to the brink of collapse. Some say that by their decisions, governments help fuel bubbles in financial markets. 10-3.

Q: Do you believe there are any negative aspects to deregulation in terms of business ethics? A: A potential dark side of deregulation is the possibility of the occurrence of the things mentioned in the question. 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 support agencies responsible for oversight of financial services industries.

10-4.

Q: Do you think increasing regulation is effective in helping prevent global financial crises? A: This is a good opportunity to discuss extraterritoriality. On the one hand, should the US government have the right to control and legislate US business activity abroad? On the other hand, should US firms be allowed to exploit a loophole and avoid paying higher taxes? Students supporting the use of an offshore financial center to avoid taxation in national markets must explain why it is okay for multinational and global companies to evade national taxation but small, largely domestic companies cannot reduce their tax burden. They must justify letting a company using an offshore center off the hook in terms

of contributing more to the national infrastructure, health care, education, and general welfare of the people of the nation. Students supporting a clampdown on offshore centers must explain why their use to shelter income and avoid regulations is unethical. 10-5.

Q: Do you think the warning of Adam Smith, one of the first philosophers of capitalism, against the dangers of ―colluding producers,‖ applies to the financial-services sector? A: Countries retain the most important regulatory aspects of their legal systems and support their agencies responsible for oversight of the financial services industries. The ―colluding producers‖ argument may apply to surges in merger and acquisition activity. However, as long as regulators scrutinize proposed mergers and acquisitions for anticompetitive consequences, greater concentration may continue across many industries.

Practicing Management Case

International

Samsung’s Earnings and the Won 10-8.

Q: Apart from a weak and strong won influencing Samsung’s currency translations, how does each affect Samsung’s exports from South Korea? A: Currency values influence demand for Samsung’s products on world markets. When the won is weak (valued low relative to other currencies) Samsung could see the price of its exports decline. Samsung’s lower prices on world markets can give it an opportunity to gain market share. When the won is strong (valued high relative to other currencies) Samsung will see the price of its exports rise. Samsung may be able to counter this higher export price by sacrificing some profit margin and lowering its asking price.

10-9.

Q: How might an official South Korean digital currency potentially benefit Samsung? A: Samsung will learn a great deal while testing South Korea’s digital currency with the government. The company will experience obstacles along the way and learn how to overcome them. Samsung will develop the payment system for android and can later adapt that system for the digital currencies of other nations.

10-10. Q: Why do you think South Korea’s government is testing its digital currency with Samsung and not another company? A: Samsung is a global leader in mobile phones that use the android operating system. No doubt, Samsung devices using android will be key in expanding the prevalence of mobile payments in South Korea. Apple is the other main global player with its devices using the iOS operating system. The global potential market for making mobile payments on personal, smart devices is enormous. Samsung’s base and political connections in South Korea, its quality reputation, and market dominance in android made it the obvious choice as a partner with which the government can explore the use of its digital currency. 10-11. Q: How exactly does Samsung Heavy Industries buy and sell forward contracts to reduce its exchange-rate risk? A: Samsung Heavy Industries (SHI) identifies the currency it will accept for payment for a ship at the time a contract is written. Most often, it receives payment in US dollars. SHI will need to convert these dollars into won at that time but it does not know what the exchange rate will be then. So, SHI hedges this exposure to eliminate exchange-rate risk using forward contracts. During the course of construction, SHI receives installments from the purchaser of the ship at several, pre-determined intervals. Because it knows the dates when it will receive payments, SHI can purchase forward contracts to buy dollars at a specific exchange rate on those specific dates. Using hedging in this way, SHI protects itself from a rising won and its receipt of less money than expected after it converts US dollars into won.

CHAPTER 11 INTERNATIONAL MONETARY SYSTEM LEARNING OBJECTIVES: 11.1 Describe the importance of currency values to business activities.

11.2 Outline the factors rates. 11.3 Explain attempts to exchange rates. 11.4 Describe efforts to exchange rates.

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CHAPTER OUTLINE: Importance of Currency Values Desire for Stability and Predictability Efficient Versus Inefficient Market View Forecasting Techniques Factors That Determine Exchange Rates Law of One Price Purchasing Power Parity McCurrency Exchange Rates and Inflation Money Supply Unemployment and Interest Rates Evaluating Purchasing Power Parity Added Costs Trade Barriers Business Confidence and Psychology Fixed Exchange Rate Systems 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 Smithsonian Agreement Final Days Floating Exchange-Rate System Jamaica Agreement Later Accords Today’s Exchange-Rate Arrangements Pegged Exchange-Rate Arrangement Currency Board 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

fixed

floating

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 INTRODUCTION This chapter explores factors that determine exchange rates and various international attempts to manage them. It presents different methods of forecasting exchange rates and explores attempts to create systems of both fixed and floating exchanges rates. It also reviews recent financial crises and the functioning of the international monetary system. 11.1 IMPORTANCE OF CURRENCY VALUES Exchange rates affect demand for products. When a country’s currency is weak, the price of its export’s declines, making the exports more appealing on world markets (see Figure 11.1). We see the opposite effects for a strong currency. 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’ domestic purchasing 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. 11.1.1 Desire for Stability and Predictability 1. Unfavorable movements in currency values can be costly for business. Stability makes for accurate financial planning and cash flow forecasts. 2. Predictability reduces odds that a company will be caught offguard by unexpected rate changes. Reduces the need for costly insurance (currency hedging) against possible adverse exchange rates. 3. Figure 11.2 shows how the value of the U.S. dollar has changed over time. The figure reveals the dollar’s periods of instability, which challenged the financial management capabilities of international companies. Before undertaking international business,

11.1.2 1.

11.1.3 1.

managers try to forecast exchange rates and the impact of currency values on earnings. Efficient Versus Inefficient Market View The efficient market view says prices of financial instruments reflect all publicly available information at any given time. This says forward exchange rates accurately forecast future rates. 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. The inefficient view is more compelling considering private information. For example, a currency trader who holds privileged information can act on this information to make a profit. Forecasting Techniques Fundamental Analysis Fundamental analysis uses statistical models based on fundamental economic indicators to forecast exchange rates. These variables include inflation, interest rates, the money supply, tax rates, government spending, and government spending. Technical Analysis Technical analysis uses charts of past trends in currency prices and other factors to forecast exchange rates. This technique examines conditions that prevailed during changes in exchange rates and tries to estimate the timing, magnitude, and direction of future changes. Forecasting exchange rates is not a pure science, despite sophisticated statistical techniques. For example, people might miscalculate the importance of certain economic events, placing too much emphasis on some elements and ignoring others.

11.2 FACTORS THAT DETERMINE EXCHANGE RATES The purchasing power of currencies is extremely important in international business. A currency can gain purchasing power and lose purchasing power. To understand what determines exchange 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. 11.2.1 Law of One Price 1. Law of one price says an identical product must have an identical price in all countries when the price is expressed in a common

11.2.2 1.

currency. Product must be identical in quality and content and be entirely produced within each country. 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. The act of buying in the one market (higher demand) and selling in the other (greater supply) would cause prices to equalize eventually. Purchasing Power Parity (PPP) PPP theory says that an exchange rate between two nations’ currencies is equal to the ratio of their price levels. Economic forces will push a market exchange rate toward that calculated by PPP or an arbitrage opportunity arises. McCurrency The Economist magazine publishes its ―Big Mac Index‖ using the law of one price to determine the exchange rate between the US dollar and other currencies. Fair predictor of the ―direction‖ rates should move. Exchange Rates and Inflation Exchange rates adjust for different rates of inflation in different countries, which is necessary to maintain purchasing power parity between nations. 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. US goods become more expensive for Mexican firms, and Mexican goods become cheaper for US firms. a. Money Supply 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.

Unemployment and Interest Rates i. 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. ii. Low interest rates encourage consumers and businesses to borrow and spend, causing inflationary pressure. 11.2.3 Evaluating Purchasing Power Parity PPP is better at predicting long-term exchange rates than short-term rates. Short-term forecasts, however, are most beneficial to managers. 1. Added Costs PPP assumes no transportation costs, thus overstating the threat of arbitrage. The presence of transportation costs can allow unequal prices between markets to persist, causing PPP to fail. 2. 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. 3. Business Confidence and Psychology PPP overlooks business confidence and human psychology. Nations try to maintain confidence of investors, businesspeople, and consumers in their economies and currencies. 11.3 FIXED EXCHANGE-RATE SYSTEMS 11.3.1 The Gold Standard Gold was internationally accepted as payment 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. Great Britain was the first to implement the gold standard in the early 1700s. 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 converting one currency into another is fixed by international governmental agreement. b. The US dollar was fixed at $20.67/oz of gold and the British pound was fixed at £4.2474/oz. So, the dollar-pound exchange rate equaled $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 it 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. A nation that imports more than it exports sends gold out of the country to pay for imports. The government must decrease its paper currency in the domestic economy because it cannot be valued in excess of its 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 lower the price of its exports on world markets and exports rise until the nation’s international trade is again in balance. Collapse of the Gold Standard a. The gold standard was violated when nations financed their efforts in the First World War by printing paper currency. This caused rapid inflation and nations abandoned 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. This decision of the US to effectively devalue its currency and Britain’s decision to not do so lowered the price of US exports and increased the price of British goods imported. Whereas it had previously required $4.87 to purchase one British pound, it now took $8.24 ($35.00 ÷ £4.2474). This drastically increased the price of imports from Britain (and other countries). 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. 11.3.2 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 a. Incorporated fixed exchange rates by tying the value of the US dollar directly to gold, and the value of other currencies to the value of the dollar. b. Fixed US dollar par value at $35/oz of gold; other currencies had par values against the US dollar, not gold. c. Members were to keep their currencies from deviating more than 1 percent above or below their par values. Extended the right to exchange gold for dollars only to national governments. 2. 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 only, and not be used for temporary misalignments.

World Bank a. Officially called the International Bank for Reconstruction and Development (IBRD). Created to fund national economic development. b. Immediate purpose was to finance European reconstruction after the Second World War. Later shifted its focus to the general financial needs of developing countries. c. Finances economic development projects in Africa, Asia and South America. Offers funds to countries unable to obtain capital for projects considered too risky. Often helps develop transportation networks, power facilities, and agricultural and educational programs. International Monetary Fund a. Intended to regulate fixed exchange rates and enforce the rules of the international monetary system. Purposes of the IMF are to: (1) Promote international monetary cooperation, (2) Facilitate expansion and balanced growth of international trade, (3) Promote exchange stability and avoid competitive exchange devaluation, (4) Make resources temporarily available to members, (5) Shorten the duration and lessen the degree of disequilibrium in the international balance of payments of member nations. i. Special Drawing Right IMF asset whose value is based on a weighted ―basket‖ of five currencies: the US dollar, EU euro, Chinese renminbi, Japanese yen, and British pound. Collapse of the Bretton Woods Agreement Bretton Woods faltered in the 1960s because of US trade and budget deficits. Other nations holding US dollars doubted the government had gold reserves to redeem all of its paper currency, resulting in a global sell-off of US dollars. a. Smithsonian Agreement The Smithsonian Agreement was to restructure and strengthen the international monetary system. It (1)

lowered the value of the dollar in terms of gold to $38/oz., (2) required other countries to increase the value of their currencies against the dollar, and (3) increased the 1 percent floatation band to 2.25 percent. Final Days Many nations abandoned the system in 1972 and 1973, and currency values floated freely against the US dollar.

11.4 FLOATING EXCHANGE-RATE SYSTEM The new system of floating exchange rates was to be a temporary solution. No new international monetary system emerged but there were several efforts to manage exchange rates. 1. Jamaica Agreement This 1976 accord (1) formalized the existing managed float system of exchange rates, (2) eliminated gold as the primary reserve asset of the IMF; and (3) expanded the IMF’s mission to act as a ―lender of last resort‖ for nations with balance-of-payments difficulties. 2. Later Accords From 1980 to 1985 the US dollar rose against other currencies, pushing up prices of US exports and adding to its 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 G7 nations (the G5 plus Italy and Canada) to affirm the dollar was appropriately valued and that they would intervene in currency markets to maintain its current market value. 11.4.1 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 tie a currency to a more stable and widely used one in international trade. b. Many small countries peg their currencies to the US dollar, the EU euro, the special drawing right (SDR)

of the IMF, or even a basket of currencies. Countries that peg their currency to the US dollar include The Bahamas, Belize, Eritrea, Turkmenistan, and Saudi Arabia. 2. Currency Board a. A monetary regime based on a commitment to exchange domestic currency for a specified foreign currency at a fixed exchange rate. It makes a government legally bound to hold an amount of foreign currency equal to the amount of domestic currency, which helps cap inflation. b. The currency board’s survival depends on sound budget policies. 11.4.2 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 1980s, developing countries (especially in Latin America) had amassed huge debts with 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. Political turmoil shook investors’ faith in Mexico’s financial system in 1993–1994. Its government responded slowly to the flight of portfolio investment capital. b. In late 1994, the Mexican peso was devalued, forcing a loss of purchasing power on the Mexican people. The IMF and private commercial banks in the United States provided around $50 billion in loans to support Mexico’s economy. c. Mexico repaid the loans ahead of schedule and once again has a sizable reserve of foreign exchange.

Southeast Asia’s Currency Crisis a. On July 11, 1997, speculators sold off Thailand’s baht on world currency markets. The baht plunged and every other economy in the region experienced 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. Russia’s Ruble Crisis a. Russia’s problems in the 1990s: (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 the Russian government tried to defend its ruble on currency markets when currency traders sold it. Russia received a $10 billion aid package from the IMF and promised to reduce debt, collect taxes, cease printing currency, and peg its currency to the dollar. c. Then in 1998 the government found itself once again trying to defend the ruble. By late 1998, the IMF had lent Russia more than $22 billion. Argentina’s Peso Crisis a. By late 2001, Argentina had been in recession for nearly 4 years. Argentina’s exports were expensive because its currency was linked to a strong US dollar through a currency board. b. The country finally defaulted on its $155 billion of public debt in early 2002, the largest default by any country ever. c. The government scrapped its currency board and the peso quickly lost about 70 percent of its value. d. From 2001 through 2002, the economy shrank by 15 percent, unemployment shot up to 21 percent, and poverty engulfed 56 percent of its citizens. e. Argentina’s plan of boosting wages, imposing price controls, keeping the peso low, and increasing public spending worked for a time. But

11.4.3 1. 2.

inflation soon reached double digits and cut purchasing power, increased poverty, and shrank the economy. The IMF loaned Argentina $50 billion. The nation was hit hard by the pandemic in 2020. In 2021, Argentina restructured its debt and made arrangements to repay the IMF $45 billion by 2032. In early 2022, inflation was rising 54 percent a year. Future of the International Monetary System Recurring crises are raising calls for a new system designed to meet the challenges of a global economy. 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. 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.

Quick Study Questions Quick Study 1 1.

Q: How might a weakening currency influence the price of a nations’ exports and imports? A: A weakening currency is losing purchasing power on world markets. It lowers the price of a country’s exports on world markets and increases the price of imports.

Q: What two overall features do managers prefer currencies and exchange rates to embody? 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.

Q: What is the main difference between the two views of whether or not prices of financial instruments reflect all publicly available information? A: The efficient market view states that prices of financial instruments reflect all publicly available information at any given time. The inefficient market view states that prices of financial instruments do not reflect all publicly available information.

Q: What are the names of the two techniques used to analyze and forecast exchange rates? A: Fundamental analysis uses statistical models based on fundamental economic indicators to forecast exchange rates. These variables include inflation, interest rates, the money supply, tax rates, government spending, and government spending. Technical analysis uses charts of past trends in currency prices and other factors to forecast exchange rates. This technique examines conditions that prevailed during changes in exchange rates and tries to estimate the timing, magnitude, and direction of future changes.

Quick Study 2 1.

Q: What is the name for the principle that an identical item must have an identical price in all countries when price is expressed in a common currency and what are the 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. If the price is not identical in each country, an arbitrage opportunity would arise.

Q: What do we mean by the expression, ―an implied PPP exchange rate‖? 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 products that a person in country B can buy with currency B. When we calculate an exchange rate between the two currencies using this ratio of price levels, we call it an implied exchange rate. We can compare this implied rate to the actual exchange rate we see in currency markets.

Q: How does inflation in a country influence its currency’s exchange rate with other countries? A: Exchange rates adjust for different rates of inflation in different countries, which is necessary to maintain purchasing power parity between nations. For example, if inflation in Mexico is higher than in the United States, the exchange rate adjusts to reflect that a US dollar will buy more pesos due to higher inflation in Mexico. US goods become more expensive for Mexican firms, and Mexican goods become cheaper for US firms.

Q: What factors can influence the power of purchasing power parity to accurately predict 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. 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 and there will be no leveling of prices between the two markets. 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. Fourth, PPP overlooks business confidence and human psychology. The confidence of businesspeople and consumers impacts the value of a nation’s currency. Currency traders can also influence the exchange rate of a nation’s currency if they believe it to be overvalued or undervalued. Quick Study 3 1.

Q: The gold standard is an example of what type of international monetary system? A: The gold standard was an international monetary system in which nations linked the value of their paper currencies to specific values of gold. 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. 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.

Q: What were the main advantages of the gold standard? A: There were 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. A nation that imports more than it exports sends gold out of the country to pay for imports. The government must decrease its paper currency in the domestic economy because it cannot be valued in excess of its 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

lower the price of its exports on world markets and exports rise until the nation’s international trade is again in balance. 3.

Q: What were the most important elements of the Bretton Wood 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 US Dollar. The system balanced the strict discipline of the gold standard with flexibility. It incorporated fixed exchange rates by tying the value of the US dollar directly to gold, and the value of other currencies to the value of the dollar. Members were to keep their currencies from deviating too far above or below their par values. It also extended the right to exchange gold for dollars only to national governments. It allowed devaluation only in extreme circumstances called fundamental disequilibrium—when a trade deficit causes a permanent negative shift in the balance of payments. Finally, it created the World Bank to fund national economic development and the International Monetary Fund to regulate fixed exchange rates and enforce the rules of the international monetary system.

Quick Study 4 1.

Q: What do we call an exchange-rate system in which currencies float against one another with governments intervening to stabilize currencies at target rates? A: A managed float system is one in which currencies float against one another, with governments intervening to stabilize their currencies at particular target exchange rates.

Q: What is a name for an exchange-rate system in which currencies float freely against one another without government interference? A: A free float system is an arrangement whereby a nation lets its currency float within a margin around the value of another more stable currency.

Q: What are some of the countries that have recently faced currency crises and received assistance from the IMF? A: By the early 1980, certain developing nations (especially in Latin America) had amassed huge debts with international banks, the IMF, and the World Bank. In 1982, Mexico, Brazil and Argentina announced that they would be unable to pay interest on their loans. At the same time, many of these countries were

experiencing inflation. Mexico faced a peso crisis in 1993 and 1994, and in response the IMF and the United States stepped in with approximately $50 billion dollars in loans. On July 11, 1997, speculators sold off Thailand’s baht on world currency markets forcing an 18 percent drop in its value. It continued to drop causing a crisis that was felt in the entire area. Indonesia, South Korea and Thailand needed and received assistance from the IMF and the World Bank. In early 1996, traders sold vast quantities of the Russian ruble, and the Russian government attempted to defend the ruble on currency market. As its foreign exchange reserves dropped, the government received a $10 billion aid package from the IMF. The problems continued and by the time it was all over in 1998 the IMF had lent Russia more than $22 billion. By 2001, Argentina had been in recession for four years. This was due in part to Brazil’s devaluation of its own currency in 1999, making Brazil’s exports cheaper on world markets, making Argentina’s good more expensive, because the peso was linked to a strong US dollar through a currency board. Eventually Argentina was running out of money and unable to service its debt obligations. The problems persisted and eventually the IMF granted a loan of $50 billion to Argentina. In 2022, Argentina's economy was weak with high inflation and a disillusioned population. Teaming Up Suppose you and several classmates are a team assembled by your Brazil-based company to estimate demand in the US market for its newly developed product. The market research firm your team has hired requires $150,000 to perform a thorough study. Your team is informed that your company’s total annual research budget is 3 million Brazilian reais (R$3 million) and that no more than 20 percent of the budget can be spent on any single project. 11-3.

Q: If the current exchange rate is R$5/$, will your team request the market study? Explain. A: The answer is no. Converting Brazilian real into dollars at an exchange rate of R$5/$, we arrive at an annual research budget of $600,000 (R$3,000,000/$ = $600,000). The research project costing $150,000 is 25 percent of the total 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. 11-4.

Q: If the exchange rate changes to R$3/$, will your team request the market study? Explain. A: The answer is yes. Converting Brazilian real into dollars at an exchange rate of R$3/$, we arrive at $1,000,000 (R$3,000,000/$ = $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.

11-5.

Q: At what exchange rate does your team change its decision from rejecting the market study to accepting it? A: The threshold exchange rate at which the project decision changes from ―accept‖ to ―reject‖ is R$4/$. 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 (R$3 million) by that stated in dollars ($750,000), we arrive at a R$/$ exchange rate of R$4/$.

Ethical Challenges You are the chair of an IMF task force. Your job is to evaluate the policy of bailing out national governments that suffer major losses in the private sector in the name of protecting the value of their currency. Taxpayers in industrial countries typically foot the bill for IMF activities, with loans typically running into the many billions of dollars. Some critics call this system a kind of socialism that uses taxpayer money from stable economies to rescue financial institutions and investors from their own mistakes. Financial crises often originate as privatesector affairs, but then central banks step in and pledge foreign exchange reserves to shore up the currency. 11-6.

Q: Do you agree with the belief that the current system privatizes profits and then socializes losses if the government steps in with a bailout? A: Students might look at the global financial crisis 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 shareholders in these companies certainly 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. 11-7. Q: What sort of alternative can you envision to replace the current system, which often involves an IMF bailout? A: Students should support suggestions with as much detail as possible. Although some students will surely have a better grasp of these bailouts than others, all should be encouraged to get creative. This question sometimes works best as a class discussion in which students can help each other to formulate solutions, even ones sparked by a student’s initial comment. Students find the brainstorming a fun activity—jotting ideas on sticky notes, placing them on a board, and later regrouping and creating some concrete suggestions. Practicing Management Case

International

Argentina Survives a Crisis—Again 11-10. Q: Why did Argentina peg its currency to the dollar initially? Why did it do away with its currency board? A: 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 severe inflation. But the peso–dollar link contributed to Argentina’s problems after Brazil devalued its currency, raising relative prices of Argentina’s goods on global markets. 11-11. Q: How are local and international companies adapting Argentina’s business environment? A: The Argentine units of US companies that collected revenue in pesos had a difficult time repaying dollardenominated debt when the peso’s value initially fell. Not all parent firms rescued their ailing subsidiaries in Argentina because most were independent entities. For example, AES Corp., of Arlington, VA reported that

most of its Argentine businesses were in default on their project-financing arrangements. But AES said it 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. Restrictions placed on currency exchange forced importers to wait several months or more while the government authorized payments in dollars. Companies struggled with new rules that raised taxes on exporters and other cash-rich firms to help the government pay for social services. Local firms 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 are enduring the economic crisis, loss of markets abroad, and so on. 11-12. Q: How have Argentina’s economic difficulties affected the savings and purchasing power of ordinary Argentines? A: Strapped for cash, the government seized the savings accounts of its citizens and restricted how much they could withdraw at a time. Street protesters turned violent and attached 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 find recent articles in the business press for reports on how international aid is perceived by the Argentines (while paying attention to the people’s differing economic status) and the international community. There will no doubt be a disparity in views. 11-13. Q: What recent steps has Argentina taken recently to reform its economic policies? A: Students can consult the business and financial press as well as the International Monetary Fund’s website to update the situation.

CHAPTER 12 INTERNATIONAL STRATEGY AND ORGANIZATION LEARNING OBJECTIVES: 12.1 Explain the company analysis techniques that precede strategy selection. 12.2: Describe the various strategies that companies use to reach their goals. 12.3: Outline the key issues behind the selection of organizational structure. 12.4: Describe various international organizational structures and types of work teams. CHAPTER OUTLINE: Company Analysis Company Mission and Goals Types of Mission Statements Core Competency and Value Creation Unique Abilities of Companies Value Chain Analysis Primary Activities Support Activities Business Environment Strategy Formulation 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 Issues of Organizational Structure Centralization versus Decentralization When to Centralize

When to Decentralize Coordination and Flexibility Structure and Coordination Structure and Flexibility Types of Organizational Structure International Division Structure International Area Structure Global Product Structure Global Matrix Structure Work Teams Self-Managed Teams Cross-Functional Teams Global Teams 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 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. Companies also must assess the competitive environment and the national and international business environments. A well-defined strategy coordinates divisions and departments to reach corporation-wide goals effectively and efficiently. A clear, appropriate strategy focuses on the activities performed best to avoid mediocre performance or total failure. 12.1 COMPANY ANALYSIS 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 (See Figure 12.1). 12.1.1 Company Mission and Goals

Mission statement is a 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. Often describe how a company’s operations affect stakeholders—all parties (from suppliers and employees to stockholders and consumers) who affect, or are affected by, a company’s activities. b. The mission statement of an international business depends on the type of business, the domestic and international stakeholders, and the most important aspect of the business for achieving its goals. c. Managers must define objectives. Objectives at the highest level in a company tend to be stated in general terms. Those at the level of business units are more specific, and department-level objectives are the most specific and can carry numerical performance targets. 12.1.2 Core Competency and Value Creation Before formulating strategies, managers analyze the company, industry, and national business environment(s). They should examine industries and nations targeted for potential entry. This helps managers discover its competencies and the activities that create customer value. 1. Unique Abilities of Companies a. Core competency is an ability of a company that competitors find extremely difficult or impossible to equal. They are multiple skills coordinated to form a single technological outcome. b. Skills are learned through on-the-job training and personal experience, but core competencies develop over a long period and are difficult to teach. 2. Value Chain Analysis Process of dividing a company’s activities into primary and support activities and identifying those that create value for customers. a. Primary Activities Company activities directly related to the creation of a product, its marketing and delivery to buyers, and its after-sales support and services. These include inbound and outbound logistics, production (goods and services), marketing and sales, and customer service.

b. Support Activities Company activities that contribute to the value-creating potential of each primary activity. These include firm infrastructure, human resource management, technology development, and procurement. Each is a source of strength or weakness for a company. 12.1.3 Business Environment 1. National differences in language, religious beliefs, customs, traditions, and climate complicate strategy formulation. 2. Manufacturing processes must sometimes be adapted to the supply of local workers, local customs, traditions, and practices. 3. Differences in political and legal systems complicate international strategies. 4. Different national economies complicate strategy formulation, and it can also affect the location in which a company chooses to perform an activity.

a. b. c. d.

12.2 STRATEGY FORMULATION A company’s strengths and capabilities as well as environmental forces influence strategy. 12.2.1 Two International Strategies The two strategies presented here are not for companies that export only. Exporters do not have foreign direct investments and should instead devise an appropriate export strategy. 1. Multinational Strategy Adapts products and marketing strategies in each national market to suit local preferences. 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. Not suited to industries in which price competitiveness is a key to success. 2. Global Strategy a. Offers the same products using the same marketing strategy in all markets. b. 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. c. Benefit: cost savings from standardized products and marketing; lessons learned in a market are shared. d. Drawback: may overlook differences in buyer preferences; only simple

modifications in features. Competitors can step in and satisfy unmet needs creating a niche market. 12.2.2 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. 1. Growth Strategy a. 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. b. Organic growth relies on internally generated growth. c. 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. 2. Retrenchment Strategy Reduces the scale or scope of a corporation’s businesses. Typical when economic conditions worsen or competition increases. Close factories with unused capacity, lay-off employees, sell unprofitable business units. 3. Stability Strategy a. Guards against change, Avoids growth and retrenchment. b. Corporations have met objectives, are satisfied with accomplishments, and see no opportunities or threats. 4. Combination Strategy a. Mixes growth, retrenchment, and stability strategies across a corporation’s business units. b. Common because rarely do international corporations follow identical strategies in each business unit. 12.2.3 Business-Level Strategies A company may need only one strategy for its one line of business where others may need many strategies. Key to an effective business-level strategy is a general competitive strategy in the marketplace. 1. Low-Cost Leadership Strategy

Exploits economies of scale to have the lowest cost structure of any competitor in an industry. b. Companies have a myriad of cost including administrative costs and the costs of its various primary activities, including marketing, advertising, and distribution. c. Low-cost leadership is based on efficient production in large quantities, which guards against attack by competitors because of the large start-up costs. d. 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. Works best with mass-marketed products aimed at price-sensitive buyers. 2. Differentiation Strategy a. Company designs products to be perceived as unique. b. Tends to force a company into a lowermarket-share position because it involves the perception of exclusivity or meeting the needs of a certain group. c. Companies develop loyal customer bases to offset smaller market shares and higher costs of producing and marketing a unique product. d. 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. 3. Focus Strategy a. Company focuses on the needs of a narrowly defined market segment by being the low-cost leader, by differentiating its product, or both. b. Competition forces more products to be distinguished by price, quality, or design. Greater product range leads to refinement of market segments. 12.2.4 Department-Level Strategies Achieving 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. 1. Primary and Support Activities Each department creates customer value through lower costs or differentiated products. a. 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. b. Support activities create customer value. For example, R&D identifies market segments with unsatisfied needs and designs products to meet them. 12.3 ISSUES OF ORGANIZATIONAL STRUCTURE Organizational structure is the way in which a company divides its activities among separate units and coordinates activities among them. An appropriate organizational structure for a firm’s strategic plans will help it achieve its goals. 12.3.1 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. This is very important when one subsidiary’s output is another’s input. b. Companies might 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 create a single global organizational culture.

When to Decentralize a. Decentralization is beneficial when fast-changing business environments require local responsiveness. b. Subsidiary managers in close contact with local business environment can result in products suited to the needs and preferences of local buyers. c. Fosters participative management practices and employee morale is higher if subsidiary managers and subordinates are involved in decisions. d. Delegating decisions can increase commitment. Local managers rewarded for their decisions often invest more in making and executing them. 12.3.2 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. Structure defines 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. Structure is not permanent but is modified to suit changes within a company and in its external environment. b. Changes in strategy and the business environment can force changes in organizational structure. 12.4.

TYPES OF ORGANIZATIONAL STRUCTURE Four organizational structures are common for most international companies. 12.4.1 International Division Structure (see Figure 12.4). 1. 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

12.4.2 12.5) 1.

3. 4.

12.4.3 1. 2.

12.4.4 1.

within that market. Concentrates international expertise in one division where the manager becomes a specialist in foreign exchange, exporting, etc. Firm reduces costs, increases efficiency, and prevents international activities from disrupting home operations. Potential problems: (1) international managers must often rely on home-country managers for financial resources and technological know-how, (2) poor coordination between the international division and the rest of the company can hurt performance, and (3) destructive rivalries may arise between different country managers within the division. International Area Structure (See Figure 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. Each geographic division operates as a selfcontained unit, with decision making decentralized to country or regional managers. Useful structure when there are vast cultural, political, or economic differences among nations or regions. By controlling activities in their environments, general managers become experts on the unique needs of their buyers. But because units act independently, resources may overlap, and crossfertilization of knowledge across units can be limited. Global Product Structure (See Figure 12.6) Divides worldwide operations according to a company’s product areas. Suitable when a firm has a diverse set of products. 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 (See Figure 12.7) 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. Brings together geographic area managers and product area managers in joint decision making. 3. 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. 4. Two major shortcomings: (1) complex coordination can slow decision making and reaction time, and (2) shared responsibility can cause a manager to attribute poor performance to the other manager. 12.4.5 Work Teams Work teams can be useful in improving responsiveness by cutting across functional boundaries that can 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 self-managed team in many manufacturing companies because they reduce production waste and costs. c. Cultural differences can cause resistance to the concept of selfmanagement 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 2.

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

Quick Study Questions Quick Study 1 1.

Q: What do we call a written statement of why a company exists and what it plans to accomplish? A. 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.

Q: What is the name of a company’s special ability that competitors find extremely difficult or impossible to equal? 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 successfully deescalate potential conflict situations in the workplace. 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: Value chain analysis involves separating a company’s activities into what two categories of activities? A: Value-chain analysis is the process of dividing a company’s activities into primary and support activities and identifying those that create value for customers. Primary activities include inbound and outbound logistics, production, 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. Quick Study 2 1.

Q: What are the two general, international strategies available to companies? A: A multinational (multidomestic) strategy is one 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 this strategy is that it does not allow companies to exploit scale economies in product development, manufacturing, or marketing. A global strategy is one 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 this strategy is that it may cause a company to overlook important differences in buyer preferences from one market to another.

Q: Name three generic business level strategies companies can use to compete in an industry. A: A company can use one of three generic businesslevel strategies for competing in its industry: lowcost leadership, differentiation, or focus. Low-cost leadership is a strategy in which a company exploits economies of scale to have the lowest cost structure of any competitor in its industry. Differentiation is a strategy in which a company designs its products to be perceived as unique by buyers throughout its industry. Focus is a strategy 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.

Q: What activities are important to analyze in formulating department-level strategies? A: Formulation of department level strategies begins with an analysis of a company’s capabilities that support its strategy; to the primary and support

activities that create value for customers. Quick Study 3 1.

Q: What is the name for the way in which a company divides its activities among separate units and coordinates activities among them? 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.

Q: What type of decision making helps coordinate the operations of international subsidiaries? A: A vital issue for top managers is determining the degree to which decision making in the organization will be centralized or decentralized. Centralized decision making is the degree to which decision making occurs 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.

3. Q: What is a benefit of decentralized decision making in an organization? A: Decentralized decision making is beneficial when fast changing national business environments put a premium on local responsiveness. Quick Study 4 1.

Q: What type of organizational structure tends to concentrate all international expertise in one division? A: An international division structure separates domestic from international business activities by creating a separate international division with its own manager.

Q: What is the name for the organizational structure that divides worldwide operations according to a firm’s product areas? A: A 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.

Q: What do we call a group of employees who work at

similar levels in different departments? A: 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. Teaming Up Two groups of four students each will debate the merits of adopting either a multinational or a global strategy (each side will advocate one strategy). 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. The 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 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 called upon to summarize their position in class. It may also be useful to give students some time to do outside research to prepare for the debate. Ethical Challenge You are the CEO of a multinational corporation that is expanding its business to several times its current size and entering dozens of countries in the next 10 years. Your company will be operating globally and is considering altering its strategy and organization structure accordingly. Social, political, economic, and legal changes in recent years are inspiring your company to revise its operating policies. You are personally involved in updating your firm’s code of ethics that reflects today’s moral atmosphere. You want your firm’s code to be effective across all markets in which it operates. 12-3.

Q: Given the complexity of the issues involved, what sort of ethical code is appropriate for a firm involved in dissimilar nations? A: Building a code of ethics for a multinational or global firm is a complicated task. In many foreign countries, business practices that would not be appropriate domestically and perhaps illegal are often a normal part of doing business (e.g., gift giving

practices, bribery, kickbacks, etc.). Two general approaches can be taken: (a) operate internationally with policies and procedures it has developed at home, or (b) modify its practices in each foreign country where it operates. One universal ethical code would likely need to be extremely vague (and then be of questionable usefulness) or state compliance with local customers (and risk being called out for practicing cultural relativism). It is probably best to provide a straightforward explanation of the home country’s base policy and then create a ―national rider‖ for each market as the company enters each one. See the ethics coverage in Chapter 2 for a detailed discussion. 12-4.

Q: Do you think 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). Again, see the ethics coverage in Chapter 2 for a detailed discussion.

Practicing Management Case

International

Flying High with Low Fares 12-7.

Q: What do you think is Ryanair Holdings’ core competency, and what activities in its brands’ value chains do you think create the greatest value for customers? A: Ryanair’s core competency is its ability to provide a safe and reliable flight service while squeezing excess costs out of every aspect of its business. And, despite some complaints from time to time, the proof that Ryanair's customers receive utility from the company’s service is evident in its repeat business. Customers keep coming back because they accept no-frills flights to slightly inconvenient destinations because it saves them money. In an inflationary economy or otherwise difficult economic times, that’s a priority for most people.

12-8.

Q: What business and economic forces do you think encouraged Ryanair to choose to compete on the basis of a low-cost strategy in the airline industry?

A: Despite the price of its flights being around half those of British Airways and Aer Lingus, Ryanair struggled to make a profit. It likely had no choice but to restructure its business if it wanted to survive. The company cut costs further so it could reduce prices to the point at which travelers would accept a no-frills flight to an out-of-the-way airport in order to save money. To execute its budget airline strategy, Ryanair hired CEO, Michael O’Leary, who had worked at successful US budget airline, Southwest. O’Leary brought knowledge gained at Southwest back to Ireland and put it to work at Ryanair. 12-9.

Q: Do you think a low-cost leadership strategy can help, hinder, or have no discernable effect on helping a company to weather an economic slowdown? A: Once a company has cut costs to the bone to become the low-cost leader in its industry, there typically is little room left to cut costs further in an economic slowdown. The only option in this case, might be to eliminate services, stop flying less popular routes, or stop flying to relatively expensive destinations. Companies following differentiation or focus strategies will also have difficulty unless they have excess profit margin they can sacrifice. If these other companies drop services to reduce costs, customers might begin to see fewer reasons to pay extra for their products over that of the low-cost leader.

12-10. Q: Considering the models of organizational structure presented in this chapter, how would you describe Ryanair’s structure? A: Ryanair is a registered holding company. Its national subsidiaries seem to behave as fairly independent units that cooperate when it is mutually beneficial, for example, when one buys aircraft from another.

CHAPTER 13 ANALYZING INTERNATIONAL OPPORTUNITIES

LEARNING OBJECTIVES: 13.1: Explain the basic appeal of a market or site and the role of national factors. 13.2: Describe how to measure market and site potential and perform a final selection. 13.3: Identify the main sources of secondary market research data. 13.4: Describe common methods used to conduct primary market research. CHAPTER OUTLINE: Basic Appeal and National Factors Identify Basic Appeal Determining Basic Demand Determining Availability of Resources Assess the National Business Environment Cultural Forces Political and Legal Forces Regulations and Bureaucracy Political Stability Economic and Financial Forces Measure and Select the Market or Site Measure Market or Site Potential Measuring Market Potential Income Elasticity National Data Measuring Site Potential Select the Market or Site Field Trips Competitor Analysis Secondary Market Research Public Information Sources Private Information Sources Issues with Secondary Research Availability of Data Reliability of Data Comparability of Data Primary Market Research Trade Shows and Trade Missions Interviews and Focus Groups Surveys and Environmental Scanning Issues with Primary Research 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 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. 13.1 BASIC APPEAL AND NATIONAL FACTORS 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 (See Figure 13.1). 13.1.1 Identify Basic Appeal For a potential market this means estimating basic product demand. For a potential site this means assessing the availability of resources required. 1. Determining Basic Demand Must explore the suitability of a nation’s physical and cultural environment and whether certain products are banned. 2. Determining Availability of Resources a. Raw materials for manufacturing must be local or imports. Imports may face tariffs, quotas, or other barriers. b. Companies making labor-intensive products often relocate to lower-wage countries. c. Companies may go abroad for financing if not available at home or when interest rates are high at home. 13.1.2 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. Companies sometimes locate production in the local market when modifications must be made to a product’s physical features for cultural reasons. c. Local work ethic, education, and level of managerial skills affect siteselection decisions. 2. Political and Legal Forces

Regulations and Bureaucracy i. Attitudes toward trade and investment are reflected in the quantity and types of restrictions a government places on imports, exports, and investment in its country. ii. Governments can create investment barriers to ensure domestic control of a company or industry (e.g., imposing rules on domestic ownership or restricting companies from removing profits). iii. Lean and smoothly operating bureaucracy can encourage investment whereas an inefficient, cumbersome, or corrupt one can discourage it. iv. Companies will endure an inefficient bureaucracy if the benefits outweigh the cost of inefficiencies. b. Political Stability i. Companies must monitor political events and political risk that threaten operations and earnings. ii. Political risk increases if a company cannot estimate the future political environment accurately. iii. Companies can obtain political risk information from political risk agencies, international relations scholars, political and union leaders, bankers, etc. 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 can 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.

13.2 MEASURE AND SELECT THE MARKET OR SITE 13.2.1 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 products sold, how they are sold, and their features. Different levels of economic development can require different approaches to researching market potential. a. Information for estimating market potential in industrialized nations may be more readily available than for emerging markets. b. Industry reports can be used to approximately estimate market demand. These often include  Market shares of largest competitors  Volume of exports and imports  Structure of wholesale and retail networks  Population, social trends, and marketing methods  Total expenditure on product and substitutes  Retail sales volume and prices  Future market outlook and potential opportunities c. Income Elasticity 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 (percent change in quantity demanded divided by percent change in income). i. Income-elastic products—demand increases more relative to an increase in income. Tend to be discretionary purchases such as jewelry or expensive furniture. ii. Income-inelastic—demand increases less relative to increase in income. Tend to be essential including food, beverages, utilities, and toiletries. d. National Data In some markets companies can face a

lack of data to estimate market potential. They can calculate a marketpotential index using country data and then rank locations according to their appeal:  Market size: Snapshot of market size  Market intensity: Estimate wealth or buying power  Market growth rate: See if market is expanding or not  Market consumption capacity: Spending capacity  Commercial infrastructure: Distribution channels and communication assessment.  Market receptivity: Market ―openness‖ assessment  Economic freedom: Extent of freemarket principles  Country risk: Political, economic, social, financial risk 4. Measuring Site Potential a. Companies must assess the quality of resources they will employ locally. Most important resource is often labor and management. b. Wages are lower if labor is abundant, relatively less skilled (though perhaps well-educated), or both. Training can require a substantial investment of time and money. c. Companies must assess the productivity of local labor and managers. d. Company should examine local infrastructure, including roads, bridges, airports, seaports, and telecommunications systems, for the impact on efficiency. 13.2.2 Select the Market or Site This involves intensive efforts to assess the 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 (See Chapter 12)

Intensely competitive markets put downward pressure on prices firms can charge customers. Appealing sites for production and R&D increase the costs of doing business. Competitor analysis should address the following:  Number of competitors (domestic and international)  Market share of each competitor  Competitors appeal to market segments or mass market  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  Competitor control of production inputs (labor, capital, materials, etc.) 13.3 SECONDARY MARKET RESEARCH Secondary market research is obtaining information that already exists within the company or that can be obtained from outside sources. It can help estimate demand for a product or research a business environment relatively inexpensively. 13.3.1 Public Information Sources 1. Global institutions designed to promote free trade collect and disseminate a wide range of national economic data. 2. These include the World Trade Organization, United Nations, International Trade Center, World Bank, International Monetary Fund, and the Asian Development Bank. 3. Commerce departments and international trade agencies of most countries also supply import and export regulations, quality standards, and sizes of various markets. 4. The Central Intelligence Agency’s World Factbook is useful throughout the market- or site-screening process because of its facts on each nation’s business environment. 5. The International Trade Administration (ITA), operated by the Department of Commerce details product standards in other countries. It also offers advice on

opportunities for US companies in individual markets and offers information on federal export-assistance programs. 13.3.2 Private Information Sources 1. Associations of firms within an industry or trade often publish information to keep members abreast of market happenings and opportunities in their particular industry. 2. They sometimes commission specialized studies of their industries and offer them to members at subsidized prices. 13.3.3. Issues with Secondary Research Unique circumstances present difficulties that force adjustments in conducting market research in different nations. 1. Availability of Data a. Whereas industrialized markets have secondary data on product markets, emerging and developing countries have less. And when available, it may not be reliable. b. International research agencies are entering these markets and increasing the availability of information. 2. Reliability of Data a. Tainted information can result from improper local collection methods and analysis techniques. b. International research agencies are employing advanced techniques to collect and analyze emerging and developing markets and supplying more reliable information. 3. Comparability of Data a. Data obtained from other countries must be interpreted with caution. Terms such as poverty, consumption, and literacy can differ greatly from one country to another. b. Governments can measure data differently and affect its comparability among nations. Care must be taken to not misinterpret data. 13.4 PRIMARY MARKET RESEARCH Primary market research is the process of collecting and analyzing original data and applying results to current research needs. Primary research helps complete the broad picture supplied by secondary data. 13.4.1 Trade Shows and Trade Missions 1. Trade show is an exhibition at which members

2. 3.

13.4.2 1.

13.4.3 1.

3. 13.4.4

of an industry or group of industries showcase their latest products, study activities of rivals, and examine recent trends and opportunities. Trade mission is a government-sponsored international trip designed to explore international business opportunities. Trade missions are appealing for small- and medium-size firms because (1) it offers added clout as they are seen with homecountry government officials, and (2) it is a cost-effective way to visit several national markets in one trip. Interviews and Focus Groups These techniques can uncover potential or current buyers’ emotions, attitudes, and general impressions of a company or its product. Interviews must be conducted carefully in other countries if they are to yield unbiased and reliable information. A focus group is an unstructured but indepth interview of a small group of individuals (8 to 12 people) by a moderator. It is helpful in learning attitudes about a company or its product. Moderators should be natives of the countries in order to detect subtle differences in verbal and body language. A consumer panel is research in which people record in personal diaries information on their attitudes, behaviors, or purchasing habits. This can be useful if people might tend to agree with others in a group setting—as in group-oriented cultures. Surveys and Environmental Scanning A survey is research in which current or potential buyers answer a series of written or verbal questions. They are helpful in obtaining facts, opinions, and attitudes and are capable of gathering a vast amount of data in a single sweep. Environmental scanning is an ongoing process of gathering, analyzing, and dispensing information. This entails obtaining factual and subjective information on business environments. Contributes to well-informed decisions and effective strategies by helping develop contingency plans in a volatile environment. Issues with Primary Research

3. 4. 5.

Unique conditions and circumstances in other countries can present difficulties that force adjustments in the way research is performed. Marketers in unfamiliar markets must pay attention to how cultural variables can potentially pose issues while collecting primary data. Translations of questions to be asked of individuals must be done carefully so the intended meaning is not altered. Written surveys are impractical in countries with low literacy rates although verbal responses can be obtained. Companies with little experience in a market can hire local agencies to assist in the research process.

Quick Study Questions Quick Study 1 1.

Q: What is involved in conducting the first step of the screening process for markets and sites? A: The first step in identifying potential markets is to assess the basic demand for a product. Similarly, the first step in selecting a site for a facility to undertake production, R&D, or some other activity is to explore the availability of the required resources.

Q: What are some cultural forces that a company should research 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.

Q: What are the political and legal forces for a company to research when assessing a nation’s business environment? A: Nations differ in their attitudes toward trade and investment from other countries. Governments can create barriers to investment, for example, by placing

restrictions on ownership or by forcing joint ventures with local firms. They can bar foreign companies from competing in certain sectors of the economy. They can restrict companies from freely removing capital from the host nation. Governments can impose regulations that can significantly increase production costs and require companies to divulge proprietary information. A clean and smoothly operating bureaucracy can encourage investment whereas an inefficient, cumbersome, or corrupt one can discourage it. Political risk can threaten the market of an exporter, the production facilities of a manufacturer, or the ability of a company to remove profits from the country in which they were earned. The biggest risk for an international company is unforeseen political changes. Political uncertainty and risk rise if a company cannot anticipate future political change. 4.

Q: What are the economic and financial forces to consider when assessing a nation’s business environment? A: 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 exchange rates can make it difficult to predict future earnings and calculate the funds needed for a planned investment.

Quick Study 2 1.

Q: What term describes the sensitivity of demand for a product relative to changes in income? 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 incomeelastic 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 forecasts of

potential demand for their products. 2.

Q: Which factors are commonly included in a marketpotential index? A: The main variables commonly included are: market size, market intensity, market growth rate, market consumption capacity, commercial infrastructure, market receptivity, economic freedom, 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.

Q: How important is it for top managers to pay a visit to a market or site before making a final decision? 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 and increase the cost of doing business.

Quick Study 3 1.

Q: What do we call the process of obtaining information that already exists within a company or can be obtained from outside sources? A: The process of obtaining information that already exists within the company or that can be obtained from outside sources is called secondary market research.

Q: What are several public sources of existing market information for companies? A: The main public sources of secondary research data are many. Global institutions designed to promote free trade collect and disseminate a wide range of national economic data. These include the World Trade Organization, United Nations, International Trade Center, World Bank, International Monetary Fund, and the Asian Development Bank. Commerce departments and international trade agencies of most countries also supply import and export regulations, quality standards, and sizes of various markets. The Central Intelligence Agency’s World Factbook provides facts on each nation’s business environment. The International Trade Administration operated by the Department of Commerce details product standards in other countries. It also offers advice on opportunities for US companies in individual markets and offers information on federal export-assistance programs.

Q: From what private sources might companies obtain existing market information? A: Associations of firms within an industry or trade often publish information to keep members abreast of market happenings and opportunities in their particular industry. They sometimes commission specialized studies of their industries and offer them to members at subsidized prices.

Q: What are three potential issues that can arise with the use of secondary research data? A: (1) Availability of Data: Whereas industrialized markets have secondary data on product markets, emerging and developing countries have less. And when available, it may not be reliable. International research agencies are entering these markets and increasing the availability of information. (2) Reliability of Data: Tainted information can result from improper local collection methods and analysis techniques. International research agencies are employing advanced techniques to collect and analyze emerging and developing markets and supplying more reliable information. (3) Comparability of Data: Data obtained from other countries must be interpreted with caution. Terms such as poverty, consumption, and literacy can differ greatly from one country to another. Governments can measure data differently and affect its comparability among nations. Care must be taken to not misinterpret data.

Quick Study 4 1.

Q: What is the term for the act of collecting and analyzing original data and applying results to current research needs? 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: What is the appeal of trade shows and trade missions for small and medium-sized companies? A: A trade show is an exhibition at which members of an industry or group of industries showcase their latest products, study activities of rivals, and examine recent trends and opportunities. They are

appealing to small- and medium-size companies because they assemble a large number of potential suppliers and buyers in one location, which reduces travel expenses. A trade mission takes government officials and businesspeople on international trips to explore business opportunities. Trade missions are appealing for small- and medium-size firms because it offers added clout as they are seen with home-country government officials, and is a cost-effective way to visit several national markets in one trip. 3.

Q: What type of information are interviews, focus groups, and surveys good at providing? A: Interviews, focus groups, and surveys are good at providing information as to how individuals feel about a company or its product. These techniques can uncover potential or current buyers’ emotions, attitudes, and general impressions. This type of buyer information is needed when deciding whether to enter a market and when developing an effective marketing plan. Interviews must be conducted carefully in other countries if they are to yield unbiased and reliable information.

4. Q: What potential issues can arise when collecting and analyzing original data? A: There are several issues that can arise with primary research. Unique conditions and circumstances in other countries can present difficulties that force adjustments in the way research is performed. Marketers in unfamiliar markets must pay attention to how cultural variables can potentially pose issues while collecting primary data. Translations of questions to be asked of individuals must be done carefully so the intended meaning is not altered. Written surveys are impractical in countries with low literacy rates although verbal responses can be obtained. Companies with little experience in a market can hire local agencies to assist in the research process. Teaming Up As a team, select an emerging market that interests you. Compile some fundamental country data and then do additional research following the steps in this chapter. Flesh out the nature of the market opportunity offered by this country or its suitability as a manufacturing site. Next, select a company that is pursuing opportunities in

the country. Determine whether the company’s activities are consistent with the market or site potential as your team researched it. A: This is a chance to get students working on the Market Entry Strategy Project that accompanies this text if it was assigned. 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. Ethical Challenge You are the executive director of Qualitative Research Consultants Association (QRCA), an organization designed to assist market research practitioners. Every QRCA member must agree to abide by a ten-point code of ethics that forbids certain practices, including 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. 13-3.

Q: Why do you think the QRCA and other market research organizations create such codes? A: Qualitative research can be extremely helpful in helping a business to identify customer needs, clarify marketing messages, generate ideas for improvements in a product, extend a line or brand, and/or gain perspective on how a product fits into a customer’s lifestyle. It can also help entrepreneurs understand their customers’ or clients’ feelings, values, and perceptions of a particular product or service. The codes were created by the QRCA to ensure that its members uphold the highest standards of ethical and professional behavior, not only in their work, but in their relationships with clients, field suppliers, colleagues and respondents.

13-4.

Q: Do you believe they are helpful in reducing unethical research practices? A: Such codes are designed to provide researchers with ethical guidelines of conduct. Whether or not 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, if they choose, researchers can recall the code, simply

disregard behavior.

it,

and

ahead

with

the

opportunistic

13-5.

Q: As QRCA executive director, what other areas of marketing research do you believe should be covered by ethical codes of conduct? A: 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 information, have been brought before various government bodies worldwide and different laws passed.

Practicing Management Case

International

Vietnam’s Robusta Economic Growth 13-8. Q: Do you think Starbucks overlooked anything when it entered Vietnam that might explain its slow expansion there? A: At least two key issues arise when Vietnamese customers are asked about their Starbucks experience. First, Starbucks is more expensive than traditional coffee shops in Vietnam and a pricier option than its main competitor, Highlands Coffee. Second, although robusta coffee is one of the more bitter coffees, it is the traditional taste experience in Vietnam that people there tend to prefer. One’s preferred taste in food and beverages is one of the most ingrained cultural traits and can be extremely difficult for a person to change. Whether Starbucks overlooked the issue or whether it knew and thought it could overcome it is unknown. These are two key factors holding back Starbuck’s expansion in Vietnam. 13-9. Q: What methods of research would you use to learn how consumers in Vietnam view Starbucks’ coffee and store atmosphere? A: Several primary market research tools can be used to gain a complete picture of Vietnamese consumers’ views of the Starbucks experience and its coffee. Initially, Starbucks could conduct a survey to uncover a great number of individuals’ opinions and attitudes relatively quickly. It could then conduct in-depth interviews one-on-one with people who have visited Starbucks or who would take a taste test to add depth to the survey findings. It could also hold focus groups (by hiring Vietnamese researchers) to gather additional information. All of these techniques help to uncover consumers’ emotions, attitudes, and general impressions of Starbucks and its coffee. 13-10. Q: Based on the data provided in the case, would you rate Vietnam highly or poorly on a market-potential index? Explain. A: Vietnam’s government, although run by the communist party, seems to be doing many of the right things. It is shifting the economy away from an export-dependent model to one characterized by services and growing domestic demand as consumers tend to grow wealthier. The economy is also

growing strongly. Its GDP per capita at purchasing power parity is very good for an emerging market and the country ranks ―high‖ on the human development index. With a population of nearly 100 million, it is a significant country and its people are highly entrepreneurial. The country is investing in modernizing its physical and technological infrastructure and that should help propel future economic growth. Vietnam is also attracting foreign investment. Meanwhile, it appears that its country risk (political, economic, social, and financial) will remain relatively low. Altogether, Vietnam would rate quite highly on a market-potential index produced by most countries. 13-11. Q: How do you think the task of researching potential markets and sites in Vietnam will change if it succeeds in becoming a high-income nation relatively soon? Explain. A: Simply put, as the economy continues to grow and develop, more and more businesses will enter its domestic market to serve the needs of a growing middle class. As a result, market information will become more plentiful and the understanding of Vietnamese consumers will grow more refined. This is how the market research field has developed in many other formerly developing and emerging markets and is expected to be the way Vietnam will go as well.

CHAPTER 14 SELECTING AND MANAGING ENTRY MODES LEARNING OBJECTIVES: 14.1: Describe the nature of exporting and countertrade. 14.2: Explain the various methods of export/import financing. 14.3: Describe the different types of contractual entry modes. 14.4: Describe the various kinds of investment entry modes. CHAPTER OUTLINE: Exporting 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 Representative Distributor Indirect Exporting Agents Export Management Company Export Trading Company Freight Forwarder 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 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 Partner Selection 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 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. 14.1 EXPORTING AND COUNTERTRADE One of the most common methods of buying and selling goods internationally is exporting. 14.1.1 Why Companies Export 1. Expand total sales when the domestic market is saturated. 2. Diversify sales to level cash flows, making it easier to coordinate payments to creditors with receipts from customers. 3. 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. 14.1.2 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. Perform market research to learn if demand exists in a target market. b. Novice exporters should focus on one or a few markets that are culturally understood. c. A new exporter should seek advice on regulations, general exporting, and the target market. 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 should focus on building trust and cooperation. b. Later meetings can estimate success of cooperation. c. In the most advanced stage, negotiations take place and details of agreements are finalized. 4. Step 4: Commit Resources a. After agreement is reached 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 company activities expand, they discover the need for an export department or division. See Chapter 12 for organizational design issues to consider at this stage. 14.1.3 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 hire local representative or distributor. a. A sales representative represents its own company’s products, not those of other companies. It promotes products by attending trade fairs and making personal visits to local retailers and wholesalers. They 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 but also reduces its control. 2. Indirect Exporting Company sells to intermediaries who resell to buyers in a target market. The choice of intermediary depends on many factors, including the importance of exports in total sales, available resources, and the growth rate of the target market. a. Agents i. Individual or organization that represents one or more indirect exporters in a target market. Compensated with commissions on sales. ii. Can represent several indirect exporters. Might focus promotional efforts on products of the company paying the highest commission. b. Export Management Company i. EMC exports products on behalf of indirect exporters, operating

contractually, either as an agent or as a distributor. ii. Additional services on 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 in target market. Disadvantage: breadth and depth of an EMC’s service hinders exporter’s international skills development. iv. After the EMC contract expires, a company can go at it alone in exporting its products. c. Export Trading Company i. ETC provides services in addition to those directly related to indirect exporters’ activities: Export and countertrade services, develop distribution channels, provide storage, finance trade and investment, and even manufacture products. ii. Concept met limited success in the United States. iii. Governments, financial institutions, and companies have closer working relationships in Asia. The US regulatory environment is wary of such arrangements, and the lines between companies and industries are clearly drawn. d. Freight Forwarder i. Specialist in export related activities such as customs clearing, tariff schedules, shipping, and insurance fees. ii. Freight forwarders can pack shipments for export and take responsibility for getting a shipment from the port of export to the port of import. 14.1.4 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. 1. Types of Countertrade a. Barter: Exchange of goods or services directly for other goods or services without the use of money. b. Counterpurchase: Sale of goods or services to a country by a company that promises to make a future purchase of a specific product from that country. c. Offset: Agreement that a company will offset a hard-currency sale to a nation by making a future hard-currency purchase of an unspecified product from that nation. 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. 2. Countertrade can provide access to markets otherwise off-limits because of a lack of hard currency. Typically involves commodity and agricultural products. 3. 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. 14.2 EXPORT/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. There are several main export/import financing methods (Figure 14.2): 14.2.1 Advance Payment 1. 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. 2. Prior payment eliminates the risk of nonpayment but creates the complementary

14.2.2 1.

3. 4.

14.2.3 1. 2.

risk of non-shipment—importers might pay for goods but not receive them. Documentary Collection (see Figure 14.3) Bank acts as an intermediary without accepting financial risk. Used in ongoing business relationships between two parties. The documentary collection process can be broken into three main stages and nine smaller steps. 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. After receiving the appropriate documents from the exporter, the exporter’s bank sends the documents to the importer’s bank. Documentary collection reduces the risk of non-shipment 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. Letter of Credit (see Figure 14.4) Importer’s bank issues a letter pledging to pay the exporter when the exporter fulfills the terms listed in the letter. Used when parties are unfamiliar with each other, an importer’s credit rating is unknown or questionable, and when a market’s regulations require it. Banks issues the letter of credit after an importer has deposited a sum equal to the value of the imported merchandise. The exporter then delivers a documentary packet to its bank. The exporter’s bank delivers the letter of credit and documentary packet to the importer’s bank for review. When the importer’s bank is satisfied that the terms of the letter have been met, it sends payment to the exporter’s bank, which then credits the exporter’s account. The importer pays its bank (or makes provision for future payment) and, in return, receives the documentary packet that includes title to the merchandise.

14.2.4 1. 2. 3.

Several types of letters of credit: a. 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. b. A revocable letter of credit can be modified by the issuing bank without obtaining approval from either the exporter or the importer. c. 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. 6. Letter of credit also reduces the risk of nonshipment over advance payment. Risk of nonpayment is also increased over advance payment but is lower than the letter-ofcredit method because the importer’s bank accepts the risk of nonpayment. Open Account Exporter ships merchandise and later bills the importer. Used for sales between two subsidiaries within an international company and when the parties are familiar with each other. Reduces risk of non-shipment for importer but increases the risk of nonpayment for exporter.

14.3 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. 14.3.1 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 limited period of time. 2. Licensors typically receive royalty payments based on a percentage of licensee’s revenue generated by the property and may receive a one-time fee. 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 exchange intangible property with one another. 5. Advantages of Licensing a. Finance international expansion. b. Low risk method of international expansion. c. Lower likelihood of a product will be counterfeited. d. Licensees can upgrade existing production technologies. 6. Disadvantages of Licensing a. May restrict a licensor’s future activities. b. May reduce global consistency in quality and marketing. c. May lend strategically important property to competitor. 14.3.2 Franchising 1. Contractual entry mode in which one company (the franchiser) supplies another (the franchisee) with intangible property and assistance over an extended period. Franchisers typically receive compensation as flat fees, royalty payments, or both. 2. The brand name or trademark is normally the most important item desired by the franchisee (e.g., KFC, Starbucks). 3. Franchising differs from licensing in three ways: a. More control over a product’s sale in a target market. b. Licensing is fairly common in manufacturing industries and franchising is primarily used in the service sector. c. Licensing normally involves a one-time transfer of property and franchising requires franchiser’s ongoing assistance. 4. Advantages of Franchising 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. 5. Disadvantages of Franchising a. May be cumbersome to manage many franchisees across several nations. b. Franchisees can experience a loss of organizational flexibility in franchising agreements. 14.3.3 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 of general managers. 3. Advantages of Management Contracts a. Exploit an international opportunity yet 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 of Management Contracts a. Supplier’s personnel remain exposed to political or social turmoil in the nation. b. Supplier of expertise may nurture a formidable new competitor in the local market. 14.3.4. Turnkey (build-operate-transfer) Projects 1. Designing, constructing, and testing a production facility for a client. Often large-scale and involve government agencies. 2. Transfer special process technologies or production-facility designs to a client (e.g., power plants, telecommunications, petrochemical facilities). 3. Advantages of Turnkey Projects a. Firm specializes in its core competency. b. Government obtains infrastructure from the world’s leading companies. 4. Disadvantages of Turnkey Projects a. Company may be awarded a project for political reasons rather than for technological know-how. b. Can create future competitors. 14.4 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. 14.4.1 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: High-tech products may need new facilities because state-of-the-art operations are hard to locate. 3. Yet a ground-up subsidiary can take time to construct new facilities, hire and train employees, and launch production. 4. Advantages of a Wholly Owned Subsidiary a. Managers have complete control over daily operations in the target market and over the subsidiary’s technologies, processes, and other intangible properties. b. Firm can coordinate activities of all national subsidiaries. 5. Disadvantages of a Wholly Owned Subsidiary a. Can be too expensive for small- and medium-sized firms. b. Higher risk due to the substantial resources invested. 14.4.2 Joint Ventures Separate company created and jointly owned by two or more independent entities to achieve a common

business objective. 1. Joint Venture

Configurations

(see

Figure

14.5) a. Forward integration joint venture Parties invest together in activities later in value chain. b. Backward integration joint venture Parties invest together in activities earlier in value chain. c. Buyback joint venture Parties supply the venture’s inputs and absorb its output. d. Multistage joint venture One partner integrates backward and the other forward. 2. Advantages of Joint Ventures a. Can reduce risk as it exposes fewer of a partner’s assets to risk than would a wholly owned subsidiary—each partner risks only its contribution. b. Penetrate international markets otherwise off-limits. c. Access another company’s global distribution network. d. Defensive reason: Local government or government-controlled company as a partner gives authorities a direct stake in helping to ensure the venture’s success. 3. Disadvantages of Joint Ventures a. Co-ownership can result in conflict between partners and cause managerial paralysis. b. Yet a loss of control over operations can result when the local government is a partner in the joint venture. 14.4.3 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 partners will purchase shares in each other’s company. 4. Advantages of Strategic Alliances a. Share the cost of an international investment project. b. Tap into competitors’ specific strengths (e.g., channels of

distribution). 5. Disadvantages of Strategic Alliances a. Can create a future competitor. b. Conflict can arise and eventually undermine cooperation. 14.4.4 1.

Partner Selection Suitable partners must offer something valuable. Managers must evaluate the benefits of a potential international cooperative arrangement as they would any other investment opportunity. Although the importance of locating a trustworthy partner seems obvious, cooperation should be approached with caution. Each party’s managers must be comfortable working with people of other cultures and, perhaps, living abroad. Managers also must be comfortable working with and within one another’s corporate culture. Each partner must be firmly committed to the stated goals of the arrangement. Detailing duties and contributions of each party through prior negotiations helps ensure continued cooperation.

Quick Study Questions Quick Study 1 1. Q: What are the four steps, in order, involved in creating an export strategy? A: Companies should not simply respond to international requests for their products but develop a 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 them. Third, they should initiate meetings. Meetings early in the process 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 gauge the potential success of any agreement if both sides are interested. Fourth, they must commit resources to get the job done. After the meetings, negotiations, and contract signings, it is time to put the company’s human, financial, and physical resources to work. 2.

Q: What is the main indirect exporting?

difference

between

direct

and

A: With direct exporting, a company sells its products directly to buyers in a target market. Indirect exporting occurs when a company sells its products to intermediaries who then resell to buyers in a target market. 3.

Q: What are the names of each type of countertrade and how is each one defined? 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.  Barter is the exchange of goods or services directly for other goods or services without the use of money.  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.  Offset is an agreement that a company will offset a hard-currency sale to a nation by making a hardcurrency purchase of an unspecified product from that nation in the future.  Switch trading is countertrade whereby one company sells to another its obligation to make a countertrade purchase in a country.  Buyback is the export of industrial equipment in return for products produced by that equipment.

Quick Study 2 1.

Q: What is the name for export/import financing that presents the greatest risk for exporters? A: Open account poses the greatest risk for exporters because they ship merchandise and later bill importers for the value. It is the most favorable method for importers because they do not pay for merchandise until it is received.

Q: What do we call export/import financing in which a bank acts as an intermediary without accepting financial risk? A: Documentary collection is when a bank acts as an intermediary without accepting financial risk. Documentary collection is detailed in Figure 14.3.

Q: What is the name for export/import financing in which the importer’s bank issues a letter pledging to

pay the exporter when the exporter fulfills the terms listed in the letter? A: A letter of credit is export/import financing in which the importer’s bank issues a letter pledging to pay the exporter when the exporter fulfills the terms listed in the letter. The letter-of-credit process is detailed in Figure 14.4. 4.

Q: Which export/import financing approach presents the greatest risk for importers? A: Advance payment poses the greatest risk for importers because they for merchandise before it is shipped. It is the most favorable method for exporters because they receive payment for merchandise before it is shipped.

Quick Study 3 1.

Q: What is it called when a company grants another the right to use intangible property for a limited period of time? A: Licensing is a contractual arrangement whereby one company owning intangible property (the licensor) grants another business (the licensee) the right to use that property for a limited period of time.

Q: What is it called when a company supplies intangible property and other assistance over an extended period of time? A: Franchising is a contractual arrangement whereby one company (the franchiser) supplies another (the franchisee) with intangible property and other assistance over an extended period.

Q: What do we call the practice in which one company supplies another with managerial expertise over a specific period of time? A: A management contract is a contractual arrangement whereby a company supplies another with managerial expertise for a specific period of time.

Q: What is the name of the practice in which a company designs, constructs, and tests a production facility for a client and then transfers its ownership to the client? A: A turnkey (build-operate-transfer) project is a contractual arrangement whereby a company designs, constructs, and tests a production facility for a client.

Quick Study 4 1.

Q: What is the name for a facility that is entirely owned and controlled by a single parent company? A: A wholly owned subsidiary is an investment entry mode whereby a facility is entirely owned and controlled by a single parent company.

Q: What do we call a company that is created and jointly owned by two or more independent entities to achieve a common business objective? A: A joint venture is an investment entry mode whereby two or more independent entities create and jointly own a separate company to achieve a common business objective.

Q: What is the name for a relationship between two or more entities to cooperate to achieve the strategic goals of each but not form a separate entity? A: A strategic alliance is an investment entry mode whereby two or more entities cooperate (but do not form a separate company) to achieve the strategic goals of each.

Q: Why should companies choose partners carefully when joining forces in global markets? A: 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. Although the importance of locating a trustworthy partner seems obvious, cooperation should be approached with caution. Each party’s managers must be comfortable working with people of other cultures and, perhaps, living abroad. Managers also must be comfortable working with and within one another’s corporate culture. And 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.

Teaming Up This project is designed to introduce you to the complexity of negotiations and to help develop your negotiating skills. Background: An automobile manufacturer from Western Europe

and one from the United States are considering joining forces and entering Southeast Asia. The companies want to create a subsidiary that will assemble a new, affordable electric vehicle model near Bangkok, Thailand. Major components would come from suppliers in China, India, and Poland. The vehicles would be sold in emerging markets throughout Southeast Asia and the Indian subcontinent. The companies are hoping to strike a $500 million joint venture deal with Thailand’s government. The companies would supply all technology and management, and the government would contribute a minority share of financing to the venture. The government’s main contribution is seen as providing local tax breaks (and other financial incentives) and a stable business environment. Financial capital is flowing into Thailand at a fair pace. The currency is strong, and inflation remains low. The new assembly plant would boost the local economy, reduce unemployment, and increase wages. But some local politicians fear the companies might be interested only in exploiting Thailand’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 companies 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. Students may also be able to judge their own abilities and skills as international negotiators. Ethical Challenge You are chief operating officer of a US-based telecommunications firm considering a joint venture inside Kenya with a local firm. The consultant you hired to help you through the negotiations 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 in any market. This is especially true when each partner contributes personnel to the venture because cultural perspectives cause people to see ethical dilemmas differently. This concerns you because you planned to staff the venture with people from both Kenya and the United States. In light of this recent information, you are

reassessing your entry mode options. 14-3.

Do you think your two companies can establish a set of ethical principles before commencing operations that will guide a potential joint venture? A: Many companies are confronted with a dilemma similar to this one when they sign joint venture agreements with firms from developing countries that have cultures with a different set of ethical standards. A firm could suggest a policy of rewards, such as profit sharing, and punishments, such as fines, be implemented to encourage more openness and honesty in the process. Further, up-front and frank discussions of potentially damaging ethical issues can help avoid potentially disastrous results rooted in ethical differences.

14-4.

What ethical issues might arise in conjunction with other entry modes discussed in this chapter? A: There are many differences between the US and Kenyan cultures that can add to the complexity of a joint venture agreement. 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.

14-5.

Is there a company that succeeded under circumstances that are similar to those that your firm faces? A: There are many differences between the US 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 US and Kenyan 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 Management Case

International

Marvel’s Cinematic Universe 14-8.

Q: Why do you think some of the best-known characters in the world of comics created decades ago still have strong appeal today? A: The characters created years ago appeal to our sense of adventure and those ideas of justice that span cultures. The age-old conflict between good versus evil has universal appeal. The superhero who captures the villains of society and helps to deliver

justice is something people worldwide can relate to, especially fans of comics. Also, people can relate to the regular individuals who attain Superhuman capabilities one way or another. Marvel’s characters, and those of other comic publishers, have the same worries and fears of regular folks when they are not in Superhero form. Although children and adolescents were the primary target for comics, young adults and even adults found the characters and their stories highly relatable. 14-9.

Q: What do you think was the main reason Marvel initially sold the Spider-Man movie rights to Sony in 1999? Do you think it regrets the sale? A: Marvel had a poor record in bringing its characters to the big screen at the time it sold its Spider-Man movie rights to Sony. Marvel’s lack of success with its Spider-Man and Captain America TV programs and its failed film called Howard the Duck was still fresh on everyone’s minds. This likely lead it to a strategy of licensing or selling movie rights to others who could do it more successfully. Marvel was also working to build up cash as it emerged from bankruptcy and the sale provided cash flow. Finally, the future of comics, in general, appeared so poor at the time that it could have been a strategy to squeeze as much cash out of the business as possible before the industry imploded.

14-10. Q: Do you think Disney’s 2021 agreement with Sony is favorable for Disney despite it needing to wait a long time before being able to show Spider-Man movies? A: The deal gives Disney the rights to show Spider-Man films long term. It need only wait until it is shown in theatres, sold and rented, and then shown for a time on Netflix. After that, Disney can include Spider-Man films in its Disney+ and Hulu streaming libraries. This can help drive subscriptions to these high-margin services. And Marvel movies continue to have characters appearing in many films throughout the Marvel Cinematic Universe. This will drive fans of certain characters to view movies they might not otherwise watch. The deal does not give Disney control of other assets, such as the 2008 The Incredible Hulk movie because Universal controls movie rights to that film. However, one should not rule out that cash-rich Disney might strike a deal for that film too. 14-11. Q: Will non-fungible tokens (NFTs) become more important or less important method for companies to

pursue international markets in the future? Explain. A: Growth of the metaverse and virtual reality technologies makes it hard to bet against the future popularity of NFTs. Whether or not it is a wise ―investment‖ for companies involve themselves in building the metaverse infrastructure, it seems that fans are completely embracing the collection and trading of NFTs.

CHAPTER 15 DEVELOPING AND MARKETING PRODUCTS LEARNING OBJECTIVES: 15.1 Describe the factors to consider in developing international product strategies. 15.2 Outline the international promotional strategies and methods available to firms. 15.3 Explain the factors to consider when designing international distribution strategies. 15.4: Describe the two main international pricing strategies and factors to consider. CHAPTER OUTLINE: Developing Product Strategies Laws and Culture Brand and Product Names Selecting International Brand and Product Names Other Product Issues Counterfeit Goods Shortened Product Life Cycles Creating Promotional Strategies Push and Pull Strategies International Advertising Standardizing or Adapting Advertisements Communicating Promotional Messages Blending Product and Promotional Strategies 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 Market Exposure Cost and Channel Length Special Distribution Issues Developing Pricing Strategies Worldwide Pricing Dual Pricing Factors That Affect Pricing Decisions Transfer Price Arm’s Length Pricing Price Controls Dumping 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 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. Companies that cannot sell the same product abroad as at home must create new products, modify promotional campaigns, or adjust their marketing strategies in some other way. Yet how do managers decide when their marketing strategies can remain the same or if they need modification? This dilemma is referred to as the standardization-versus-adaptation decision. 15.1 DEVELOPING PRODUCT STRATEGIES 15.1.1 Laws and Culture 1. Companies must adapt their products to satisfy laws and regulations in a target market. 2. Companies sometimes must adapt their products to suit local buyers’ preferences rooted in culture. 3. Not all companies modify products but find a different cultural need that it satisfies. 4. The fact that many developing countries have looser consumer-protection laws can create an ethical issue if exploited. 15.1.2 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

3. 4. 5.

products a certain value based on experiences with a brand. Brand names help consumers select, recommend, or reject products. They also function as legal property that owners can protect from competitors. A consistent worldwide brand image is important as more consumers and businesspeople travel internationally. Companies must review its brand image and update it if needed. 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 can. 15.1.3 Other Product Issues 1. Counterfeit goods are imitation products passed off as legitimate trademarks, patents, or copyrighted works. Chapter 4 presents how companies protect intellectual property from counterfeiting. 2. Counterfeits can damage buyers’ images of a brand when they are of inferior quality to the original. Buyers who purchase a brand expect a level of craftsmanship and satisfaction, and if it fails to deliver on expectations, the brand image is tarnished. 3. Companies traditionally extended a product’s life by introducing it into different markets consecutively; first in industrialized nations and later in developing markets. 4. Waterfall Strategy is the sequential introduction of a product into new markets abroad one at a time. 5. Advanced telecommunications alert consumers around the world to the latest product introductions; consumers in developing and emerging markets also desire the latest products. 6. Companies now undertake new product development at a rapid pace, which shortens product life cycles.

15.2 CREATING PROMOTIONAL STRATEGIES Promotion mix includes activities designed to reach distribution channels and target customers through communications such as personal selling, advertising, public relations, and direct marketing. 15.2.1 Push and Pull Strategies 1. Pull strategy: Promotional strategy to create buyer demand that will encourage distribution 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: Promotional strategy to pressure distribution channel members to carry a product and to promote it to final users. Used by producers of goods that are sold to retail outlets. 3. The strategy to use depends on several factors. 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. b. Access to mass media: If developing and emerging markets have fewer forms of mass media, it can be more difficult to increase consumer awareness and generate product demand. Advertisers may prefer billboards and radio if consumers cannot afford cable or satellite TV. 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 among buyers who are not brand loyal; buyers will the brand carried by the seller. A push strategy is also suited for industrial products because potential buyers usually need to be informed about a product’s special features and benefits. 15.2.2 International Advertising International advertising differs from domestic advertising. Cultural similarities mean 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 must determine which aspects of the advertising campaign to standardize. b. Companies can reach a global audience by sponsoring global sporting events, such as the Olympics and World Cup Soccer. c. Marketers tried to standardize advertising across Europe to appeal to a so-called Euro-consumer. Many attempts failed for language and cultural reasons. Successful panEuropean ads are highly visual, contain few words, and focus on the product and consumer. 15.2.3 Communicating Promotional Messages 1. Marketing communication is the process of sending promotional messages about products to target markets. 2. 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. 3. Laws that govern promotion in another country also can force changes in marketing communication. 4. Marketing communication is typically considered a circular process (see Figure 15.1): 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. 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. 15.2.4 Blending Product and Promotional Policies Companies extending marketing to international markets develop communication strategies that blend product and promotional strategies. The right communication strategy considers the nature of the product and the promotion mix. There are five product/promotional methods. 1. Product/communication 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 technology ties the world together. Best suited for companies selling upscale, brandname personal items using a global strategy. c. Useful to low-cost leaders in their industries; one product and one promotional message keep costs down. 2. Product extension/communication adaptation a. Extends the same product into new target markets but alters its promotion. Requires communications adaptation because the product satisfies a different need, serves a different function, or appeals to a different type of buyer. b. The product is not altered so it contains costs; developing new promotional campaigns is expensive. c. Communications may need to be adapted in developing markets because media coverage can be limited. Marketers can instead use door-to-door personal

selling and regional product shows or fairs. 3. Product adaptation/communication 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 buyer preferences. It can be successful if a firm sells a differentiated product and charges a higher price to offset production costs. 4. Product/communication 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. 5. 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 poor infrastructure. 15.3 DESIGNING DISTRIBUTION STRATEGIES Distribution is planning, implementing, and controlling the physical flow of a product from its point of origin to its point of consumption. The

physical path that a product follows on its way to customers is called a distribution channel. 1. Service providers such as consulting companies, health-care organizations, and news services need distribution channels as well as goods manufacturers. 2. Companies develop their international distribution strategies based on two related decisions: (1) how to get the goods into a country (Chapter 14) and (2) how to distribute goods within a country (this chapter). 15.3.1 Designing Distribution Channels When managers establish distribution policies, they consider the market exposure needed and the cost of distribution. 1. Market Exposure a. Exclusive channel: Manufacturer grants the right to sell its product to only one or a limited number of resellers. Producers have significant control over sales to wholesalers and retailers. b. Exclusive channels create barriers for outsiders to penetrate the channel and helps constrain distributors from selling competing brands. 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 brands. 2. Cost and Channel Length a. Channel length refers to the number of intermediaries between the producer and the buyer. b. In a zero-level channel (called direct marketing) producers sell directly to final buyers. In a one-level channel there is one intermediary between producer and buyer, and so on. c. Cost goes up as the number of intermediaries rises because each one adds a fee for services.

15.3.2 1.

15.4

Special Distribution Issues Value density: Value of a product relative to its weight and volume; an important variable in formulating distribution policies. As a rule, the lower a product’s value density, the more localized the distribution system. Commodities, including cement, iron ore, and crude oil, have low value density ratios. This means that the cost to transport these goods is high relative to their values. Products with high value-density ratios include monitors, semiconductors, and premium perfumes. Because the cost of transporting these products is small relative to their values, they can be processed or manufactured in optimal locations, then shipped to markets worldwide. Some companies’ products are substantially similar worldwide yet require small manufacturing adjustments in the final production stage. When products need to be modified for local markets, companies can design their distribution system accordingly. Each nation’s distribution system develops over time and has some unique characteristics. A good understanding of the distribution system can reduce uncertainty and risk.

DEVELOPING PRICING STRATEGIES The pricing policy must match a company’s overall international strategy. 15.4.1 Worldwide Pricing Pricing strategy in which a product has the same price in all international markets. It can be difficult to achieve for four reasons. 1. Production costs differ from one nation to another. 2. Producing in just one location cannot guarantee the same selling price in international markets because of the different cost of reaching different markets. 3. Purchasing power of local buyers must be considered. 4. Fluctuating currency values can affect a

product’s price abroad. 15.4.2 Dual Pricing Pricing strategy in which a product has a different price (typically higher) in export markets than it has in the home market. 1. Price escalation is the name for when a product has a higher selling price in the target market than it does in the home market. This typically results from exporting costs and currency fluctuations. 2. But a product’s export price can be lower than that in the home market. This can occur when a company wants exports to cover only additional costs associated with exporting (e.g., tariffs). 3. To apply dual pricing in international markets domestic and international buyers must be kept separate. If not, buyers could undermine the policy through arbitrage— buying products at lower prices in one market and reselling them at higher prices in others. 15.4.3 Factors That Affect Pricing Decisions 1. Transfer Price Price charged for a good or service transferred among a company’s headquarters and its subsidiaries. a. Companies enjoy great freedom in setting transfer prices; subsidiaries in countries with high taxes charged other subsidiaries low prices. This lowers the parent company’s overall taxes by lowering profits in the hightax country. b. The ability to manipulate earnings using transfer prices may change with the signing of a global tax treaty among more than 130 nations in 2021. The extent to which the practice is reduced depends on how many nations follow through on ratifying the treaty and if it can be enforced. 2. Arm’s Length Pricing Free-market price that unrelated parties charge one another for a specific product. a. Many governments now assign arm’s length prices to clamp down on tax avoidance. There is also pressure on companies to be good corporate citizens in target markets.

Developing and emerging markets suffer from lost revenue when international companies manipulate prices to reduce tariffs and taxes. These nations need revenue to build schools, hospitals, and infrastructure, which in turn, benefit companies by improving local productivity and efficiency. Price Controls Upper or lower limits placed on the prices of products sold within a country. a. Upper-limit price controls provide price stability when prices are rising. Companies that want to raise prices must apply to government authorities. b. Lower-limit price controls can be imposed to help local companies compete against lower-priced imports or done to ward off price wars. Dumping Price of a good is lower in export markets than in a company’s domestic market (see Chapter 7). a. Accusations of dumping are often made against foreign competitors when inexpensive imports flood a domestic market. b. 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. c. Antidumping tariffs punish producers in the offending nation by increasing the price of their products.

Quick Study Questions Quick Study 1 1.

Q: What issues pertaining to law and culture may affect international product strategy? 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. Not all companies modify products

but find a different cultural need that it satisfies. The fact that many developing countries have looser consumer-protection laws can create an ethical issue if exploited. 2.

Q: What factors related to brand and product names might influence a company’s international product strategy? A: When consumers see a product labeled with a particular brand name, they assign to that product a certain value based on past experiences with that brand. Brand names help consumers select, recommend, or reject products. They also function as legal property that owners can protect from competitors. A consistent worldwide brand image is important as more consumers and businesspeople travel internationally. Products in international markets need carefully selected names whether standardized or localized. Company and product names are made up of morphemes— semantic elements, or language building blocks. Product names may offend people in international markets if not carefully researched.

Q: What other product issues can influence a company’s product or brand reputation in a market abroad? A: Counterfeit goods can damage buyers’ images of a brand when they are of inferior quality to the original. Buyers who purchase a brand expect a level of craftsmanship and satisfaction, and if it fails to deliver on expectations, the brand image is tarnished. Companies traditionally extended a product’s life by introducing it into different markets consecutively— first in industrialized nations and later in developing markets. But today, advanced telecommunications alert consumers around the world to the latest product introductions. Consumers in developing and emerging markets also desire the latest products. Finally, companies now undertake new product development at a rapid pace, which shortens product life cycles.

Quick Study 2 1.

Q: What are two general promotional strategies that a company can use in its marketing? A: A pull strategy is used to create buyer demand that will encourage distribution channel members to stock a company’s product. Buyer demand is generated in order to “pull” products through distribution channels to end-users. Alternatively, a push strategy is used to pressure distribution channel members

to carry a product and to promote it to final users. Manufacturers of products commonly sold to retail outlets often use a push strategy. 2.

Q: Why might a company standardize its international advertising efforts? A: Companies that do market their products across national boundaries try to contain costs by standardizing as many aspects of their campaigns as possible. But companies seldom standardize all aspects of their international promotions for a variety of reasons, including differences in culture and laws. A business that standardizes its advertising often controls campaigns from the home office. This policy helps it project a consistent brand image and promotional message across all markets. Companies can achieve consistency by standardizing their basic promotional message, creative concepts, graphics, and information content.

Q: What are the five ways that a company can blend its product and promotional strategies? A: The five ways a company can blend its product and promotional messages are: (1) Product Communication Extension (Dual Extension)– extends the same home-market product and marketing promotion into target markets. (2) Product Extension/Communication Adaptation– extends the same product into target markets but alters its promotion. (3) Product Adaptation/Communication Extension–adapts product to international markets but retains a its original marketing communication. (4) Product/Communication Adaptation (Dual Adaptation)–adapts both the product and its marketing communication to suit the target market. (5) Product Invention–requires that an entirely new product be developed for the target market.

Quick Study 3 1.

Q: What are the two general types of distribution channel that companies can choose from based on desired exposure? A: They can choose from either an exclusive or intensive channel. An exclusive channel is one in which a producer grants the right to sell its product to only one or a limited number of resellers. An intensive channel is one in which a producer grants the right to sell its product to many resellers.

2. Q: How does channel length factor into distribution channel design? A: Channel length refers to the number of intermediaries between the producer and the buyer. In a zero-level channel, which is also called direct marketing, producers sell directly to final buyers. A one-level channel places one intermediary between the producer and buyer. Two intermediaries make up a twolevel channel, and so forth. Cost goes up as the number of intermediaries rises because each one adds a fee for services. 3.

Q: How does a product’s value density influence the design of its distribution strategy? A: 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. Commodities are low value density. This means that the cost of transporting these goods is high relative to their values. Alternatively, the cost to transport high value density products will be small relative to their value. These products can be processed or manufactured in the optimal location and then shipped to market. A company selling a high value-density global product might be able to serve the world market from one location.

Quick Study 4 1.

Q: What are the two main types of pricing strategy that international businesses employ? 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: How do companies use transfer prices internationally and why might this practice decline in the future? A: Subsidiaries in countries with high corporate tax rates reduce their tax burdens by charging a low price for their output to other subsidiaries. In this way, the subsidiary helped lower the global tax burden of the parent company. Likewise, subsidiaries in

countries with low tax rates would charge relatively high prices for their output. The ability to manipulate earnings using transfer prices may change with the signing of a global tax treaty in 2021. The extent to which the practice is reduced will depend on how many nations ratify the treaty and how successful nations are at enforcing it. 3.

Q: What do we mean by the term arm’s length price and why is it significant? A: An arm’s length price is the free-market price that unrelated parties charge one another for a specific product. Countries are trying to better coordinate their efforts to clamp down on tax avoidance through transfer-price manipulation. Therefore, many governments now assign arm’s length prices for tax purposes. There is also pressure on companies to be good corporate citizens in target markets. Developing and emerging markets suffer from lost revenue when international companies manipulate prices to reduce tariffs and taxes. These nations need revenue to build schools, hospitals, and infrastructure, which in turn, benefit companies by improving local productivity and efficiency.

Teaming Up Products often serve different needs, appeal to different buyers, or are perceived differently in various markets. Consider a good or service that is sold in your country and another country that uses different marketing strategies in each. One of the countries must be the product’s home market. 15-3. Q: In the home market, was the product’s initial introduction a new innovation or an extension of an existing product? 15-4. Q: Which blended product/promotion method described in the text was used to launch the product from the home market into the other market? 15-5. Q: What factors likely explain why the company selected that particular method? A: Students might need to do some further research into the company’s business activities before answering these questions fully. This is an excellent exercise to assign one week ahead to give students time to gather with their teams and formulate ideas. The next week each team could present their answers to the class and make for an interesting discussion.

Ethical Challenge You are a lawyer working with the International Court of Justice in The Hague in the Netherlands. Your task is to review a decision by a US judge regarding extraterritoriality. The case: French survivors of the Holocaust sued a US website for selling Nazi memorabilia to French citizens online. Although this activity is illegal according to French law, it is allowed in the United States where it is protected by free speech laws. The French website of the company abided by French law and did not sell such memorabilia, so the US federal judge threw out the case. The judge ruled that French law does not have the right to dictate the behavior of US firms operating inside the United States. Today, the internet can make it difficult to determine where jurisdictions begin and end. 15-6.

Q: If you had been the US judge in this case, would you have ruled similarly? A: Extraterritoriality is the right or privilege of a state to exercise authority in certain circumstances beyond the limits of its territory. In other words, the laws of your country follow you when you do business in another country. As it was pointed out, French law does not have the right to dictate the behavior of US companies operating in the United States. Also, as the question points out, the French citizens are accessing the merchandise and purchasing from the company’s US website. French law would apply if the sale was occurring on the company’s website used in France.

15-7.

Q: What factors most influenced your decision? A: Students will need to formulate their responses based on the decision they made above.

15-8.

Q: Do you know of any internet controls that companies or governments can use to stop such cases from occurring in the future? A: There are a number of ways to view this dilemma. From the US perspective, French law does not have jurisdiction over the operations of US 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 website. Thus, from the French perspective it could be argued that because French citizens can access the company’s US website, that France’s laws apply. The company’s perspective must be considered as well. Is this negative publicity worth the marginal income the company earns from such sales? Finally, the perspectives of the individuals

who accessed the websites, the creators of the websites, and the sellers should be factored into any decision. Practicing Management Case

International

Red Bull’s Marketing Strategy 15-11. Q: How essential were Red Bull’s early marketing tactics, sometimes called guerilla marketing, to early efforts at establishing its brand? A: Red Bull’s early marketing tactics were critical to its success and directly targeted its consumer segment aged 18 to 34 years old. The filling of recycle bins in London with empty Red Bull cans represents a classic guerilla marketing technique that worked extremely well. It handed out free samples on college campuses and at sporting events and branded itself as irreverent and equated itself with having fun. Red Bull’s brand ambassadors were key in spreading the word—people we call influencers today. The company ran promotional events at music festivals and other businesses to promote Red Bull. The company began sponsoring daredevil events to further brand as ―edgy‖ and cool. 15-12. Q: What is it about the Red Bull Media House’s creations that help the company build such a strong bond with consumers? A: Content produced by Red Bull Media House is the highest quality and appeals to the interests of their target audience. The Media House films daredevils doing breathtaking stunts in all types of sports at various Red Bull-sponsored events. The media arm’s stated intention is to ―inspire with beyond-theordinary stories.‖ Red Bull makes its high-interest video creations available for other media outlets to use (some free of charge) as part of the brand’s promotional strategy. 15-13. Q: What sort of distribution strategy does Red Bull employ? Be as specific as you can. A: Red Bull relies on intensive channels. It grants the right to sell its drinks to many resellers. This provides convenience for consumers because it makes Red Bull available practically anywhere refreshments are sold. It does not provide Red Bull with direct

control over reseller decisions, but due to its popularity it garners excellent shelf space. Incidentally, Red Bull relies to a great extent on the use of a pull strategy. That is, it creates buyer demand that encourages distribution channel members to stock its drinks. The buyer demand that Red Bull generates in order to ―pull‖ products through distribution channels to consumers. 15-14. Q: Can you think of any additional products or product categories to which Red Bull might successfully apply its brand? Explain. A: Students should have some excellent replies to this question. Red Bull could likely branch out into anything that smacks of daredevilish, adrenalinespiking fun. However, the company could risk diluting its brand, saturating the market with too many RedBull branded products, and losing sight of its core products.

CHAPTER 16 MANAGING INTERNATIONAL OPERATIONS LEARNING OBJECTIVES: 16.1 Describe the elements to consider when formulating production strategies. 16.2 Outline the issues to consider when acquiring physical resources. 16.3 Identify the key production matters that concern managers. 16.4 Explain the potential ways to finance business operations. CHAPTER OUTLINE: Production Strategy Capacity Planning Facilities Location Planning Location Economies Centralization versus Decentralization Process Planning Standardization versus Adaptation Facilities Layout Planning Acquiring Physical Resources

Reasons to Make Lower Costs Greater Control Reasons to Buy Lower Risk Greater Flexibility Market Power 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 American Depository Receipts Advantages of ADRs Venture Capital Emerging Stock Markets Internal Funding Internal Equity, Debt, and Fees Revenue from Operations Capital Structure

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 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. 16.1 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. 16.1.1 Capacity Planning Assessing a company’s ability to produce enough output to satisfy market demand.

If capacity now used is greater than the expected market demand, production must be scaled back. 2. Yet 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. 3. If market demand is growing, managers must determine in which facilities to expand production or whether additional facilities are needed to expand capacity. 4. Capacity planning is also extremely important for service companies. For example, a hotel needs to estimate the number of rooms to offer, business meeting rooms, a Wi-Fi system, videoconferencing capabilities, and so on. 16.1.2 Facilities Location Planning Selecting a location for production facilities. 1. Factors include the cost and availability of labor and management, raw materials, component parts, energy, political stability, extent of regulation and bureaucracy, economic development, and local culture, including beliefs about work and important traditions. 2. Reducing production costs through lower wages is often needed when labor accounts for a large portion of production costs. 3. Service companies must locate near their customers and consider customers’ needs when locating facilities. 4. Supply issues are important in location planning. Greater distances between production facilities and target markets lengthens the time for customers to receive shipments. 5. Maintaining larger inventories in target markets may be needed in case of potential shipment delays. This increases the cost of storage and insurance. 6. Shipping costs are greater when production is conducted far from target markets. Transportation costs are a driving force behind the globalization of the steel and potentially other industries. 7. Location Economies Economic benefits derived from locating production activities in optimal locations.

Companies can take advantage of location economies by undertaking business activities there or obtain products and services from companies located there. b. The key point 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. 8. Centralization Versus Decentralization a. Centralized production concentrates production facilities in one location. Decentralized production spreads facilities over several locations—can mean a facility in each market. b. Companies pursuing low-cost leadership often centralize production facilities as much as possible to benefit from economies of scale. c. Low-cost leaders sell undifferentiated products in all markets and do not need to be near markets to observe buyer preferences. They can choose locations with the lowest combined production and transportation costs. d. Companies selling differentiated products find that decentralized production close to customers improves responsiveness to buyer preferences. e. Firms must balance the cost of getting inputs into production and getting products to market. f. R&D and manufacturing tend to locate closer together if cooperation is needed to achieve differentiation. Yet technology allows for greater separation today. 16.1.3 Process Planning Deciding the process that a company will use to create its product. 1. Low-cost strategies often require largescale production because producers want the cost savings from economies of scale. 2. Differentiation strategies demand extra value by offering something unique, such as superior quality, added features, or special brand images. 3. Availability and cost of labor is crucial.

If labor in a host country is relatively lower cost, a company may opt for less technology and more labor-intensive production methods. 4. Standardization Versus Adaptation a. Production processes can be standardized or adapted for modified products in different markets. b. Large production batches reduce the cost of producing each unit and offset higher initial investment in automation. Costs are further reduced as employees work and learn. c. Differentiation often requires decentralized facilities to improve local responsiveness. These facilities produce for national or regional markets and tend to be smaller but increase per-unit production costs. R&D costs are higher for products with special designs, styles, and features. 16.1.4 Facilities Layout Planning Deciding the spatial arrangement of production processes within production facilities. 1. If an abundance of space combines with a lower cost of land, companies can have more flexibility in designing facilities. 2. Facility layout depends on the type of production process, which depends on a company’s business-level strategy. Just-intime inventory may reduce facility size due to lower inventories. 16.2 ACQUIRING PHYSICAL RESOURCES International companies need to decide whether to acquire facilities and production equipment or build their own. They must decide whether to make or buy products for production processes, and determine the sources of any required raw materials. The make-or-buy decision refers to deciding whether to make a product or to buy it from another company. 16.2.1 Reasons to Make Vertical integration is the process whereby a company extends its control over additional a stage of production that provides an input or receives an output. A company that integrates upstream into activities that provide an input engages in backward integration. One that integrates downstream into activities that receive an output engages in forward integration. 1. Lower Costs a. Companies use in-house production when it costs less than buying on the open

market. Producing a product can (1) avoid potential import tariffs that add to cost, and (2) avoid additional services provided by intermediaries that increase costs. c. Smaller companies may be less likely to make, unless they own special technology or another competitive advantage. 2. Greater Control a. Making products can give managers greater control over raw materials, product design, and the production process itself—all important factors in product quality. b. In-house production can also eliminate the need for a company to persuade a supplier to specially modify a product on its behalf. c. A company may also make a product when buying would require it to provide key technology to a supplier. 16.2.2 Reasons to Buy Outsourcing is buying from another company a good or service that is part of a company’s valueadded activities. By outsourcing, a company can reduce the degree to which it is vertically integrated and lessen the overall number of specialized skills and knowledge that it must possess. 1. Lower Risk a. Buying a product can avoid exposing facilities, equipment, and employees to social unrest or open conflict. b. Reduces the need for insurance coverage needed in an unstable country. Still, political instability can cause delays in receiving needed parts through global value chains. 2. Greater Flexibility a. Buying a product can reduce the need to invest in specialized equipment and facilities that reduce flexibility. b. Sourcing products from one or more outside suppliers retain or gain flexibility. c. Buying from several suppliers in different countries still allows for outsourcing from one location if instability interrupts the supply chain in another. d. Buyers can react to a volatile exchange rate that increases the cost of imported product by switching among multiple suppliers in different countries and currencies. b.

16.2.3 1. 2.

16.2.4 1.

2. 3. 4.

Maintaining operational flexibility by not investing in production facilities can allow a company to alter its product line quickly. f. By not locking up its capital in plant and equipment a company maintains financial flexibility to access capital and pursue opportunities. Market Power a. Buyers can gain a great deal of power with suppliers simply by becoming important customers. b. Sometimes a supplier can become bound to one particular customer and increase a buyer’s market power. c. This can give a buyer significant control with respect to suppliers in dictating quality improvements, making special modifications, and forcing cost reductions. Raw Materials The twin issues of quality and quantity drive many decisions about raw material acquisition. Some industries and companies rely almost exclusively on the quantity of locally available raw materials. Adequate supply must be available to justify investment. Raw material quality has a huge influence on the quality of a company’s end product. Certain products require a minimum quality of an ingredient product. Fixed Assets Fixed assets are physical items that a company plans to use over the long term to help generate income. Examples include production facilities, inventory warehouses, retail outlets, and office equipment. Companies can either (1) acquire or modify existing factories, or (2) build new facilities—called a greenfield investment. Considering either option involves many individuals, such as production managers, site-acquisition experts, and legal staff. Local infrastructure must support proposed on-site business operations.

16.3 KEY PRODUCTION CONCERNS Company strategy and its organizational structure play a role in determining the number and location of manufacturing facilities. Let’s see how manufacturing companies maximize quality and minimize shipping and inventory costs, and examine some important reinvestment-versus-divestment decisions. 16.3.1 Quality Improvement Efforts 1. Quality improvement efforts help keep production costs low by reducing waste in valuable inputs, reducing the cost of

retrieving defective products, and reducing the cost to dispose of defective products. 2. Furthermore, a 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. 3. Quality is also important for service providers, yet complex because services are often created and consumed simultaneously. Activities conducted prior to service delivery are also important. 4. Total Quality Management a. TQM is a company-wide commitment to meet or exceed customer expectations through continuous quality improvement efforts and processes. Each individual is responsible for focusing on the quality of their output. b. By continuously improving quality, a company differentiates itself from rivals and attracts loyal customers. 5. ISO 9000 a. International Standards Organization (ISO) 9000 is a series of individual standards that a company is certified as achieving when it meets the highest quality standards in its industry. b. To become certified companies must demonstrate the reliability and soundness of all business processes that affect the quality of their products. 16.3.2 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 might adopt just-in-time (JIT) manufacturing—inventory is kept to a minimum and inputs arrive to the production process exactly when they are needed. 4. JIT drastically reduces the costs of large inventories and reduces wasteful expenses because defective materials and components are spotted quickly during production. 5. The technique quickly spread throughout

16.3.3 1. 2.

4. 5.

manufacturing industries worldwide. But the global pandemic highlighted the supply chain shortages that can result from maintaining low inventories. Reinvestment versus Divestment Companies tend to reinvest profits in markets that require lengthy payback periods as long as the extended outlook is good. They reinvest when a market is experiencing rapid growth. Investing in expanding markets is attractive because potential customers may not yet be loyal to one company or brand. Companies tend to scale back or divest international operations if it is apparent that profitability will take longer than expected. Political, social, or economic problems can force companies to reduce or eliminate operations altogether. Companies invest in operations that offer the best return on investment. This can mean reducing or divesting operations in profitable markets to invest in more profitable opportunities elsewhere.

16.4 FINANCING BUSINESS OPERATIONS Companies need financial resources to pay for operating expenses and to fund new projects. They must buy raw materials and component products for manufacturing and assembly activities. At times they need large sums of capital to expand production capacity or enter new geographic markets. They must also pay for training and development programs, compensate employees, and advertise. 16.4.1 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 international capital flows. 3. Borrowing locally can be advantageous, especially when the value of the local currency has fallen against that of the home country. 4. Yet companies are not always able to borrow funds locally and may be forced to seek international sources of capital. 5. A back-to-back loan is one in which a parent company deposits money with a host-country bank, which then lends the money to a subsidiary located in the host country (see

Figure 16.1). 16.4.2 Issuing Equity The international equity market consists of all stocks bought and sold outside the home country of the issuing company. This helps firms access investors with funds unavailable domestically. Yet getting shares listed on another country’s stock exchange can be complex. 1. American Depository Receipts a. To maximize international access to funds, non-US companies list themselves on US stock exchanges by issuing American Depository Receipts (ADRs)— certificates that trade in the United States and that represent a specific number of shares in a non-US company. b. International companies may also issue Global Depository Receipts (GDRs). These are similar to ADRs but are listed and traded in London and Luxembourg. c. Advantages of ADRs: (1) Buyers pay no currency-conversion fees, (2) there are no minimum purchase requirements, and (3) ADRs appeal to US mutual funds that are limited in how much money they can invest in companies not registered on US exchanges. 2. Venture Capital a. Venture capital is financing from investors who take part ownership in a business that is expected to experience rapid growth. 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. Emerging stock markets tend to be volatile because investments are often hot money—portfolio investment that can be quickly withdrawn in a crisis. By contrast, patient money is direct investment in factories, equipment, and land that cannot be withdrawn as easily. b. Moreover, large and sudden selloffs of equity can occur in emerging stock markets because of uncertainty regarding the nation’s future economic growth. 16.4.3 Internal Funding Ongoing international business activities and new investments can also be financed internally with funds supplied by the parent company or its

international subsidiaries (see Figure 16.2). 1. Internal Equity, Debt, and Fees a. Parent companies often finance the operations of new subsidiaries until they grow financially independent. b. Subsidiaries can obtain capital by issuing equity solely to the parent, which benefits from an appreciating share price. c. In return, subsidiaries with excess cash loan money to parent or sister companies when they need capital. 2. Revenue from Operations a. Revenue is money earned from the sale of goods and services. It 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 used only to expand operations or survive lean periods. c. A transfer price is the price charged for a good or service transferred between a company and subsidiaries. Transfer pricing can be used if there are no national restrictions on the use of foreign exchange or on the repatriation of profits from host countries. 16.4.4 Capital Structure 1. A company’s capital structure is the mix of equity, debt, and internally generated funds used to finance a company’s activities. 2. Firms try to strike the right balance among financing methods to minimize risk and the cost of capital. 3. If a company defaults on its payments to creditors, it can be forced into bankruptcy. The same is true for holders of preferred stock. 4. Thus, a company prefers to not 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 income tax owed. 6. National restrictions can influence an MNC’s choice of capital structure, including limits on international capital flows, the cost of local versus international

financing, access to international financial markets, and currency exchange controls. Quick Study Questions Quick Study 1 1.

Q: What is the name for the process of assessing a company’s ability to produce enough output to satisfy market demand? 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: What do we mean by the term location economies and why is it relevant to international business? A: 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 it could generate anywhere else.

Q: What do we call the act of deciding on the process that a company will use to create its product? 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 product adaptation.

Q: What is it called when a company decides the spatial arrangement of production processes within production facilities? A: Deciding the spatial arrangement of production processes within production facilities is call facilities layout planning. If an abundance of space combines with a lower cost of land, companies can have

more flexibility in designing facilities. Facility layout depends on the type of production process, which depends on a company’s business-level strategy. Just-in-time inventory may reduce facility size due to lower inventories. Quick Study 2 1. Q: Vertical integration can help a company extends its control over what? A: Vertical integration is when a company extends its control over a stage of production that provides an input or receives an output. A company that integrates upstream into activities that provide an input engages in backward integration. One that integrates downstream into activities that receive an output engages in forward integration. Vertical integration can influence the make-or-buy decision. Its potential advantages include lower production costs, greater control over production, ability to modify products as it desires, and keeping key technology in-house. 2.

Q: For what reasons might a company make a product rather than buy it from a supplier? A: 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 a product 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 inhouse when buying from a supplier requires providing them with a key technology.

Q: For what reasons might a firm buy a product from a supplier rather than make it itself? A: One reason a company may buy rather than make a product is to lower risk. Political risk is quite high in certain markets if there is a chance that a government might 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 potential of products being 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. Quick Study 3 1.

Q: What are two main reasons that a company might strive toward quality improvement efforts? A: Companies strive toward quality improvement for two reasons. First, quality products help keep production costs low because they reduce waste in valuable inputs, 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.

Q: What is meant by the term ISO 9000? A: The International Standards Organization (ISO) 9000 is series of individual standards that a company is certified as achieving when it meets the highest quality standards in its industry. To become certified, companies must demonstrate the reliability and soundness of all business processes affecting the quality of their products.

Q: In what production technique is inventory kept to a minimum and inputs arrive to the production process exactly when they are needed? A: Just-in-time (JIT) manufacturing is when inventory is kept to a minimum and inputs arrive to the production process exactly when they are needed is all. JIT drastically reduces the costs of large inventories and reduces wasteful expenses because defective materials and components are spotted quickly during production. The technique quickly spread worldwide. But the global pandemic highlighted the supply chain shortages that can result from maintaining low inventories.

Q: Under what conditions might a company reinvest in or divest operations? A: Companies tend to reinvest profits in markets that require lengthy payback periods as long as the extended outlook is good. They reinvest when a market is experiencing rapid growth. Investing in expanding markets is attractive because potential customers may not yet be loyal to one company or brand. Companies may try to reduce international competition by investing in the home markets of international competitors. Companies tend to divest international operations if it is apparent that profitability will take longer than expected. Political, social, or economic problems can force companies to reduce or eliminate operations altogether. Companies invest in operations that offer the best return on investment. This can mean reducing

or divesting operations in profitable markets invest in more profitable opportunities elsewhere.

Quick Study 4 1.

Q: Through what three sources do companies tend to obtain the financial resources they need? A: Companies can obtain financial resources through one of three resources: (1) borrowing (debt), (2) issuing equity (stock ownership), or (3) internal financing. Companies try to get the lowest interest rates possible on borrowed funds but difficulties include exchange-rate risk, restrictions on currency convertibility, and restrictions on international capital flows. Borrowing locally can be advantageous, especially when the value of the local currency has fallen against that of the home country. Companies are not always able to borrow funds locally and then seek international sources. The international equity market can help firms access investors with funds unavailable domestically. Venture capital is financing from investors who take part ownership in a business that is expected to experience rapid growth. Companies also obtain funds internally. Parent companies often finance the operations of new international subsidiaries until they grow financially independent. Subsidiaries can obtain capital by issuing equity solely to the parent. Subsidiaries with excess cash can loan money to parent or sister companies when they need capital. Long-term success depends on a company generating sufficient revenue to sustain day-to-day operations.

Q: What can a non-US company issue in order to access US capital markets? A: To maximize international access to funds, a non-US company can list shares directly in the United States by issuing American Depository Receipts (ADRs)— certificates that trade in the United States and that represent a specific number of shares in a non-US company. There are three main advantages of ADRs. (1) Buyers pay no currency-conversion fees, (2) there are no minimum purchase requirements, and (3) ADRs appeal to US mutual funds that are limited in how much money they can invest in companies not registered on US exchanges.

Q: What do we call a company’s mix of equity, debt, and internally generated funds used to finance its activities? A: A company’s capital structure is the mix of equity, debt, and internally generated funds used to finance a

company’s activities. Firms try to strike the right balance among financing methods minimize risk and the cost of capital. Teaming Up Suppose you and several classmates are a team assembled by the chief financial officer of the consumer-goods company you work for that is based in Mexico. Your company wishes to expand internationally and enter the US market but lacks the necessary financial capital. Your team’s task is to research the company’s options. 16-3.

Q: What are the financing options available to your company? A: The company could obtain financial resources though three sources: (a) debt financing – the use of borrowed funds, (b) equity financing – the process of raising capital through the sale of stock in the business and (c) internal funding – funds coming from within the company from previous operations.

16-4.

Q: Considering the current situation in the Mexican and international capital markets, why is each option feasible? A: In responding to this question, students will have to become aware of current financial and economic conditions in Mexico. They will have to be aware of interest rates in the US and Mexico, and the value of the Mexico Peso in relation to the US dollar. Less availability of funds from the capital market would occur should interest rates increase, and/or the Mexican Peso depreciates in relation to the US dollar.

16-5. Q: Why are certain options off limits, given current market conditions? A: Students should be sure to consider the current financial and economic conditions prevailing in Mexico currently. Options for financing can rapidly change depending on financial and economic conditions. Students should supply several financing options under different scenarios for Mexico’s economy. Ethical Challenge You are special assistant to the governor of a US state in which unemployment (especially in rural areas) is relatively high. After nearly three years in office and elected on a pledge to create jobs, the governor is concerned. Respecting your moral stance on big issues, the

governor is seeking your insight. An electric vehicle (EV) producer from another country just told the governor that your state is on its list of potential sites for a new EV assembly facility. The facility is expected to employ about 1,500 people, with plenty of spillover effects for the wider economy. The governor informs you that the EV producer expects significant incentives and concessions. The governor would like to offer some $500 million in tax breaks and subsidies in an effort to bring the new facility to the state. 16-6.

Q: What plan of action do you advise the governor to take? A: Students will have to decide whether attracting businesses, keeping them, and getting them to expand operations is worth tax breaks and other incentives. The question could be set up as a debate, with one side supporting the incentives and the other side discouraging the offering of incentives to the EV producer.

16-7.

Q: Do you believe the tax breaks and subsidies are an appropriate use of taxpayer money? A: When tax incentives are considered, the state and the local community stands to gain by new business activity. These benefits are tax revenues associated with added employees that are expected to either relocate to the state or be hired from the state’s existing population. If a new business buys a tract of land and builds a factory on it, the business increases the community’s property tax base. The factory adds value to the otherwise vacant land. The state might allow the business to pay a reduced property tax rate for the first few years the factory is open. This would lower the company’s tax liability at a time when other operating costs are running high. With the factory expecting to employ 1,500 people, the state will also experience an increase in income tax revenue. This also leads to a reduction in unemployment.

16-8.

Q: Would you feel comfortable defending your advice if it were to become public? Explain. 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 Management Case

International

Just-in-Time Plus Just-in-Case 16-11. Q: Why do you think Toyota, itself, does not produce more of the crucial parts that go into their automobiles and electric vehicles? Which reasons to buy do you think outweigh reasons to make? A: Toyota has certainly calculated the costs and benefits of making versus sourcing its parts from suppliers. It simply knows that buying from suppliers is more cost-effective and results in high quality because the company is a specialist in making that component. Toyota purchases most of its parts from suppliers with whom it has a long history or those suppliers in which it has part ownership. These relationships give Toyota significant market power relative to its suppliers—they want to maintain a good working relationship with Toyota. Now, suppliers of crucial components maintain six months’ worth of inventory. This helps reduce the risk involved in purchasing from suppliers and then becoming subjected to an unforeseen disruption. 16-12. Q: Why do you think Toyota is investing nearby its assembly operations in the US market and elsewhere? Identify as many motives as you can in its home country, Japan, and target markets. A: Toyota and other companies have shortened and strengthened supply chains following lessons learned during the pandemic and, before it, the tsunami in Japan. Factories turning out lower-cost components halfway around the world does not help assembly operations if a business cannot obtain the parts because of a supply chain disruption. Companies are relearning the importance of having parts suppliers in closer proximity to assembly. Some companies are willing to forgo some cost savings by making parts in sub-optimal locations if it can strengthen and better secure the supply chain. They view the added costs as a sort of insurance policy if things go sideways. 16-13. Q: Scientists warn that climate change will increase weather-related difficulties for companies.

Can you think of precautions that companies could take to protect their operations? Explain. A: Shortening supply chains to prevent or reduce the impact of unforeseen disruptions on company operations is already underway. Other vehicle makers are following Toyota’s example of protecting their supply chains. Volkswagen, BMW, and Mercedes-Benz created a shared system that is similar to Toyota’s, called Catena-X. The partners created a Europe–wide supplier database to aid them in potential future disruptions. Companies also need to be nimble and agile and able to quickly address problems that appear in any aspect of the company’s activities. Businesses should reduce silos that confine all employees to specific departments with little cross-fertilization of ideas. Increased use of cross-functional teams and moving away from a process-focused organization to one that is project focused is another way companies can increase responsiveness to externally caused emergencies. 16-14. Q: For a product you are relatively familiar and that is composed of several or more parts, which ones do you think are ―must-have‖ components? How many of those parts does the producer, itself, make? A: Selection of merchandise, rather than a service, will likely make it easier for students to answer these questions. However, students might be very wellinformed about some services. Students could also be given a week to research outside sources (or consult online sources in class) and answer this last question.

CHAPTER 17 HIRING AND MANAGING EMPLOYEES LEARNING OBJECTIVES: 17.1 Explain the three types of staffing policies that international companies use. 17.2 Describe the key international recruitment and selection issues. 17.3 Summarize the main international training and development methods.

17.4 Describe international compensation issues and labor– management relations. CHAPTER OUTLINE: International Staffing Policies 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 Overcoming 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 Compensation, Labor, and Management Managerial Employees Bonuses and Benefits Nonmanagerial Workers Labor–Management Relations International Labor Movements A Final Word A comprehensive set of specially designed PowerPoint slides is available for use with Chapter 17. These slides and the lecture outline below form a completely integrated package that simplifies the teaching of this chapter’s material.

Lecture Outline 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 relationships with them. International HRM differs considerably from domestic HRM. There is the issue of expatriates—citizens of one country who are living and working in another. And culture is central to the discussion of HRM in international companies. 17.1 INTERNATIONAL STAFFING POLICIES Staffing policy is the customary means by which a company staffs its offices. It is influenced by the extent of a firm’s international involvement. Three approaches to staffing international operations are often blended in practice. 17.1.1 Ethnocentric Staffing Individuals from the home country manage operations abroad. 1. Appeals to companies that want control over decision making abroad and that formulate policies designed to work in every country. This policy is primarily used only for top managerial posts internationally because it can be too costly and impractical at lower levels. 2. Advantages of Ethnocentric Staffing a. Can help overcome a competitive local labor market as foreign and local companies compete for a limited number of talented individuals available locally. b. Can help recreate operations in the image of home-country operations, which is important for companies wanting to instill shared values across all national subsidiaries. c. Some companies believe that managers sent from the home country will look out for the company’s interests more than host-country natives will. Can be important in nationalistic markets and when concerned with industrial espionage. 3. Disadvantages of Ethnocentric Staffing a. Expense of relocating managers and families from the home country plus relocation bonuses can grow expensive. b. The presence of home-country managers

in the host country can contribute to a ―foreign‖ image of a business. This can make lower-level employees feel that managers do not understand the culture and their needs. 17.1.2 Polycentric Staffing Individuals from the host country manage operations abroad. 1. Well-suited to companies that want to grant national units a significant amount of autonomy in decision making. 2. Managers new to the company can visit the home office for an extended period to learn its culture and business practices. 3. Advantages (+) and Disadvantages (−) of Polycentric Staffing a. (+) Managers have deep understanding of the local market. The understand the subtle cues of the culture and need not overcome cultural barriers. They may have a better feel for the needs of employees, customers, and suppliers. b. (+) Eliminates the high cost of relocating expatriate managers and families. c. (−) A company can become a collection of national businesses The potential lack of integration, knowledge sharing, and common image may negatively impact performance of a company with a global strategy. 17.1.3 Geocentric Staffing The best-qualified individuals of any nationality manage operations abroad. 1. The local manager is from the host country, the home country, or a third country depending on the operation’s needs. This policy is often reserved for top-level managers. 2. Advantages (+) and Disadvantages (−) of Geocentric Staffing a. (+) Develops global managers who can adjust easily to any business environment and cultural differences Useful for companies trying to break down nationalistic barriers between subsidiaries. b. (−) Can be costly to implement. The high demand for people with these special skills can inflate their salaries. 17.2 RECRUITING AND SELECTING HUMAN RESOURCES

Companies try to recruit and select qualified managers and nonmanagerial workers who are well suited to their tasks and responsibilities. 17.2.1 Human Resource Planning Forecasting a company’s human resources needs and its supply. 1. 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. 2. Phase two: Estimate future HR needs and whether to hire employees or to subcontract production to other producers. a. This decision can raise ethical questions. Subcontracting work to lower-wage nations and allegations of workplace abuse has encouraged many firms to establish codes of conduct and take steps to ensure compliance. 3. Phase three: Develop a plan for recruiting and selecting people to fill vacant and anticipated positions. a. Companies sometimes must also make plans for reducing its workforce—a process called decruitment—when current HR levels are greater than anticipated. 17.2.2 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. Recent college graduates who have come from other countries to attend college in the firm’s home country. b. Common practice among US 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. Familiarity with the culture of the target market, including its customs, traditions, and language is very important. 3. Local Managerial Talent

a. Hiring local managers is common when cultural understanding is a key job requirement. b. 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 a. Companies recruit locally for nonmanagerial positions if there is little need for specialized skills or training. b. A specialist from the home country can be brought in to train people chosen for more demanding positions. c. Companies recruit locally when government restricts the number of foreign workers allowed in the host country; this can reduce local unemployment rates. d. Some countries will allow foreign nonmanagerial workers. 17.2.3 Selecting Human Resources Screening and hiring the best-qualified applicants with the greatest performance potential. 1. For international assignments, it is essential to measure a person’s ability to bridge cultural differences. 2. Expatriate managers must adapt to a new way of life in the host country and work with others from different cultural backgrounds. 3. Culturally sensitive managers increase the likelihood that a company will achieve its business goals. 4. Recruiters assess cultural sensitivity by asking candidates questions about their receptiveness to new ways of doing things and can employ global aptitude tests. 5. The cultural sensitivity of each family member moving to the host country needs assessment to help avoid expatriate failure. 17.2.4 Culture Shock Psychological process affecting people living abroad that is characterized by homesickness, irritability, confusion, aggravation, and depression. 1. A person experiencing it has trouble

adjusting to the new environment in which they find themselves. 2. Sometimes employees return early from an international assignment because of cultural stress. 3. Selecting managers who are comfortable living in unfamiliar cultures is an extremely important factor when recruiting for international posts. 17.2.5. Reverse Culture Shock Psychological process of re-adapting to one’s home culture. 1. Values and behavior that once seemed so natural can now seem strange and unnatural. 2. Returning managers may find that either no position or a standby position awaits them in the home office. 3. Companies sometimes do not take advantage of the cross-cultural capabilities of managers who have spent many years abroad. 4. Expatriates who successfully adapt to new cultures sometimes leave their companies after returning home due to difficulty blending back into the company culture. 5. Overcoming Reverse Culture Shock a. Spouses and children can also have difficulty leaving an adopted culture and returning home. b. Home-culture reorientation programs and career counseling for returning managers and families can be effective. c. Employers can bring the family home for a short stay prior to a permanent return to lessen reverse culture shock. d. Career development programs can help companies retain valuable managers— ideally these are designed prior to an employee going abroad. e. A mentor can be assigned to a returning manager and be someone with whom the manager can discuss issues related to work, family, and readjusting to the home culture.

17.3 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. Major providers of online training include Coursera, LinkedIn learning, Skillsoft and Udemy to name only several. Online

learning is delivering a consistent message to an infinite number of employees worldwide. 17.3.1. Methods of Cultural Training (see Figure 17.1) 1. The extent of a company’s international involvement requires a corresponding level of cultural knowledge from employees. 2. Highly international companies need employees with language fluency and in-depth experience abroad. Small companies or those new to global business can begin with basic cultural training. 3. The goal of cultural training is to create informed, open-minded, and flexible managers with a level of cultural training appropriate to the duties required of them. 4. Environmental briefing and cultural orientations a. Environmental 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, and basic phrases in the local language. b. This can involve role-playing whereby a trainee responds to a situation and is evaluated by a team of judges. c. Sensitivity training teaches people to be considerate and understanding of other peoples’ feelings and emotions. 6. Language training a. This 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 long-term assignments. c. Foreign-language skills among top executives may provide a competitive edge. d. Trainees should learn around 3,500 words—enough to be understood in most situations.

Field experience a. Field experience involves visiting the culture, mingling with the local people, and embedding oneself in the local culture for some time. b. The trainee enjoys the unique cultural traits and feels the stresses inherent in living in the culture.

17.3.2 Compiling a Cultural Profile Cultural profiles can be helpful in deciding whether to accept an international assignment. Sources for building a cultural profile: 1. CultureGrams: Frequent updates make this a timely source of information. Individual sections profile each culture’s background and its people, customs, and society. It also provides information of required entry visas and vaccinations. 2. Bureau of Consular Affairs: This office is found within the US Department of State and has a good deal of relevant factual information on various countries. 3. Information can also be obtained by contacting the embassies of other countries and by locating people with firsthand knowledge and specific books and films. 17.3.3 Nonmanagerial Worker Training 1. Nonmanagerial workers also have training and development needs, especially in developing and newly industrialized countries where workers may lack experience in industry. 2. This need may grow as companies continue to explore opportunities in emerging markets. 3. In many countries, national governments cooperate with business to train nonmanagerial workers. Japan and Germany lead the world in vocational training and apprenticeship programs for nonmanagerial workers. 17.4 COMPENSATION, LABOR, AND MANAGEMENT The goal is to attract and retain the best and brightest employees and reward them for performance. Determining compensation is complicated because a country’s compensation practices are rooted in its culture, laws, and economic system. 17.4.1 Managerial Employees 1. Compensation packages must reflect the cost

of living—the financial cost of maintaining a certain standard of living in a specific location. Includes factors such as the cost of groceries, dining out, clothing, housing, schooling, heath care, transportation, and utilities. 2. The cost of living is higher in some countries than it is in others. It usually varies between large cities to rural towns within a country. 3. Most companies add a certain amount to an expatriate manager’s pay to cover greater cost-of-living expenses abroad. Yet managers who relocate to lower cost-of-living countries are paid the same amount as they were receiving at home or they would be penalized for accepting an international job. 4. Companies also cover other costs incurred by expatriate managers such as high-quality local education. 5. Managers recruited from within the host country generally receive the same pay as managers who work for local companies. 6. Bonuses and Benefits a. Companies commonly offer inducements for international postings; the most common being a financial bonus. b. Hardship pay is additional compensation for working in a country with particularly difficult living conditions. c. The US government offers citizens working abroad a ―foreign-earned income exclusion.‖ Citizens can exclude $112,000 (for tax year 2022 and adjusted each year for inflation) from their taxable income, even if it is earned in a country that does not tax income. Earnings above that amount are taxed, as are non-financial benefits received. 7. Companies should have in place policies to handle expatriates’ emergency medical expenses. Also, some benefits are mandated by the host-country government. 17.4.2 Nonmanagerial Workers Two main factors influence the wages of nonmanagerial workers. 1. First, their compensation is strongly influenced by increased cross-border

business investment. Workers’ wages tend to equalize across borders when employers can relocate easily internationally. Jobs and improvement in some workers’ lives can come at workers’ expense in other nations. 2. Second, labor is more mobile than ever before. For example, EU countries have abolished the requirement that workers from one EU nation obtain visas to work in another. 17.4.3 Labor−Management Relations Positive or negative relations between a company’s workers and its management. 1. Companies are better able to surmount unexpected obstacles when management and workers cooperate with each other. 2. One way to increase morale and generate commitment to improved quality and customer service is to reward workers with a greater stake in the company. 3. Because relations between labor and management are human relations, they are rooted in culture and are affected by political movements. 4. Large international companies tend to make high-level labor decisions at home and leave lower-level decisions to managers in each country. Localizing management decisions can foster better labor–management relations. 5. A labor union is an organization that represents workers’ interests in negotiating with employers. Negotiations are often rooted in drives for better wages and working conditions. 6. Under codetermination, German workers enjoy a direct say in the strategies and policies of their employers. 7. International Labor Movements a. Unions around the world are improving the treatment of workers and reducing incidents of child labor. b. Yet it can be difficult for a union in one nation to support its counterpart abroad. Events abroad are difficult to comprehend and workers sometimes compete for the jobs that multinational companies offer. c. Labor unions in one country might offer concessions to attract the jobs created by a new production facility. d. Some argue that this phenomenon creates

downward pressure power worldwide.

wages

and

union

Quick Study Questions Quick Study 1 1.

Q: What is the name given to the policy of staffing operations abroad with home-country nationals? A: In ethnocentric staffing, individuals from the home country manage operations abroad. This policy tends to appeal to companies that want to maintain tight controls over the decision making of branch offices abroad. This policy is primarily used only for top managerial posts internationally because it can be too costly and impractical at lower levels.

Q: What staffing policy employs individuals from the host country to manage local operations? A: In polycentric staffing, individuals from the host country manage operations abroad. This policy is wellsuited to companies that want to grant national units a significant amount of autonomy in decision making. But this 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 an extended period.

Q: What type of company is most likely to employ a geographic staffing policy? A: In geocentric staffing, the best-qualified individuals of any nationality manage operations abroad. The local manager is from the host country, the home country, or a third country depending on the operation’s needs. This policy is often reserved for top level managers. It is particularly useful for global companies trying to break down nationalistic barriers between subsidiaries.

Quick Study 2 1.

Q: What do we call the process of forecasting a company’s human resource needs and supply? A: Human resource planning is forecasting a company’s human resource needs and supply. The process involves three stages: (1) Taking an inventory of the company’s current human resources; (2) estimating the company’s future needs for human resources; and (3) developing a

plan for recruiting and selecting human resources. 2.

Q: What is meant by the term culture shock? A: Culture shock is a psychological process affecting people living abroad that is characterized by homesickness, irritability, confusion, aggravation, and depression. A person experiencing it has trouble adjusting to the new environment in which they find themselves. Sometimes employees return early from an international assignment because of cultural stress. Selecting managers who are comfortable living in unfamiliar cultures is an extremely important factor when recruiting for international posts.

Q: What is the name for the psychological process of readapting to one’s home culture? A: Reverse culture shock is the psychological process of readapting to one’s home culture Values and behavior that once seemed so natural can now seem strange and unnatural. Companies sometimes do not take advantage of the cross-cultural capabilities of managers who have spent many years abroad. Spouses and children can also have difficulty leaving an adopted culture and returning home. Home-culture reorientation programs and career counseling for returning managers and families can be effective. Career development programs can help companies retain valuable managers.

Quick Study 3 1.

Q: What are the advantages of online workplace training? A: One appeal of online training is that it delivers a consistent message to an infinite number of employees worldwide. By contrast, employees receiving training provided in local setting can result is as many variations on a lesson as there are locations where it is taught. Online workplace training may not engage people as well as in-person training and it may not tech soft skills as well, such as appropriate facial expressions and tone of voice, but its ability to flexibly train large groups cost effectively makes it a viable alternative to traditional training methods. Major providers of online training include Coursera, LinkedIn learning, Skillsoft and Udemy to name only several.

Q: What six methods are commonly used to prepare managers for an international assignment? A: Environmental briefings 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, and basic phrases in the local language. This method can involve roleplaying. Sensitivity training teaches people to be considerate and understanding of other peoples’ feelings and emotions. Language training gets a trainee ―into the mind‖ of local people to learn more about why people behave as they do. This is perhaps the most critical part of cultural training for longterm assignments. Field experience involves visiting the culture, mingling with the local people, and embedding oneself in the local culture for some time. 3.

Q: What is a good source of cultural information once a manager is already inside a country? A: Once inside a country, the embassy of the home nation is a good source for further cultural advice. Embassies maintain networks of home-nation professionals who work in the local culture, some with many years of experience on which one can draw.

Quick Study 4 1.

Q: What do we call the financial cost of maintaining a certain standard of living in a specific location? A: Cost of living is the financial cost of maintaining a certain standard of living in a specific location.

Q: What might an expatriate manager receive for working in a country with particularly difficult living conditions that are significantly below those in the home country? A: A manager asked to relocate to a country in which living conditions are significantly below those in the home country may receive hardship pay, which is additional compensation for working in a country with particularly difficult living conditions.

Q: What do we call the positive or negative relations between a company’s workers and its management? A: The positive or negative relations between a company’s workers and its management are referred to as labor—management relations.

Teaming Up

Suppose you and several of your classmates are a team assembled by your employer to decide whether to begin personality testing all employees. the reason is that a group of researchers recently found that the top three reasons people quit or underperform in the job are rooted in personality rather than skill, knowledge, or qualification. Personality testing in the workplace is widespread in Australia, Europe, and the United States, and is catching on in Asia. 17-3.

Q: What personality traits might help explain poor performance at work? Explain. A: Companies seek highly-effective and productive employees. Personality has implications for individual performance as well as ability to work within groups. Key personality traits that lead to better performance include emotional stability, extroversion, openness to experience, agreeableness, and conscientiousness. Emotional stability is the degree to which an employee is anxious, depressed, and insecure. Extroversion is the degree to which an employee is sociable, talkative, assertive, active, and ambitious. Openness is the extent to which an employee is intellectually curious. Agreeableness is the extent to which an employee is good natured and well-liked. Conscientiousness is the degree to which an employee is dependable, responsible and organized.

17-4.

Q: Could the reason why Asian societies have not used such testing in the past be rooted in culture? Explain. A: Asian countries have been slow to adopt the use of personality testing in the workplace. This is due, in part, to cultural differences. Chapter 3 presented the importance of culture in the values and behavior of a society. The Hofstede Framework developed five dimensions for examining cultures. Asian countries tend to rank lower than others on Individualism, and are primarily collectivist cultures. Loyalty is key in collectivist cultures and fosters strong relationships whereby people take responsibility for fellow members of the group. Asian cultures also rank highly on LongTerm Orientation. This indicates a society’s time perspective and an attitude of persevering to overcome obstacles.

17-5.

Q: What advantages might global aptitude tests offer firms that do business globally? A: Students will likely need to do research (in the library or on the Internet) to answer this question

adequately. Ethical Challenge You are the expatriate general manager at a manufacturing facility in a developing country. You are aware of increasing concern among your employees 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 supportive of efforts to organize workers. In fact, despite the calm demeanor when the subject of unions is raised, you believe that upper management in the home country could react severely if workers unionized. Headquarters would likely shift production elsewhere, close the plant, and transfer you to another country. 17-6.

Q: Can you propose anything that could improve conditions for workers (short of unionizing) that could also get the approval of upper management? A: As manager of the manufacturing facility, you could request that headquarters provide things other than salary that could improve workers’ standard of living. The company could donate to local charities, perhaps, that help poor families in the country. It could give local schools and hospitals grant money for needed repairs and equipment. The company could provide health check-ups free of charge for the workers and their families. Anything that could help raise living standards yet not jeopardize the jobs of employees is likely the best approach.

17-7.

Q: If you attempted what you proposed above but then failed, would you encourage workers to unionize? Explain. A: For companies that have shifted production to certain lower-cost manufacturing hubs, students might consider the threat to move operations again as being very real. Yet the cost of moving, including the hiring and training new workers will cut into productivity and efficiency. Students may look at these decisions from a long-term perspective and see the small victories as the best that can be done at the moment. They might consider these moves as small steps along the way to constantly improving supply chains.

Practicing Management Case

International

IKEA’s HR Leadership 17-10. Q: Do you think companies in certain cultures might find it easier to adopt an approach to human capital that is similar to IKEA’s? Explain. A: The ―social ambition‖ philosophy of IKEA is likely to be more easily adopted in cultures that are more group oriented, or collectivist in nature. People in those cultures already have a deep concern for others and concern for how the group perceives them. IKEA also seeks to eliminate titles of individuals in the organization that distinguish management from workers and that delineate a pecking order of who ranks higher within the company. This flatter organizational structure also appeals to collectivist cultures. IKEA’s human resource policies are likely to be most suited to collectivist cultures that also score low on power distance, which means a culture is not very accepting of inequality. 17-11. Q: Do you think IKEA will be successful in its push into emerging markets with its ―co-worker‖ philosophy? Do you think it might be more successful in certain markets and, if so, which ones? Explain. A: Yes, IKEA is likely to be successful in its push into emerging markets. As stated above, many emerging markets are group oriented. Moreover, there seems to be a budding trend in certain developed nations toward greater fairness, equality, and concern for society over the individual. Nevertheless, the chapter describes how companies’ policies and activities can change culture. The one area in which IKEA might experience some difficulty regards its recruitment policies. IKEA’s goal of recruiting half men and half women in all of its stores in all markets might experience resistance in cultures that have strong family traditions. But if it manages these situations delicately and with skill, it may not have any problems at all. 17-12. Q: What are some advantages of IKEA’s recruitment, selection, and employment of its ―coworkers‖? A: The company’s recruitment begins with finding individuals whose values align with IKEA’s values of equality and accomplishing goals through togetherness. Much of human management has to do with treating

individuals with respect. The advantages to IKEA likely include having very loyal employees, high employee morale, low employee turnover, and a generally cooperative spirit throughout the company that all contribute to performance and the bottom line. 17-13. Q: Why do you think IKEA’s approach to human resource management has been so successful? A: The entire IKEA organization is oriented around its social ambition and the value of togetherness. Everything about the company is authentic and grew from these values. Nothing is borrowed or added to IKEA’s philosophy because management hired a business consultant who said that the company should adopt the latest trending strategy or that it should take on a specific persona. Everything about the IKEA approach is organic and authentic. And the company’s employees and customers can feel that it’s real.