Business environment

Nature of Inter-national Business Environment

• The environment of inter-national business is regarded as the sum total of all the external forcesworking upon the firm as it goes about its affairs

in foreign & domestic markets.

• The environmental factors are divided into :

1. Political –legal 2. Economic3. Cultural, &4. Technological Groups

InternationalBusiness

Environment of Inter-national Business

1. Political Environment

• Political environment refers to the influence of the

system of government & judiciary in a nation on

inter-national business

• The system of government in a nation wields

considerable impact on its business

• The type & structure of government prevailing in a

country decides, promotes, fosters, encourages,

shelters, directs, & controls the business of that

country

• A political system (another name for the type of

government) that is stable, honest, efficient, &

dynamic & which ensures political participation to

the people, & assures personal security to the

citizens, is a primary factor for economic develop-

ment

• The developed economies of to-day owe their success

to a large extent to the political system they richly

enjoyed “there is to-day”, comments John Kenneth

Galbraith, “no country with a stable & honest

government that does not have or has not had a

reasonably satisfactory state of economic progress”

Democracy

• Two basic political systems are in existence all over

the world, namely, democracy & totalitarianism

• In its pure sense, democracy refers to a political

arrangement in which the supreme power is vested

in the people

• Democracy may manifest itself in any of two funda-

mental manners

• If each individual is given the right to rule & vote on

every matter, the result is pure democracy which is

not, however workable in a complex society with a

large constituency

• Hence the republican form of government follows whereby the public, in a democratic manner, electtheir representatives who do the ruling.

• A representative democracy rests on the assumption that should the elected representatives fail to perform adequately they will be voted down at the next election

• Democracies maintain stable business environmentsprimarily through laws protecting individual property rights

• In theory, business prospers when the private sectorenjoys freedom to decide, freedom to earn, & freedom to spend

• But in practice free markets, property rights, & democracies do not guarantee economic growth

• India, for example, is the world’s largest democracy yet experienced slow economic growth till recently

• Meanwhile, countries under near totalitarian

regimes achieved rapid economic growth

• The so-called Asian Tigers – Hong Kong, Singapore,

South Korea, & Taiwan – for example, built strong

market economies in the absence of democratic

practices.

Totalitarianism

• In totalitarianism, also called authoritarianism,

individual freedom is completely sub-ordinated to

the power of the authority of state & concentrated

in the hands of one person or in a small group,

which is not constitutionally accountable to the

people

• Societies ruled by pressure clique – political,

economic or military or by a dictator, plus most

oligarchies & monarchies – belong to this category

• The doctrines of fascism & erstwhile communism

are examples of totalitarianism

• During the First & Second World Wars, the

authoritarian governments began to appear in most

mature economies

• Even after the Second War, the totalitarian system

became most common in newly independent nations

• Administrative efficiency of the dictators was often

cited as an advantage for coping with the problems

of new-born states

• Surprisingly many nations are ruled by dictators

or monarchies even to-day

• Nazi Germany (under Adolf Hitler) & the former

Soviet Union under (under Joseph Stalin) are

historic examples of totalitarian governments

• To-day, Cambodia, Myanmar, China, Cuba, Congo,

& Iraq are prominent examples of totalitarian

governments

Types of Totalitarianism

Totalitarianism, in itself is of four types :

a) Theocratic Totalitarianism

b) Secular Totalitarianism

c) Tribal Totalitarianism

d) Right-Wing Totalitarianism

a) Theocratic Totalitarianism

• When a country’s religious leaders are also its

political leaders, its political system is called a

theocracy

• Religious leaders frame & enforce laws &

regulations that are based on religious beliefs

• A political system that is under the control of

religious leaders is theocratic totalitarianism

• Afghanistan, some Sheikhs of the Middle East &

Iran are the countries which have such political

dispensation

b) Secular Totalitarianism

• A political system in which political leaders are

guided by military & bureaucratic power is called

secular totalitarianism

• In such a system, the military controls the govern-

ment & makes decisions which it deems to be in the

best interest of the country

• An example is Pakistan

• Until the early 1980’s secular totalitarianism were

common throughout Latin America

• They were also found in several Asian countries,

particularly South Korea, Taiwan, Singapore,

& the Philippines

• Since the early 1980’s, however, this form of govern-

ment has been losing its ground

• The majority of Latin American countries are now

genuine democracies, while significant political

freedom has been granted to the political opposition

in countries such as South Korea, Taiwan & the

Philippines

c) Tribal Totalitarianism

• A third form of totalitarianism is the tribal

totalitarianism

• This exists principally in African countries, such as

Zimbabwe, Tanzania, Uganda, & Kenya

• Tribal totalitarianism occurs when a political party

that represents the interests of a particular tribe

monopolises power

d) Right-Wing Totalitarianism

• Here, private ownership of property is endorsed by

government, market forces are also allowed free

play, but political freedom are rarely granted

• Argentina, Brazil, Chile, & Paraguay were under

right-wing totalitarian governments in the 1980’s

• China is classic example of polity which though

communist by definition, is pursuing right-wing

policies

• The country is privatising state-owned enterprises,

attracting FDI, pursuing pro-business policies & isregistering a hefty growth rate

• The country appears to be an open & free society,but is essentially totalitarian

• As between democracy & totalitarianism, whichpolitical system is ideal for business growth is a relevant question

• It may be stated that democracy does not guaranteehigh rates of economic growth, nor does totalitarianism drive a country to slow economic growth

• Rate of growth – the increase in the amount of goods& services produced by a nation – is influenced by many variables other than political & civil liberties

• These include a country’s tax system, policy towards

foreign & domestic investment, political stability,

judiciary, & the like.

Political Risk

• Corporates face political risk when they conduct

business with the outside world

• Political risk is any governmental action or

politically motivated event that could adversely

affect the long-term profitability or value of a firm

• Political risk affects different firms in different ways

• It can threaten the market of an exporter, the

production facilities of a manufacturer, or the

ability of a firm to repatriate its profits from a host

country to its home country

Examples of Political Risks & their Impact on

International Business

A) Macro Risks Impact

i) Expropriation of corporate Loss of future profitsassets without prompt & adequate compensation

ii) Barriers to repatriation of No motivation to improve profits efficiency

iii) Confiscation of properties Loss of assets & future profits

iv) Loss of technology or other Loss of future profitsintellectual property

v) Campaigns against foreign Loss of sales & increased goods costs of public relations

campaigns

vi) Mandatory labour legislations Increased operating costs

vii) Civil wars Destruction of property

loss of sales, increased

security costs, disrupted

production runs

viii) Inflation Increased operating costs

ix) Currency devaluations Reduced values of repatriated earnings B) Micro Risks

i) Kidnappings, terrorist, Disrupted production, threats, etc. higher security costs,

reduced productivity ii) Increased taxation Reduced after tax profits iii) Officials’ dishonesty Loss of business, increased

operating costs

Type of Risks

Distinction is often made between Macro & Micro risks:

A) Macro Political Risk

B) Micro Political Risk

A) Macro Political Risk

• A macro political risk affects all inter-national businesses in the same way

• Expropriation, the seizure of privately owned assets,

as for example, a farm or a factory, by governmentwith little or no compensation to the owners, is a macro political risk

• The taking of ownership of an entire industry thathad been generated privately, as a part of a plan torestructure an entire economy, is called national-isation, again a macro political risk

• Communist governments in eastern Europe & China expropriated private firms following

World War II

• Fidel Castro did the same in Cuba during 1958-59

• Recently, governments in Angola, Chile, Ethiopia,

Peru, & Zambia have expropriated private firms

• Field Marshall Ayub Khan nationalised four hotels

of M.S Oberoi without paying any compensation

• In all these cases, inter-national businesses were

hard hit

• Political boycotts also result in macro political risk

• Since 1955, a number of Arab countries have

boycotted firms with branches in Israel or

companies that have allowed the use of their trade

name there

• Macro political risk can also come about because of

indigenisation laws which bind inter-national

businesses to accept equity participation by local

citizens.

B) Micro Political Risk

• A micro political risk affects specific foreign business

• Micro political risk include industry regulations,

taxes, kidnapping, & terrorist threats

• India’s decision in 1975 to reduce foreign equity to

40 per cent & Peru’s decision to nationalise its

copper mines are example of micro political risks

• The US decision to tax textile imports is another

instance

• Firms which have high visibility in host countries

are targets of micro political risk

• If agitations are caused by animosity between

factions in the host country & the government of a

foreign country, agitators may target only the most

visible companies from that foreign country, like

KFC.

Political Risk Assessment

• Inter-national business must conduct some form of political risk assessment in order to manage risks

• Typically, managers in host countries assess the potentially destabilising issues & evaluate their future impact on the firm, making suggestions for handling problems

• Top management at the head office will then establish guidelines for each host country managersto solve such problems

• Risk assessment by inter-national businesses usually

takes two forms

• One is through the use of experts or consultant

familiar with the host country or region under

consideration

• Such, consultants, advisors, or committees usually

monitor important indicators that may portend

political change

• They then assess the likelihood of political change

& develop several scenarios to describe alternative

political conditions in the future

• A second & increasingly common means of political

risk assessment used by inter-national businesses

is through the development of their internal staff

& in-house capabilities

• This type of assessment may be accomplished by

having staff assigned to foreign subsidiaries or

affiliates monitor local political activities or by

hiring people with expertise in the political &

economic conditions in regions critical to the firm’s

operations

• Whatever the method, timely information from the

people in the front line should not be missed

• Experts of consultants are no substitute for the line

managers in the foreign subsidiaries, many of whom

are host country nationals

• These managers represent the most important

resource for current information on the political

• environment & how it might affect their firm

because they are uniquely situated at the meeting

point of the firm & the host country

• Prudent inter-national businesses, however weigh

the subjectivity of these managers’ assessments &

also realise that similar events will have different

effects in different countries

• Some inter-national businesses try to quantify the

political risks associated with different countries

• Using these criteria countries are ranked as being

high or low in political risks

• The criteria generally used include the political-

economic environment, domestic economic

conditions, & external economic relations

• Russia & Turkey rank high on risk &

Singapore & the Netherlands have very low risk

• Eurasia Group, a political & economic risk analysis

firm, has composed Global Political Risk Index

(GPRI)

• The index is a composite measure of the state of a

country’s government, security, society & economy

• All indicators are scored on a scale of 0 to 100

• The higher the number, the greater the political

stability

• Table (below) contains ranking of countries on

GPRI by Eurasia

• The ranking relates to 2006 & 2007

• The safest countries are Hungary, South Korea,

Poland & Bulgaria

• Pakistan, Nigeria, Venezuela & Iran are the

countries with least safety

• India stays at 62 both in 2006 & 2007

• China has improved its ranking from 61 in 2006 to

66 in 2007

Table Composite Score

2006 2007

Hungary 78 77 S. Korea 76 75 Poland 74 72 Bulgaria 70 69 Mexico 67 67 China 66 61 Brazil 66 64 Turkey 65 64 Argentina 66 66 S. Africa 64 65 Russia 63 61 India 62 62 Thailand 61 60

Egypt 60 58

Algeria 59 59

Saudi Arabia 57 57

Indonesia 57 55

Colombia 56 55

Ukrain 56 57

Philippines 55 56

Iran 51 49

Venezuela 50 52

Nigeria 48 47

Pakistan 45 50

Managing Political Risks

• Inter-national businesses employ different methodsfor managing political risks (see the Table under

Political Risk

• As the table shows, an MNC involves itself in each of

these either directly or indirectly. Similarly, its actions can be defensive or proactive

1. Avoiding Investment2. Adaptation3. Threat4. Lobbying5. Terrorism Consultants

Direct Indirect

1. Host operations

dependent on home control

2. Diversification

1. Risk insurance

2. Home country

government

pressuring host

country government

1. Joint venture

2. Licensing agreements

3. Promote host goals

1. Lobbying home &

host governments

2. Corporate citizenship

in host country

Reactive

Proactive

Managing Risks

1. Avoiding Investment

• The simplest way to manage political risks is to

avoid investing in a country ranked high on such

risks

• Where investment has already been made, plants

may be wound up or transferred to some other

country which is considered to be relatively safe

• This may be a poor choice as the opportunity to do

business in a country will be lost

2. Adaptation

• Another way of managing political risk is adaptation

• Adaptation means incorporating risk into business

strategies

• MNCs incorporate risk by means of the following

three strategies:

a) Local Equity & Debt

b) Development Assistance

c) Insurance

a) Local Equity & Debt

• This involves financing subsidiaries with the help of

local firms, trade unions, financial institutions, &

government

• As partners in local businesses, these groups ensure

that political developments do not disturb operations

• Localisation entails modifying operations, product

mix, or any such activity to suit local taste & culture

• When McDonald’s commenced franchisee

operations in India, it ensured that sandwiches did

not contains any beef.

b) Development Assistance

• Offering development assistance allows an inter-

national business to assist the host country in

improving its quality of life

• Since the firm & the nation become partners, both

stand to gain

• In Myanmar, for instance, the US oil company

Unocal & France’s Total have invested billions of

dollars to develop natural gas fields & also spent

$ 6 million on local education, medical care, & other

improvements.

c) Insurance

• This is the last means of adaptation

• Companies buy insurance against the potential

effects of political risk

• Some policies protect companies when host

government restrict the convertibility of their

currency into parent country currency

• Other insure against losses created by violence

events including war & terrorism

• Most developed countries have created agencies to

ensure the firms against risks

• These agencies are generally state owned/sponsored

• The Overseas Private Investment Corporation

(OPIC) for instance, insures US overseas

investments against nationalisation, revolutions &

foreign exchange inconvertibility

• Similarly, the Multilateral Investment Guarantee

Agency (MIGA), a subsidiary of the World Bank,

provides insurance against political risks

• Private insurance firms, such as Lloyd's of London,

also underwrites political risk insurance

3. Threat

• Political risks can also be managed by trying to

prove to the host country that it cannot do without

the activities of the firm

• This may be done by trying to control raw materials,

technology & distribution channels in the host

country

• The firm may threaten the host country that the

supply of materials, products, or technology would

be stopped if its functioning is disrupted.

4. Lobbying

• Influencing local politics through lobbying is another

way of managing political risks

• Lobbying is the policy of hiring people to represent

a firm’s business interest as also its views on local

political matters

• Lobbyists meet with local public officials & try to

influence their position on issues relevant to the firm

• Their ultimate goal is getting favourable legislation

passed & unfavourable ones rejected

• Lobbyists render variety of services for fees

• Whether brokering a deal relating to merger or

acquisition, obtaining a refund from government

developments or getting clearances to start new

projects, services of lobbyists are always available

• Several sectors of the economy are not thrown open

to FDI

• Such sectors offer plenty of scope for lobbying

Lobbyists come from different hues as exhibit

(below) shows

The Lobbyist Universe Types Individuals Modes of Operand Effectiveness

Owner- From Ratan Meet key policy Very high since Promoters Tata, to Mukesh makers personally, they bring a lot of

Ambani, to N.R drum up popular personal cred-Naraynan Murthy, support via media ibility & the heftto Azim Prem Ji of their businessto Sunil Mittal, empires to weigheveryone has on the issues theylobbied for, champion.variously, betterpolicies in telecom, oil &gas, education retail.

Consultants Typically, retired They work the ‘old High, since theybureaucrats boys’ network have know how the themselves better access than system works,

such as Pradip employee- & which theBaijal, former lobbyists, & levers to pull.TRAI chairman, know the lay of& C.M Vasudeva, the land betterformer Expenditure than most.Secretary in the Ministry of Finance

PR firmsIncreasingly being They work Medium to used to do more through in- low, because

than just public formal channels they haverelations, PR firms & media. Limited offer ‘back office’ access tosupport Perfect both theRelations, Genesis bureaucracy& IPAN are some & the media.such firms.

Professional Reliance Industries’ Mostly interact High, since

Employees Shankar Adawal, with key they know

ITC’s K. S Vidya- bureaucrats, the innards

nathan, Renbaxy or lobby via of their

laboratories’ industry industries &

Ramesh Adige, are associations. can make

some senior compelling,

executives who have fact-based

extensive domain arguments.

knowledge &

champion specific

issues.

Politicos Usually, members They try to Medium,

of Parliament or appeal to the they are

those embedded party high typically

in the organisational commands or the used in

machinery. concerned addition to

S. Gurumurthy & ministers direct- other

Salman Khurshid ly. Lobbyists.

are two examples.

Agents Dime a dozen, They keep Medium,to

these are largely track of bids, high, this is

fixers & do not file status, an ‘ever-

have the domain work through green’

knowledge or the lower level species.

credibility of other bureaucracy

lobbyists. & grease palms.

5. Terrorism Consultants

• To manage terrorism risk, MNCs hire consultants in

counter-terrorism to train employees to cope with

the threat of terrorism.

Bargaining & Integrative Approaches

• The five strategies of managing political risk which

have been discussed above fall under two broad

approaches :

i) Relative Bargaining Power, &

ii) Integrative as well as Protective &

Defensive Techniques

i) Relative Bargaining Power

• This theory is simple – an MNC has more

bargaining power than the host country

• In other words, the firm has the power & position to

do business in a host country on its own terms &

conditions

• Initiating investment in a host country, possessing

proprietary technology, & owning critical raw

materials will enable a firm to enjoy high bargaining

power

ii) Integrative as well as Protective & Defensive

Techniques

• Another means by which an international business

seeks to avoid political risk is by integration & the

implementation of protective & defensive techniques

• Integrative techniques are designed to help the

subsidiary to become one with the host country’s

needs & culture

• The adaptation strategies discussed earlier belong to

this category

• Protective & defensive techniques are designed to

discourage the host government from interfering in

operations • In contrast to the interactive techniques, these

actually encourage non-integration of the subsidiary

in the host country environment

Examples Include : 1) Doing as little local manufacturing as possible &

conducting all research & development outside thehost country ;

2) Limiting the responsibility of local personnel &hiring only those who are vital to the operation ;

3) Raising capital from local banks & the host government as well as outside sources ;&

4) Dispersing production of the product among a

number of countries

• When should a firm use integrative techniques &

when should it use protective & defensive strategies?

• Answers to these questions depend on the technology

being used, expertise & skills, logistics, & labour

transmission of the MNC

• In all, four basic types of firms are said to use these

techniques

• The first type comprises dynamic, high technology

MNCs which possess the unique knowledge that the

host country needs

• Computer companies are a good example

• As seen from Fig.(below), these firms may not use

integrative techniques

• They keep distance from host country governments

& rely heavily on protective & defensive techniques

• The second type consists of MNCs with low or stable

technology

• These firms use relatively unsophisticated

technology

• Steel companies are one such example

• As seen from Fig.(below), these MNCs use both high

integration & high protective & defensive strategies,

although they tend to rely more on integration than

on defensive approach

• The third type consists of inter-national businesses

whose managers need to be highly skilled

• For example, food production firms require

advanced marketing & management skills to be

competitive

• These firms typically use a balanced approach of

integration & protective & defensive techniques, but

they are less concerned with either than low or

stable technology companies do

• The last type comprises firms characterised by

highly labour-intensive products, high value in

relation to weight &/or volume, & need for a strong

global marketing systems for selling the product

• Firms manufacturing sewing machines are an

appropriate example

• Companies in this category tend to rely more

heavily on protective & defensive measures than any

of the other three groups & employ only a moderate

concern for integrative techniques

Low 1

1 10 20Low Moderate High

Protective/ defensive techniques

(11, 14) •Low or stable technology

• Unified logistic(7, 10) labour transmission

Advanced management (16, 6)skill •

(14, 3) •Dynamic hightechnology

Moderate 10

Integrativetechniques

High 20Fig. Use of Integrative & Protective & Defensive Techniques by Firms in Select

Industries