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THE RISKS AND COST

ASSOCIATED WITHINTERNATIONAL BUSINESS

For the firm which enters foreign markets for thefirst time, a (hypothetical) evolution in its

internationalisation process can be envisaged:

domestic production exportinglicensing foreign direct investment

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Sources of risk in the

internationalisation process

Risk is a problem of perceived uncertainty.

Firms have a good knowledge of their home

country conditions but are less certain about

the operating environment of non-domestic

markets.

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1) Risk associated with generating profits in thehost country.

Economic factors, e.g. decreasing GDP growthrates, increasing inflation rates, reduced localpurchasing power.

Political, e.g. strikes, changes in government,changes in legislation, war.

2) Risk associated with transferring (orrepatriating) earned profits back to homecountry,

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Exchange rate risk, of which there are three types:

i) transaction risk, the risk of not achieving the planned profitmargin on sales due to an adverse movement in exchange rate from

the rate used in the pricing decision.

ii) economic risk, the risk that a sustained, real rise of a currencyagainst the currencies of competitors will adversely affect acompanys cost and therefore sales, margins and market share,

which, in turn, decreases the firms return on capital employed.

iii) translation risk, the risk of loss of net worth of the company whicharises from the legal requirement that all firms annuallyconsolidate, in a single currency, their financial statements (balancesheets and income statements) of all world-wide operations.

Exchange regulations and restrictions limiting or taxing profitrepatriation.

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CHALLENGES ARISING FROM EXPLORING

INTERNATIONAL MARKETS

Cost reduction. This comes from the moreintense competition in world markets. Pressuresfor cost reductions can be particularly intense in

industries producing commodity type productswhere meaningful differentiation on non-pricefactors is difficult and price is the maincompetitive weapon, such as petroleum, steel,

sugar and so on. To certain extent, it is also thecase for calculators, semiconductor chips, andpersonal computers.

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Local responsiveness. Pressures for local responsivenessarise from a number of sources:

Differences in consumer tastes and preferences. Forexample, American like large cars, while in Europe mediumand smaller sized cars are most welcome.

Differences in infrastructure and traditional practices. Forexample, in North America consumer electrical systems are

based on 110 volts, while in European countries 240-voltsystems are standard. Thus domestic electrical applianceshave to be customised for this difference in infrastructure.In the case of traditional practices, for example, in Britainpeople drive on the left side of the road, whereas in

neighbouring Europe, people drive on the right-hand sideof the road, thus creating a demand for right hand drivecars in Britain and left hand cars in Europe.

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Differences in distribution channels. Retailing

industry between countries can be strikingly

different. Host government demands. Economic and

political demands imposed by host country

governments necessitate a degree of localresponsiveness. This includes issues like

protectionism, local content rules and specific

technical standards.

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(3) The global-local dilemma: on the one

hand, firms are competing with each other in

the global marketplace by exploiting own firmspecific advantages in order to cut cost as

much as possible, on the other hand, firms

must respond to the needs of specific singlemarket by customising their products, which

indicates an increase of costs and a weakening

of their competitive advantages. How to deal

with this is central to the international

operation.

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Motivations For Internationalisation

Dunning, 1992). He argued that FDI will only

occur when all 3 conditions are present:

1) A firm must possess Ownership-specific

advantages not possessed by other firms. Ownership-specific advantages include assets

such as certain types of knowledge or skills, for

which however the firm has a proprietary rightof use (e.g. legally-protected rights,

technological know-how, and size and market

power).

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2) There must be Location-specific factors

that make it more profitable for the firm to

exploit its assets in foreign countries (ratherthan in domestic locations). Location-specific

factors refer to the factors which are available

in particular locations and which have to beused in those locations. Location-specific

factors can be related to markets, productions

costs, resources, and other softer issues, e.g.political and cultural.

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3) The firm must Internalise the use of theseownership-specific advantages. In other words, itmust not sell them or lease them to other firms.The greater the market imperfection, the greaterwill be the incentive for a firm to internalisemarket transactions. Example of verticalintegration: many firms control either their ownsources of supply or the destination of theiroutputs. Similarly, in order to protect theirknowledge against predators, many R&D-

intensive firms use this knowledge within theirfirms boundaries.

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c) Seeking technological capability,

management and marketing expertise, andorganisational skills. Examples include

collaborative alliance concluded by Korean

and Indian companies with EU or US firms inhigh technology sectors.

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a)Seeking physical resources:- These include

primary producers and mfg. enterprises, who are

driven to engage in FDI by the motives of costminimization and security of supply sources. The

resources they seek include minerals, raw

materials and agricultural products but especially

those whose production requires the kind of

complementary capabilities and markets that

MNEs are especially well equipped to provide..

These include minerals such as oil, zinc, copper,tin and bauxite and agricultural products such as

rubber, tobacco, sugar, coffee, tea etc.

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b)Seeking Plentiful supplies:- This kind of FDI

is usually undertaken by mfg. And service

MNEs from countries with high real labourcosts, which set up or acquire subsidiaries in

countries with lower labour costs to supply

labour intensive intermediate or final productsfor export. Eg: Mexico, Taiwan, Malaysia.

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c) Seeking technological capability:- These

also include executive search subsidiaries set

up by US firms in the UK; and R&D listeningposts established by UK chemical companies

in Japan. Each of these value-added activities

parallels the investment made. Eg; BelgianMNEs in Africa or Japanese MNE in Australia.

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2) Market Seeking: These are the enterprises

that invest in particular country or region to

supply goods or services to markets in theseor in adjacent countries. Market-seeking

investment may be undertaken to sustain or

protect existing markets or to exploit andpromote new markets. Apart from market size

and the prospects for market growth, there

are five main reasons which might prompt

firms to engage in market seeking

investment:

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a) The first is that their main customers have

set up foreign producing facilities and that to

retain their business they need to follow themoverseas. One example of this kind is that

more than 300 Japanese auto-component

suppliers have set up their own manufacturing

subsidiaries in the US, to supply the leading

Japanese auto assemblers which had

established production bases in the country.

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b) The second reason for market-seeking

investment is that foreign producers need to

adapt their products and marketing behaviourto the needs of the host country; otherwise

they would be in a disadvantageous position

to compete with local producers. Local needs

mean local tastes, local language, business

customs, legal requirements, and marketing

procedures. For example, food,

telecommunications, clothes and cars, all

need to be adapted to meet the local taste.

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c) The third reason is that the production and

transaction costs of manufacturing in the target

country are less than supplying it from a distance.The production of goods that are relatively costly

to transport and can be produced economically in

small quantities is more likely to be located near

the main centres of consumption than are those

that cost relatively little to transport and yield

substantial economies of scale in their

production, for example, washing machines aremore likely to be produced in the target market

than computers.

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d) The fourth reason is that it is increasingly important for afirm to have a physical presence in the leading marketsserved by its competitors. Such strategic market-seekinginvestment might be undertaken for defensive or

aggressive reasons.

Defensive investmentmeans following the investment ofthe competitors of a firm by making its own investment inthe same markets and in similar scale;

Aggressive investmentare those designed to advance theglobal interests of a firm by investing in an expandingmarket. For example, when the market of central and

eastern Europe opened to the international business, Pepsi-Cola made huge investment in Russia before others, andthe aim was to seize the leading role in soft drink market inthis country. This is aggressive investment.

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e) The last reason, the single most importantreason for market-seeking investment, is hostgovernment policy. Traditionally, host

governments usually imposed heavy tariff andnon-tariff barriers on import, and market seekinginvestment was a way of overcoming such tradebarriers. Since the1980s, more and more foreigngovernments have chosen to attract inwardinvestment by offering a variety of investmentincentives ranging from tax concessions tosubsidised labour and capital costs. As a result,foreign investment flourished, and globaleconomic integration has been upgradeddramatically in the past two decades.

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3)Efficiency Seeking: The efficiency seekinginvestment is undertaken to gain benefits fromthe common governance of geographically

dispersed business activities in differentcountries. Such benefits are those of theeconomies of scale and scope and of riskdiversification. That is to say, according to the

different factor endowments, cultures,institutional arrangements, economic systemsand policies, and market structures, MNCsrationalise their investment by concentrating

their production in a limited number of locations,but still serving multiple markets.

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4)Strategic Asset Seeking: Strategic asset seekinginvestment comprises those which engage in acquiring theassets of foreign corporations, to promote their long-termstrategic objectives - especially that of sustaining or

advancing their international competitiveness. The motiveof strategic asset seeking is to:

a) strengthen the present or future competitiveness of theacquiring firm concerned, either by adding to the acquiringfirms existing portfolio of assets, or by weakening that ofits competitors.

b) exploit specific cost or marketing advantages over their

competitors than to add to the acquiring firms existingportfolio of assets, others which they perceive will eithersustain or strengthen their own overall competitiveposition or weaken that of their competitors.

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Other Motives for Engaging in InternationalBusiness/Other motives for MNE activity

1)Escape Investments

Some international investment is made to escaperestrictive legislation or macro-organisational policies

by home governments.

Examples of this kind investment the shifting of itscancer and immune system research of BASF, a Germancompany, from Germany to the US as a way to confront

with the legal and political challenges from the localgreen movement; and the investment by Israeli firmsin EC before 1992 to by-pass the Arab boycott onproducts exported from Israel.

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2) Support Investments

The purpose of these investments is to supportthe activities of the rest of the enterprise ofwhich they are part. Their activities may incurcosts but the rest of the same MNC can benefit

enormously. Eg; Leading clothing wholesaleandroecial outlets in Europe and US such as SeasRoebuck, K. Mart which purchase substantialquantities of clothing and footwear from Asian

suppliers and delegate the sub contractingarrangements to their buying subsidiaries in HongKong, Singapore, Thailand etc.

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International business environment

Firms also need to acquire knowledge of thelocal business environment so that they can

operate effectively there. Countries differ in

respect to:

Cultural environment

Political environment

Economic environment Legal environment

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Cultural Environment

Culture may be defined as that complex wholewhich includes knowledge, belief, morals,

customs & other capabilities acquired by man

as a member of society.

.The collective programming of the mind

which distinguishes the members of one

human group from another.

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Identification and Dynamics of culture

The nation as a point of reference

Cultural formation and dynamics Culture istransmitted in various ways from parent tochild, teacher to pupil, social leader tofollower & one pear to another.

Change in culture may come about throughchoice or imposition.

Language is a factor that greatly affects

cultural stability- when people from differentareas speak the same language culturespreads more easily.

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that helps explain why more cultural similarity

exists among English speaking countries.

Religion is a strong shaper of values and a

cultural stabilizer Christianity, Hinduism,

Buddhism, and Islam have specific beliefs that

affects business.

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Behavioral Practices affecting business

Attitudes and values affects business behavior-whatproducts to sell, how to organize, finance, manage &control operations.

Social Stratification system - Every culture value

some people more highly than others because of apersons class or status within that culture. A

persons ranking is partly determined by his

affiliation.

Ascribed group membership based on Gender,family, age, cast, etc.

Acquired group membership based on religion,

political & professional affiliation.

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Performance orientation- In US eligibility for

jobs & promotion is governed by competence

as the work environment is driven more bycompetition than by cooperation.

In Japan where the work place is characterized

by cooperation than competition, humannessis more important.

Materialism & leisure The Japanese take

less leisure time whereas in the US, incomesallows for more leisure time. In Europe people

are more prone to enjoy leisure time than in

the US.

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Expectation of success & rewardsPeopleusually work harder at any task when the rewardfor success is high compared with that a failure.

Thus employees work attitude is determined bythe work culture and reward system. Needhierarchy is helpful for differentiating the rewardpreferences of employees in different countries.

Power DistanceWhere power distance is highthere is little consultation between superior &subordinates. Dutch managers believe in lowpower distance where as Moroccan managershave high power distance preference.

Individualism Vs collectism - A US scientistinvited to work in Japan was treated as anoutsider until he changed his work behaviour &became group friendly.

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China & Mexico are characterized by collectivistculture.

Uncertainty avoidance - In some countries fewcustomers are prepared to take the risk of tryinga new product this is important for the firms tochoose where to introduce new products.Denmark & UK have low, Belgium & Portugal are

countries with high un certainty avoidance. Trust - Higher Percentage of Norwegian than

Brazilians think that most people are trustworthy.

Future Orientation

Higher in Switzerland,Netherlander & Canada than in Russia, Poland &Italy.

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Obtaining InformationIn US & Northern Europepeople only look at information that has directbearing on the decision making, whereas in

Southern Europe most people believe thatperipheral information is valuable in decisionmaking & Infer meanings from things saidindirectly.

Information Processing - In US, TelephoneDirectories Contain Names in Alphabetical orderby last (Family Name), In Island entries areorganized by 1st (Given Name).

Communication Issues Different words, sounds,gestures, carry different meaning in Differentcountries.

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International Economic Environment

Change in one element of economics Changesenvironment.

Important indicators :

GNI (Gross National Income) total value of all

goods & services produced by a country in ayear.

GDP (Gross Domestic Product) total value of

all goods & services produced within theborders of a country in a year, includingforeign owned companies.

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Human development - access to knowledge,

nutrition, food, healthcare, employment, law

and order, recreation, freedom of expressionetc.

Inflation- aggregate demand> aggregatesupply - prices up more than income rise

Inflation - interest rate, exchange rate, cost of

living, eco stability, political stability.

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Political Environment

Political decisions/ events - can affectprofitability of business.

Imposition of tariffs, local content, export

obligations. Profit repatriation - limits.

Labour rights.

Discrimination in taxes - domestic vs foreign/favored nation.

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Types of political risks :

Shift in public policy - In disfavor of foreign/dominating companies.

To gain greater share of the benefits

May be for the masses - shift from individualism tocollectivism - These are systemic political risks.

Corruption - makes operations costly.

Bureaucracy, customs - assistance, speed money bribe big riskProcedural.

Monitory policies, tax structures, regulations altered

Distributive risk.Ethnic violence, civil disorder, war, military upheavals,and international terrorism

affect one and allCatastrophic.

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Govt. Intervention & Trade Control

What, how much, with which country a countryshould trade ?

Should market forces decide these - Laissez-faire

approach ? Should Government intervene ?

If no restriction, exports will take place from lowto high cost of production countries.

Restrictions exports hampered productionmay happen in restricting countries.

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Legal EnvironmentThe globe may be shrinking, as a place to do business, but

standards of law can still be worlds apart from country tocountry. Consequently national laws greatly impact theglobal business.

Generally Legal systems fall into the following categories.

A Common Law system

is based on tradition & usage,and judge made precedent.

A civil law system- is based on a systematic codification oflaws. More than 70 countries, including Germany, France

& Japan are civil law system countries. Theocratic Law system - Relies on religious & spiritual

principles to define the legal environment. Islamic Law isthe most prevelant theocratic system.

A Mi d L l t E h t f th

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A Mixed Legal system - Emerges when two or more of thepreceding legal systems function in a company. Majority ofcountries with mixed legal system are in Africa & Asia.

Anti-Dumping Laws - The act of exporting a product by aninternational firm at a price lower than the price it normallycharges in its home market is defined as dumping the product.

Cyber Law

Refers to the law that governs the use ofcommunication technology.

Intellectual property rights Refers to certain legal claims orrights in relation to certain inventions, names, written of

recorded media. The laws relating to IPR vary according tojurisdiction, however efforts have been made to bring aboutsome amount of harmony through treaties including WTO &TRIPS.

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International Dispute resolution Arbitration isused to resolve various commercial disputes thatmay arise in the international market place. Most

coats across the world recognize the internationalcommercial arbitration awards.

Product liability International companies mustcustomize product to comply with local standard

of a particular country. Product safety & liabilitycases may involve high punitive damages.

Marketplace Behavior - National laws determinepermissible practices in pricing, distribution,advertising of products and services. Germanyprohibits comparative advertising. In France amanufacturer can not offer a product it does notmanufacture as an inducement to buy one of itsproduct.

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Product Origin national laws shape the flow

of product across borders. Most of the

countries push foreign countries to make agreater share of the product in the local

market.

Legal Jurisdiction

Each country specifieswhich law should apply & where litigation

should occur. Usually a company will push the

court in its home country to claim Jurisdiction.