Hcba 3221 International Bus MNGT Course Outline

HCBA TEACHING NOTES 2014
HCBA 3221: INTERNATIONAL BUSINESS MANAGEMENT

Course Purpose
This course seeks to familiarise the students with multinational/transnational organisational operations.
Course Objectives
At the end of this course the student should be able to:1.
2.
3.
Understand international/global business activities, problems, techniques, and strategies.

Enable the students to understand the dynamic international business environment.
Expose the students to the dynamics of international business, marketing and management.
Course Description
TOPIC 1: Overview of international Business Management - World Business Environment - Macro environmental factors
and their implications;
TOPIC 2: Evolution of Multinational enterprises/corporations TOPIC 3: Strategies and Management of International Business - Transfer Pricing; Marketing Mix Strategies; Foreign Entry
strategies; Foreign Direct Investment;
TOPIC 4: Global Business Organization/Structure
TOPIC 5: Challenges in International Business Management .
Teaching Methodology
1. Lectures,
2. Case Analyses,
3. Group discussions,
4. Guest speakers
Instructional Materials:
These will include: Tablet, Smart board, LCD projector & Computers, Flipcharts, televisions, videos
Course Evaluation
CATs/Assignment/Presentation
Final Examination
40 %
60 %
Course Text books

th
Donald A. B., Wendell, H. Mc Culloch, Jr. (2004). International Business, 9 Ed. Homewood, Illinois: Irwin
Czinkota, M. R., Ronkainen, I. A., and Moffett, G. (2003). International Business, 4th edition, The Dryden Press, India
Reference Text books
rd
Ricky, W. G. and Michael, W. P. (2003). International Business: A Managerial Perspective, 3 Ed., Prentice Hall.
John, J. W., Kenneth, L. W. and Jerry, C.Y. H. (2001). International Business: An Integrated Approach e-Business Updated
Edition, Prentice Hall, India
Course Journals: Journal of International Business Studies, Journal of International Marketing, Journal of Strategic
Management
Reference Journals: Journal of Business, Journal of Business Management, Journal of Business & Economic Statistics
Pamela A. Ochieng
Page 1

SECTION I: OVERVIEW OF INTERNATIONAL BUSINESS MANAGEMENT
Definition of terms and concepts:
1. International business comprises all commercial transactions (private and
governmental, sales, investments, logistics, and transportation) that take place
between two or more regions, countries and nations beyond their political boundaries.
Usually, private companies undertake such transactions for profit; governments
undertake them for profit and for political reasons.
It refers to all those business activities which involve cross border transactions of goods,
services, resources between two or more nations. Transaction of economic resources include
capital, skills, people etc. for international production of physical goods and services such as
finance, banking, insurance, construction etc.
2. A multinational enterprise (MNE) is a company that has a worldwide approach to
markets and production or one with operations in more than a country. An MNE is
often called multinational corporation (MNC) or transnational company (TNC).
Well known MNCs include fast food companies such as McDonald's and Yum
Brands, vehicle manufacturers such as General Motors, Ford Motor Company and
Toyota, consumer electronics companies like Samsung, LG and Sony, and energy
companies such as ExxonMobil, Shell and BP. Most of the largest corporations
operate in multiple national markets.
3. World Business Environment: Areas of study within this topic include differences
in: Legal systems, political systems, economic policy, language, accounting standards,
labor standards, living standards, environmental standards, local culture, corporate
culture, foreign exchange market, tariffs, import and export regulations, trade
agreements, climate, education and many more topics. Each of these factors requires
significant changes in how individual business units operate from one country to the
next.
4. Macro environmental factors and their implications: THE PESTEL ANALYSIS
Political
Economic
Social-cultural
Technological
Environmental/Geographical
Legal
Pamela A. Ochieng
Page 2
5. Globalization
What is important about globalization?
Understand what is meant by the term globalization.
Be familiar with the main drivers of globalization.
Appreciate the changing nature of the global economy.
Understand the major arguments in the debate over the impact of globalization.
Appreciate how the process of globalization is creating opportunities and challenges

for business managers
Factors that influenced the growth in globalization of international business

There has been growth in globalization in recent decades due to (at least) the following eight
factors:
Technology is expanding, especially in transportation and communications.

Governments are removing international business restrictions.
Institutions provide services to ease the conduct of international business.
Consumers want to know about foreign goods and services.
Competition has become more global.
Political relationships have improved among some major economic powers.
Countries cooperate more on transnational issues.
Cross-national cooperation and agreements

TOPIC 1: GLOBALIZATION
What is Globalization?
Globalization is a shift toward a more integrated and interdependent world economy.
Globalization has two components: the globalization of markets and the globalization of
production.
Globalization of Markets
Pamela A. Ochieng
Page 3

In many markets the emergence of a global marketplace has begun to occur. There are three
causes: falling barriers to cross-border trade have made it easier to sell internationally; tastes
and preferences are converging on some global norm helping to create a global market; and
firms are facilitating the trend by offering standardized products worldwide creating a global
market.
Globalization of Production
The globalization of production refers to the sourcing of goods and services from locations
around the globe to take advantage of national differences in the cost and quality of factors
of production (such as labor, energy, land, and capital). By doing this, companies hope to
lower their overall cost structure and/or improve the quality or functionality of their product
offering, thereby allowing them to compete more effectively.
Emergence of Global Institutions
Globalization has created the need for institutions to help manage, regulate and police the
global marketplace. Institutions that have been created to help perform these functions are
the General Agreement on Tariffs and Trade (GATT), the World Trade Organization
(WTO), the International Monetary Fund (IMF), the World Bank, and the United
Nations.
The World Trade Organization (WTO) is primarily responsible for policing the world
trading system and making sure nation-states adhere to the rules laid down in trade treaties.
The International Monetary Fund (IMF) was created to maintain order in the international
monetary system and the World Bank was set up to promote economic development. The
United Nations (UN) was created to preserve peace through international cooperation.
Drivers of Globalization
The two macro factors underlie the trend towards greater globalization: the decline in the
barriers to free flow of goods, services, and capital; and technological change in
communications, information processing, and transportation technologies.
Declining Trade and Investment Barriers
International trade occurs when a firm exports goods or services to consumers in another
country.
Foreign direct investment (FDI) occurs when a firm invests resources in business activities
outside its home country.
The Role of Technology
The lowering of trade barriers made globalization of markets and production a theoretical
possibility, technological change made it a tangible reality. Managers today operate in an
Pamela A. Ochieng
Page 4

environment that offers more opportunities, but is also more complex and competitive than
that of a generation ago.
The Changing World Output and World Trade Picture
In the 1960s: the U.S. dominated the world economy and the world trade picture, U.S.
multinationals dominated the international business scene, and about half the world-- the
centrally planned economies of the communist world-- was off limits to Western international
business.
The Changing Foreign Direct Investment Picture
The share of world output generated by developing countries has been steadily increasing
since the 1960s. There has been a sustained growth in cross-border flows of foreign direct
investment.
The Changing Nature of the Multinational
A multinational enterprise is any business that has productive activities in two or more
countries.
The Changing World Order
The collapse of communism in Eastern Europe represents a host of export and investment
opportunities for Western businesses. The economic development of China presents huge
opportunities and risks, in spite of its continued Communist control. Mexico and Latin
America also present tremendous new opportunities both as markets and sources of materials
and production
The Global Economy of the Twenty-First Century
Firms should be aware that while the more integrated global economy presents new
opportunities, it also could result in political and economic disruptions that may throw plans
into disarray
The Globalization Debate
Is the shift toward a more integrated and interdependent global economy a good thing?
Anti-Globalization Protests
Anti-globalization protesters now turn up at almost every major meeting of a global
institution. Protesters fear that globalization is forever changing the world in a negative way.
Globalization, Jobs, and Income
Critics of globalization worry that jobs are being lost to low-wage nations.
Pamela A. Ochieng
Page 5

Supporters of globalization argue that free trade will result in countries specializing in the
production of those goods and services that they can produce most efficiently, while
importing goods and services that they cannot produce as efficiently.
Globalization, Labor Policies, and the Environment
Critics of globalization argue that that free trade encourages firms from advanced nations to
move manufacturing facilities offshore to less developed countries with lax environmental
and labor regulations.
Supporters of free trade point out that tougher environmental regulation and stricter labor
standards go hand in hand with economic progress and that foreign investment often helps a
country to raise its standards.
Globalization and National Sovereignty
Critics of globalization worry that economic power is shifting away from national
governments and toward supranational organizations such as the World Trade Organization
(WTO), the European Union (EU), and the United Nations.
However, supporters of globalization contend that the power of these organizations is limited
to what nation-states agree to grant, and that the power of the organizations lies in their
ability to get countries to agree to follow certain actions.
Globalization and the Worlds Poor
Critics of globalization argue that the gap between rich and poor has gotten wider and that the
benefits of globalization have not been shared equally.
Supporters of free trade suggest that the actions of governments have made limited economic
improvement in many countries.
Managing in the Global Marketplace
Managing an international business (any firm that engages in international trade or
investment) is different from managing a domestic business because countries differ,
managers face a greater and more complex range of problems, international companies must
work within the limits imposed by governmental intervention and the global trading system,
and international transactions require converting funds and being susceptible to exchange rate
changes.
EXAMPLE DISCUSSION QUESTION 1.

QUESTION: "The study of international business is fine if you are going to work in a large
multinational enterprise, but it has no relevance for individuals who are going to work in
small firms." Evaluate this statement.
Pamela A. Ochieng
Page 6
ANSWER: Globalization is changing the world economy. Firms, even small ones, can no
longer ignore events going on outside their borders because what occurs in one country has
implications for the rest of the world. Individuals who believe they can act in isolation by
working for a small firm are not being realistic, but rather myopic and insular. Today, thanks
to advances in technology, many small firms sell and source internationally very early in their
evolution, those that fail to take advantage of international opportunities may not achieve
their full potential, and ultimately may fail as competitors that do recognize the importance of
international business dominate. In the United States, for example, almost 90 percent of
firms that export employ fewer than 100 people. They also account for more than 20 percent
of U.S. exports.
PART B: What is the scenario like in Kenya and Africa? Further the above discussion citing
at least 10 small businesses and their involvement in international business in Kenya and
Africa. Do these businesses account for any percentage of exports?
TOPIC 2: NATIONAL DIFFERENCES IN POLITICAL ECONOMY
In this section we discuss the differences in national political, economic, and legal systems,
highlighting the ways in which managers in global settings need to be sensitive to these
differences.
Political differences are described along two dimensions: collectivist vs. individualist and
democratic vs. totalitarian. Economic systems are explored in terms of market
characteristics: market economies, command economies, and mixed economies. Legal
systems are discussed in terms of the protections they offer for business: intellectual property,
product safety, liability and contracts.
Political Economy
The political, economic, and legal infrastructure of a nation has a major influence on the way
managers make decisions. Political systems have two dimensions: the degree of collectivism
versus individualism, and the degree of democracy versus totalitarianism.
These dimensions are interrelated; systems that emphasize collectivism tend towards
totalitarian, while systems that place a high value on individualism tend to be democratic.
However, a large gray area exists in the middle. It is possible to have democratic societies
that emphasize a mix of collectivism and individualism. Similarly, it is possible to have
totalitarian societies that are not collectivist.
Collectivism and Individualism
Collectivism refers to a political system that stresses the primacy of collective goals over
individual goals. Advocacy of collectivism can be traced to the ancient Greek philosopher
Pamela A. Ochieng
Page 7

Plato. In modern times the collectivist system is largely the domain of nations that have
embraced socialism.
Individualism is the direct opposite of collectivism. Its central tenet is that individual
economic and political freedoms are the ground rules on which society is based.
Democracy and Totalitarianism
Democracy, as originally practiced by several city-states in ancient Greece, is based on a
belief that citizens should be directly involved in decision making. Most modern democratic
states practice representative democracy in which citizens periodically elect individuals to
represent them. Totalitarianism is a form of government in which one person or political
party exercises absolute control over all spheres of human life and opposing political parties
are prohibited. (Communist, theocratic, tribal, right wing) Totalitarianism denies its citizens
all of the constitutional guarantees asserted by representative democracies.
Economic Systems
There is a connection between political ideology and economic systems. In countries where
individual goals are given primacy over collective goals, we are more likely to find free
market economic systems. In contrast, in countries where collective goals are given
preeminence, the state may have taken control over many enterprises, while markets in such
countries are likely to be restricted rather than free.
There are three broad types of economic systems: the market economy, the command
economy, and the mixed economy.
Market Economy
A market economy is an economy in which all productive activities are privately owned, as
opposed to being owned by the state. Production is determined by the interaction of supply
and demand and signaled to producers through the price system.
Command Economy
A command economy is an economy in which the goods and services that a country
produces, the quantity in which they are produced, and the prices at which they are sold are
all planned by the government.
Mixed Economy
A mixed economy is an economy in which certain sectors of the economy are left to private
ownership and free market mechanisms while other sectors have significant state ownership
and government planning. India has a mixed economy.
Mixed economies were once very common throughout much of the world, although they are
becoming much less so. There was a time not too long ago when Great Britain, France, and
Pamela A. Ochieng
Page 8

Sweden were mixed economies, but extensive privatization has reduced state ownership of
businesses in all three.
Legal Systems
Legal systems are the systems of rules or laws that regulate behavior along with the
processes by which the laws are enforced and through which redress for grievances is
obtained.
There are three main types of legal systems or legal traditions in use around the world:
common law, civil law, and theocratic law. Common law is based on tradition, precedent,
and custom. Civil law is based on a very detailed set of laws organized into codes.
Theocratic law is based on religious teachings.
Contract Law
A contract is a document that specifies the conditions under which an exchange is to occur
and details the rights and obligations of the parties involved. Contract law is the body of law
that governs contract enforcement.
Since common law tends to be relatively ill specified, contracts drafted under a common law
framework tend to be very detailed with all contingencies spelled out. In civil law systems,
contracts tend to be much shorter and less specific because many of the issues typically
covered in a common law contract are already covered in a civil code.
When contract disputes arise in international trade, there is always the question of which
countrys laws apply. Many countries including the United States have ratified the United
Nations Convention on Contracts for the International Sale of Goods (CIGS). The CIGS
establishes a uniform set of rules governing certain aspects of the making and performance of
everyday commercial contracts between sellers and buyers who have their places of business
in different nations.
Property Rights
Property rights refer to a resource over which an individual or business holds a legal title;
that is, a resource that they own.
These rights can be violated through private or public action. Private action refers to theft,
piracy, blackmail, and the like by private individuals or groups. Public action violations
occur when public officials, such as politicians and government bureaucrats, extort income or
resources from property holders.
In the United States the Foreign Corrupt Practices Act makes bribing a foreign government
official in order to obtain or maintain business over which that foreign official has authority a
violation of United States law, and requires all publicly traded companies to keep audit
records.
Pamela A. Ochieng
Page 9

Intellectual Property Rights
Intellectual property is property that is the product of intellectual activity, such as computer
software, a screenplay, a music score, or the chemical formula for a new drug.
Ownership rights over intellectual property are established through patents, copyrights, and
trademarks.
Product Safety and Liability
Product safety laws set safety standards for products and manufacturing processes. Product
liability involves holding a firm and its officers responsible for product safety standards.
Determinants of Economic Development
Differences in economic development across countries are often linked to differences in their
political, economic, and legal systems.
Economic development can be measured by gross national income per head of population
(GNI) (rather than GNP) and purchasing power parity (PPP) which is GNI per capita
adjusted for cost of living.
Broader Conceptions of Development: Amartya Sen
The Nobel prize-winning economist Amartya Sen has argued in his theory of social
development that development should be assessed less by material output measures such as
GNI per capita/GDP per capita and more by the capabilities and opportunities that people
enjoy.
Sens influential thesis has been picked up by the United Nations, which has developed the
Human Development Index (HDI) to measure the quality of human life in different nations.
Political Economy and Economic Progress
A countrys economic development is a function of its economic and political systems.
Economic freedom associated with a market economy creates greater incentives for
innovation and entrepreneurship than either a planned or a mixed economy.
Innovation and entrepreneurship require strong property rights.. Without strong property
rights protection, businesses and individuals run the risk that the profits from their innovative
efforts will be expropriated, either by criminal elements or by the state.
There is debate on the kind of political system that best achieves a functioning market
economy with strong protection for property rights. People in the West tend to associate a
representative democracy with a market economic system, strong property rights protection,
and economic progress. Building on this, we tend to argue that democracy is good for growth.
Pamela A. Ochieng
Page 10

However, some totalitarian regimes have fostered a market economy and strong property
rights protection and have experienced rapid economic growth. Four of the fastest-growing
economies of the past 30 yearsSouth Korea, Taiwan, Singapore, and Hong Konghad one
thing in common at the start of their economic growth: undemocratic governments!
While it is possible to argue that democracy is not a necessary precondition for a free market
economy in which property rights are protected, subsequent economic growth often leads to
establishment of a democratic regime
Geography, Education, and Economic Development
In addition to political and economic systems, geography and education are also important
determinants of economic development
States in Transition
Two trends are evident: first, during the late 1980s and early 1990s, a wave of democratic
revolutions swept the world; second, totalitarian governments collapsed and were replaced by
democratically elected governments that were typically more committed to free market
capitalism than their predecessors had been.
These changes were most dramatic in Eastern Europe, where the collapse of communism
bought an end to the Cold War and led to the breakup of the Soviet Union, but similar
changes were occurring throughout the world during the same period. Across much of Asia,
Latin America, and Africa there was a marked shift toward greater democracy.
The Spread of Democracy
There are three reasons for the spread of democracy:
First, many totalitarian regimes failed to deliver economic progress to the vast bulk of their
populations.
Second, new information and communication technologies have broken down the ability of
the state to control access to uncensored information.
Third, the economic advances of the past quarter century have led to the emergence of
increasingly prosperous middle and working classes who have pushed for democratic
reforms.
Another Perspective: A number of countries and regions maintain an international Chamber
of Commerce to disseminate current information about their respective country or regional
of the world. These Chambers of Commerce provide a first stop when conducting research
on the market potential of a particular country or area.
The New World Order and Global Terrorism
There is intense speculation about the future shape of global geopolitics.
Pamela A. Ochieng
Page 11

Many countries may be increasingly difficult places in which to do business, either because
of their inherent violent conflict, or because they are part of a civilization that is in conflict
with an enterprises home country.
Another Perspective: The case of U.S.A - The U.S. State Department produces a series of
annual "Country Reports" to acquaint American businesses with other countries. Each report
contains nine sections: (1) Key Economic Indicators; (2) General Policy Framework; (3)
Exchange Rate Policies; (4) Structural Policies; (5) Debt Management Practices; (6)
Significant Barriers to US Exports and Investments; (7) Export Subsidies Policies; (8)
Protection of US Intellectual Property; and (9) Worker Rights. Information about obtaining
these reports is available through the United States Department. There is also a special
section devoted to international business.
Spread of Market Based Systems
Paralleling the spread of democracy since the 1980s has been the transformation from
centrally planned command economies to market-based economies.
The Nature of Economic Transformation
These changes have involved:
Deregulation - removing legal restrictions to the free play of markets, and allowing the
establishment and operations of private enterprises. Privatization - transferring the
ownership of state property into the hands of private individuals, frequently by the sale of
state assets through an auction.
Privatization - a way to unlock gains in economic efficiency by giving new private owners a
powerful incentivethe reward of greater profitsto search for increases in productivity, to
enter new markets, and to exit losing ones.
Implications of Changing Political Economy
Markets that were formerly off-limits to Western business are now open.
China with its 1.2 billion people and India with its population of almost 1 billion are
especially important.
However, just as the potential gains are large, so are the risks. Democracy may not thrive in
some countries.
Managerial Implications
Managers need to focus on two broad areas:
First, the political, economic, and legal environment of a country influences the attractiveness
of that country as a market and/or investment site. The benefits, costs, and risks associated
Pamela A. Ochieng
Page 12

with doing business in a country are a function of that countrys political, economic, and
legal systems.
Second, the political, economic, and legal systems of a country can raise important ethical
issues that have implications for the practice of international business.
Benefits
The long-run benefits of doing business in a country are a function of the size of the market,
the present wealth of consumers in that market, and the likely future wealth of consumers.
Costs
There are three types of costs involved in international business: political costs, economic
costs, and legal costs.
Risks
There are three types of risk involved in international business: political risk, economic risk,
and legal risk.
Overall Attractiveness
The overall attractiveness of a country as a market and/or investment site, depends on
balancing the likely long-term benefits of doing business in that country against the likely
costs and risks.
CRITICAL THINKING AND DISCUSSION QUESTIONS: Look at the questions and the
sample answers given below. Can you add your personal thought and opinion to them?
Attempt to provide your own answer for Question three.
QUESTION 1: Free market economies stimulate greater economic growth, whereas statedirected economies stifle growth. Discuss.
ANSWER 1: In a market economy, private individuals and corporations are allowed to own
property and other assets. This right of ownership provides a powerful incentive for people
to work hard, introduce new products, develop better advertising campaigns, invent new
products, etc., all in the hopes of accumulating additional personal capital and wealth. In
turn, the constant search on the part of individuals and corporation to accumulate wealth
enriches the entire economy and creates economic growth. In contrast, in a command
economy, private individuals and corporations are not allowed to own substantial quantities
of property and other assets. The objective of a command economy is for everyone to work
for the good of the society. Although this sounds like a noble ideal, a system that asks
individuals to work for the good of society rather than allowing individuals to build personal
wealth does not provide a great incentive for people to invent new products, develop better
advertising campaigns, find ways to be more efficient, etc. As a result, command economies
typically generate less innovation and are less efficient than market economies.
Pamela A. Ochieng
Page 13
QUESTION 2: A democratic political system is an essential condition for sustained

economic progress. Discuss.
ANSWER 2: Although you can always find examples of totalitarian regimes that have
achieved rapid economic growth, it seems fair to say that sustained, decades-long periods of
economic growth are quite rare under totalitarianism. There is a widespread belief in the
West that democratic principles are more conducive to long-term economic growth than are
totalitarian ones. One of the contributing factors is that democratic systems allow for the
stable transfer of power through elections, and thus provide political stability, which is an
essential prerequisite for rapid economic growth.
QUESTION 3: What is the relationship between corruption in a country (i.e., bribe-taking by
government officials) and economic growth? Is corruption always bad?
TOPIC 3: DIFFERENCES IN CULTURE
In the next paragraphs we explore the role of culture in international business: how
differences in culture across and within countries can affect the practice of business.
The discussion then addresses the major questions such as: What is culture? How does it
play itself out in social structures, religious and ethical systems, language, and education?
The need for cross-cultural literacy and an appreciation of the impact of culture on
competitive advantage are all addressed.
What is Culture?
Culture is a system of values and norms that are shared among a group of people and that
when taken together constitute a design for living.
Values are abstract ideas about what a society believes to be good, right, and desirable.
Norms are social rules and guidelines that prescribe the appropriate behavior in particular
situations. Business success requires cross-cultural literacy. Managers need an
understanding of the culture, or cultures, that prevail in the countries where they do business.
The cost of doing business in a country is influenced by culture different cultures are more
or less supportive of the capitalist approach to production. Culture is dynamic.
Values and Norms
Values and norms are the basic components of culture. Norms can be further divided into
folkways and mores.
Pamela A. Ochieng
Page 14

Values include attitudes towards concepts like freedom, honesty, loyalty, justice,
responsibility, and personal relations including marriage. Norms shape the actions of people
towards one another. Norms can be divided into folkways and mores.
Culture, Society and Nation State
While it is possible for a nation-state to have a uniform culture, this is not always the case.
Within a nation-state multiple cultures can exist, and cultures can also cut across national
borders.
The Determinants of Culture
Culture is an evolutionary product of a number of factors.
Political philosophy, economic philosophy, education, dominant language, social structure,
and dominant religion are all determinants of culture.
Social Structure
The social structure of a country can be described along two major dimensions:
individualism vs. group, and degree of stratification into classes or castes.
Individuals and Groups
A focus on the individual and individual achievement is common in many Western societies.
An emphasis on individual achievement has positive and negative implications.
On the positive side, the dynamism of the United States economy owes much to people like
Sam Walton, Steve Jobs, and Bill Gates - people who took chances, tried new things,
succeeded, and encouraged others to do likewise. On the other hand, individualism can lead
to a lack of company loyalty and failure to gain company-specific knowledge, competition
between individuals in a company rather than team building, and limitation of people's ability
to develop a strong network of contacts within a firm.
In sharp contrast to the Western emphasis on the individual, in many Asian societies the
group is the primary unit of social organization.
While this emphasis on the group may discourage job switching between firms, encourage
lifetime employment systems, and lead to cooperation in solving business problems, it tends
to suppress individual creativity and initiative.
Social Stratification
All societies have some sort of stratification, where individuals in higher strata or castes are
likely to have a better education, standard of living, and work opportunities.
Pamela A. Ochieng
Page 15

Social structure is linked to the ease with which an individual can move between strata.
Additionally, the social structure created by the strata levels and the social significances of
each strata level can have implications for the way business is conducted.
The significance of the social strata can have important implications for the management and
organization of businesses.
In cultures where there is a great deal of consciousness over the class of others, the way
individuals from different classes work together (i.e. management and labor) may be very
prescribed and strained in some cultures, or have almost no significance in others.
Religious and Ethical Systems
Religion can be defined as a system of shared beliefs and rituals that are concerned with the
realm of the sacred.
Ethical systems refer to a set of moral principles, or values, that are used to guide and shape
behavior. The ethical practices of individuals within a culture are often closely intertwined
with their religion.
Christianity
Christianity, the largest religion, is common throughout Europe, the Americas, and other
countries settled by Europeans and has three major branches: Protestant, Roman Catholic,
and Eastern Orthodox.
The "Protestant work ethic" a focus on hard work, wealth creation, and frugality - is
considered the driving force of capitalism. In the workplace this work ethic translates into a
significant emphasis on quality and productivity.
Islam
Islam has the same underlying roots of Christianity (Christ is viewed as a prophet), and
suggests many of the same underlying societal mores. Islam, however, extends this to more
of an all-embracing way of life that governs one's being. Islam also prescribes many more
rules by which people should act and live.
In Islam people do not own property, but only act as stewards for God and thus must take
care of that with which they have been entrusted. They must use property in a righteous,
socially beneficial, and prudent manner; not exploit others for their own benefit; and they
have obligations to help the disadvantaged. Thus, while Islam is supportive of business, the
way business is practiced is strictly prescribed. For instance, no interest may be paid on
business loans.
Hinduism
Pamela A. Ochieng
Page 16

Hinduism, practiced primarily on the Indian sub-continent, focuses on the importance of
achieving spiritual growth and development, which may require material and physical selfdenial.
Since Hindus are valued by their spiritual rather than material achievements, there is not the
same work ethic or focus on entrepreneurship found in some other religions. Likewise,
promotion and adding new responsibilities may not be the goal of an employee,
Buddhism
Buddhists also stress spiritual growth and the afterlife, rather than achievement while in this
world. Buddhism, practiced mainly in Southeast Asia, does not support the caste system,
however, so individuals do have some mobility not found in Hinduism, and can work with
individuals from different classes.
Confucianism
Confucianism, practiced mainly in China, teaches the importance of attaining personal
salvation through right action. Unlike religions, Confucianism is not concerned with the
supernatural and has little to say about the concept of a supreme being or an afterlife. The
needs for high moral and ethical conduct and loyalty to others are central in Confucianism.
Three key teachings of Confucianism - loyalty, reciprocal obligations, and honesty - may all
lead to a lowering of the cost of doing business in Confucian societies.
Language
Language refers to the spoken and unspoken means of communication, and is one of the
defining characteristics of culture.
Spoken Language
While English is clearly the language of international business, knowing at least some of the
local language can greatly help when working in another country.
In some situations knowing even a bit of the local language can be critical for business
success. Such knowledge may be understood as a sign that the businessperson is willing to
learn from the local firm
Unspoken Language
Unspoken language refers to nonverbal communication such as facial expressions, personal
space, and hand gestures. Managers that fail to understand the nonverbal cues of another
culture may experience a breakdown in communication.
Education
Formal education is the medium through which individuals learn many of the language,
conceptual, and mathematical skills that are indispensable in a modern society.
Pamela A. Ochieng
Page 17

Education is part of the social structure of a country, and is instrumental in shaping many
cultural values and norms. The knowledge base, training, and educational opportunities
available to a country's citizens can contribute to a competitive advantage in the marketplace.
Culture in the Workplace
Geert Hofstede conducted what is probably the most famous study about the connection
between culture and values in the workplace. Hofstede made a study of IBM employees
worldwide, and identified four dimensions to describe cultures: power distance,
individualism vs. collectivism, uncertainty avoidance, and masculinity vs. femininity.
Power distance focuses on how a society deals with the fact that people are unequal in
physical and intellectual capabilities. Individualism versus collectivism focuses on the
relationship between the individual and his or her fellows. Uncertainty avoidance measures
the extent to which different cultures socialize their members into accepting ambiguous
situations and tolerating ambiguity. Masculinity versus femininity looks at the relationship
between gender and work roles.
Hofstede later expanded his study to include a fifth dimension called Confucian dynamism
which captures attitudes toward time, persistence, ordering by status, protection of face,
respect for tradition, and reciprocation of gifts and favors.
Cultural Change
Culture is not a constant, but evolves over time. As countries become economically stronger,
cultural change is particularly common.
Implications for Managers
Managers need to be aware that societies differ because their cultures vary, and cultures vary
because of profound differences in social structure, religion, language, education, economic
philosophy, and political philosophy.
There are three important implications that flow from these differences:
1) The need to develop cross-cultural literacy
2) There is a connection between culture and national competitive advantage
3) There is a connection between culture and ethics in decision making
Cross-Cultural Literacy
Individuals and firms must develop cross-cultural literacy. International businesses that are
ill informed about the practices of another culture are unlikely to succeed in that culture. One
way to develop cross-cultural literacy is to regularly rotate and transfer people
internationally.
Pamela A. Ochieng
Page 18

Managers need to be aware of ethnocentric behavior, or a belief in the superiority of their
own culture.
Culture and Competitive Advantage
The connection between culture and competitive advantage is important because it suggests
which countries are likely to produce the most viable competitors, and it has implications for
the choice of countries in which to locate production facilities and do business.
CRITICAL THINKING AND DISCUSSION QUESTIONS

QUESTION 1: Outline why the culture of a country influences the costs of doing business in
that country. Illustrate your answer with examples.
ANSWER 1: This question has be explored throughout the section, and since there can be
numerous reasons and examples of how culture influences the costs of doing business, there
is no single acceptable response to the question. Several are highlighted below, but there
could be numerous others.
When there are simply different norms between how individuals from different countries
interact, the costs of doing business rise as people grapple with unfamiliar ways of doing
business. For example, while in the US people get down to business first, and then get to
know each other socially later, in many South American, Asian, and African countries it is
important develop a good social relationship before trying to discuss business issues.
Different class structures and social mobility also raise the costs of doing business, for if
there are inhibitions against working with people from different classes, then the efficiency
with which information can flow may be limited and the cost of running a business increased.
A country's religion can also affect the costs of business, as religious values can affect
attitudes towards work, entrepreneurship, honesty, fairness, and social responsibility. In
Hindu societies where the pursuit of material well-being can be viewed as making spiritual
well being less likely, worker productivity may be lower than in nations with other religious
beliefs. Finally, a country's education system can have important implications for the costs of
business. In countries where workers receive excellent training and are highly literate, the
need for specific worker training programs are decreased and the hiring of additional
employees is facilitated.
QUESTION 2: Do you think that business practices in an Islamic country are likely to differ
from business practices in the United States and other likeminded nations of the world? If so
how?
ANSWER 2: The cultural differences between a Muslim country and the US will cause
business practices to differ dramatically. The public role women can take, appropriate
etiquette (including simple things like not passing objects with the left hand), holidays, and
wining and dining all differ from patterns in the US. But beyond these, the underlying ideal
Pamela A. Ochieng
Page 19

and understanding of the role of business differs. Since Muslims are stewards of property
for God, rather than owners, they are more likely to use their resources carefully and may be
less likely to give up or sell something to a person who may not practice the same
stewardship. The importance of fairness to all parties in all relations means that overaggressiveness and self-interest may not be well received, and breaking an agreement, even if
technically/legally permissible, may be viewed as inappropriate and the sign of a huge
character flaw. Finally, the prohibitions on interest payments in some Muslim countries
means that the wording of the terms of an agreement must be careful so that "fair profits" are
not construed as being "interest payments."
QUESTION 3: What are the implications for international business of differences in the
dominant or ethical system of a country?
ANSWER 3: Differences in the dominant religion of a country affect relationships, attitudes
toward business, and overall economic development. First, differences in religion require
inter-cultural sensitivity. This sensitivity requires things like simply knowing the religious
holidays, accepting that some unexpected things may happen "because of Allah's will," or
understanding how interpersonal relationships may be different between "believers" and
"non-believers." (Hence non-believers may be treated differently.) Second, religious beliefs
can significantly affect a countrys attitude toward business, work, and entrepreneurship. In
one country successfully beating a competitor may be considered a great achievement while
in another it may be thought of as showing a lack of compassion, or disruptive to the society
and persons involved, both attitudes that may be derived from underlying religious beliefs.
Likewise, hard work may be either rewarded positively or viewed as something of secondary
importance to spiritual peace and harmony. Third, different dominant religions may affect
the overall competitiveness and potential for economic growth of a nation, and hence
attractiveness of a country for international business.
Basic, unarticulated assumptions about what has value, what is right and wrong, and what
constitutes good are embedded in our religions. Should rules or laws apply to all people all
the time (in the US, the answer here is probably yes); or should they change depending on the
circumstances of the particular situation (in Asia, the answer would be, of course)? Religion
plays a basic, influential role in our most fundamental values and the norms that arise from
them. So if an international business venture faces a different dominant religion in its foreign
market, managers there will have to make special efforts to understand what is really
underlying practice differences.
QUESTION 4: Choose two countries that appear to be culturally diverse. Compare the
culture of those countries and then indicate how cultural differences influence (a) the costs of
doing business in each country, (b) the likely future economic development of that country,
and (c) business practices.
Pamela A. Ochieng
Page 20

NB: Do Question 4 in groups. Use the already existing groups in class, write a report and
prepare slides for a presentation. No two groups shall choose the same pair of countries.
Ethics in International Business
We now take a look at ethics in international business. Ethics becomes an issue across
nations because of differing political systems, economic systems, legal systems and cultural
values. What is acceptable behavior in one nation may be considered unethical in another
First, some of the more common areas where ethical issues arise in international business
such as employment practices, human rights, environmental pollution, corruption, and moral
obligations are explored. Then the discussion moves to the straw men approaches to ethics.
Next, the basic philosophical theories that offer a foundation for ethical decision-making are
examined. Finally, the roots of unethical decision-making and how to make ethical decisions
are addressed
Just what is Ethics?
Ethics refers to accepted principles of right or wrong that govern the conduct of a person, the
members of a profession, or the actions of an organization.
TOPIC4: ETHICAL ISSUES IN INTERNATIONAL BUSINESS
The most common ethical issues in business involve:
employment practices
human rights
environmental regulations
corruption
the moral obligation of multinational companies
Employment Practices
Often employment practices differ among nations. What is the MNCs obligation? Should
home standards be followed, even in less developed countries? Should local standards be
embraced? What is the right basis for employment-related ethical decisions?
Human Rights
The idea of what constitutes human rights varies considerably across national borders. How
can the tensions that this reality fosters be reconciled?
Environmental Pollution
Ethical issues arise when environmental regulations in host nations are far inferior to those in
the home nation.
Pamela A. Ochieng
Page 21

The tragedy of the commons occurs when a resource held in common by all, but owned by
no one, is overused by individuals, resulting in its degradation.
Corruption
Every country that participates in international business has put measures in places to curb
corruption. For example, The U.S. Foreign Corrupt Practices Act outlawed the practice of
paying bribes to foreign government officials in order to gain business.
Moral Obligations
Social responsibility refers to the idea that business people should take the social
consequences of economic actions into account when making business decisions, and that
there should be a presumption in favor of decisions that have both good economic and good
social consequences.
Ethical Dilemmas
Ethical dilemmas are situations in which none of the available alternatives seems ethically
acceptable.
The ethical obligations of a multinational corporation toward employment conditions, human
rights, corruption, environmental pollution, and the use of power are not always clear cut
The Roots of Unethical Behavior
The causes of unethical behavior are complex and reflect:
Personal ethics
Decision-making processes
Leadership
Unrealistic performance expectations
Organizational culture
Personal Ethics
Business ethics reflect personal ethics (the generally accepted principles of right and wrong
governing the conduct of individuals). The personal ethical code that guides our behavior
comes from a number of sources, including our parents, our schools, our religion, and the
media.
Home country managers working abroad in multinational firms may experience more than
the usual degree of pressure to violate their personal ethics because they are away from their
ordinary social context and supporting culture, and they are psychologically and
geographically distant from the parent company.
Decision-Making Processes
Pamela A. Ochieng
Page 22

Business people sometimes do not realize that they are behaving unethically simply because
they fail to ask the relevant questionis this decision or action ethical?
Organizational Culture
The term organization culture refers to the values and norms that are shared among
employees of an organization.
In a company with an organizational culture that de-emphasizes business ethics, all decisions
are reduced to the purely economic.
Unrealistic Performance Expectations
When there is pressure from the parent company to meet performance goals that are
unrealistic, and can only be attained by cutting corners or acting in an unethical manner,
unethical behavior may result.
Leadership
Leaders are vital in helping a firm establish its organization culture, and setting examples. If
leaders are not acting ethically, other employees may not act ethically.
Philosophical Approaches to Ethics
There are several approaches to ethics including the straw men (the Friedman doctrine,
cultural relativism, righteous moralist, and the nave immoralist), the Utilitarian approach, the
Kantian approach, and rights and justice theories.
Straw Men
Straw men approaches to business ethics are approaches that are raised by business ethics
scholars primarily for the purpose of demonstrating that they offer inappropriate guidelines
for ethical decision making in a multinational enterprise. Four such approaches are the
Friedman doctrine, cultural relativism, the righteous moralist, and the nave immoralist.
Utilitarian and Kantian Ethics
In contrast to the straw men, most moral philosophers see value in utilitarian and Kantian
approaches to business ethics. The utilitarian approach to business ethics dates back to
philosophers such as David Hume, Jeremy Bentham, and John Stuart Mill. Utilitarian
approaches to ethics hold that the moral worth of actions or practices is determined by their
consequences. An action is judged to be desirable if it leads to the best possible balance of
good consequences over bad consequences.
Rights Theories
Rights theories recognize that human beings have fundamental rights and privileges that
transcend national boundaries and culture. Moral theorists argue that fundamental human
rights form the basis for the moral compass that managers should navigate by when making
Pamela A. Ochieng
Page 23

decisions that have an ethical component.
Justice Theories
Justice theories focus on the attainment of a just distribution of economic goods and services.
A just distribution is one that is considered fair and equitable. There is no one theory of
justice, and several theories of justice conflict with each other in important ways. One
important and influential theory of justice was set forth by John Rawls who argued that all
economic goods and services should be distributed equally except when an unequal
distribution would work to everyones advantage.
Ethical Decision Making
Five things an international business can do to make sure that ethical issues are considered in
a business decision are:
(1) favor hiring and promoting people with a well grounded sense of personal ethics
(2) build and organizational culture that places a high value on ethical behavior
(3) make sure that leaders within the business not only articulate the rhetoric of ethical
behavior, but also act in manner that is consistent with that rhetoric
(4) put decision making processes in place that require people to consider the ethical
dimension of business decisions
(5) develop moral courage
Hiring and Promotion
Not only should businesses strive to identify and hire people with a strong sense of personal
ethics, but it is also in the interests of prospective employees to find out as much as they can
about the ethical climate in an organization.
Organizational Culture and Leadership
To foster ethical behavior, businesses need to build an organization culture that places a high
value on ethical behavior.
Decision-Making Process
Business people need a moral compass to help determine whether a decision is ethical.
Ethics Officers
To ensure ethical behavior in a business, a number of firms now have ethics officers.
Moral Courage
It is important to recognize that employees in an international business may need significant
moral courage.
Summary of Decision Making Steps
Pamela A. Ochieng
Page 24

In the end, there are clearly things that an international business should do, and there are
things that an international business should not do, but there are also actions that present
managers with true dilemmas.
SECTION II: EVOLUTION OF INTERNATIONAL TRADE

TOPIC 5: INTERNATIONAL TRADE THEORY
An Overview of Trade Theory
Free trade refers to a situation where a government does not attempt to influence through quotas or
duties what its citizens can buy from another country or what they can produce and sell to another
country.
Smith, Ricardo and Heckscher-Ohlin show why it is beneficial for a country to engage in international
trade even for products it is able to produce for itself.
The Patterns of Trade
International trade allows a country to specialize in the manufacture and export of products that it can
produce efficiently, and import products that can be produced more efficiently in other countries.
Some patterns of trade are fairly easy to explain - it is obvious why Saudi Arabia exports oil, the US
exports agricultural products, and Mexico exports labor intensive goods. Yet others are not so
obvious or easily explained, such as cars in Japan.
Trade Theory and Government Policy
The various theories have differing prescriptions for government policy on trade. Mercantilism
makes a crude case for government involvement in promoting exports and limiting imports. Smith,
Ricardo, and Heckscher-Ohlin promote unrestricted free trade. New trade theory and Porters theory
of national competitive advantage justify limited and selective government intervention to support the
development of certain export-oriented industries.
Mercantilism
Mercantilism suggests that it is in a countrys best interest to maintain a trade surplus -- to export
more than it imports, and advocates government intervention to achieve a surplus in the balance of
trade.
It views trade as a zero-sum game - one in which a gain by one country results in a loss by another.
Another Perspective: A historical perspective of Mercantilism is available at the following

site {http://www.egss.ulg.ac.be/EconomieInternationale/Swe/SWEglobal.htm}.
Absolute Advantage
Adam Smith argued that countries differed in their ability to produce goods efficiently, and should
specialize in the production of the goods they can produce the most efficiently.
Pamela A. Ochieng
Page 25

If, for example, Britain were to specialize in textile production, and Spain in wine production, Smith
argued that both Britain and Spain could consume more textiles and wine than if each only produced
for their own consumption. Thus trade is a positive sum game.
Comparative Advantage
David Ricardo asked what might happen when one country has an absolute advantage in the
production of all goods. Ricardos theory of comparative advantage suggests that countries should
specialize in the production of those goods they produce most efficiently and buy goods that they
produce less efficiently from other countries, even if this means buying goods from other countries
that they could produce more efficiently at home.
Qualifications and Assumptions
The simple example of comparative advantage presented in the text makes a number of assumptions:
only two countries and two goods; zero transportation costs; similar prices and values; resources are
mobile between goods within countries, but not across countries; constant returns to scale; fixed
stocks of resources; and no effects on income distribution within countries. While these are all
unrealistic, the general proposition that countries will produce and export those goods that they are the
most efficient at producing has been shown to be quite valid.
Extensions of the Ricardian Model
Diminishing returns to specialization suggest that after some point, the more of a good that a country
produces, the greater will be the units of resources required to produce each additional item. If crops
are grown on increasingly less fertile land, mining is done on less productive ore, or less skilled
personnel need to be hired to perform high skilled jobs, production per unit of input will decrease.
(Diminishing returns implies a PPF which is convex.) In reality, countries do not specialize entirely,
but produce a range of goods. It is worthwhile to specialize up until that point where the resulting
gains from trade are offset by diminishing returns.
Opening an economy to trade is likely to generate dynamic gains of two types. First, trade might
increase a country's stock of resources as increased supplies become available from abroad.
Secondly, free trade might increase the efficiency of resource utilization, and free up resources for
other uses.
An overview of the ideas and philosophies of David Ricardo, from which his theory of
comparative
advantage
emerged,
is
available
at
{http://www.econlib.org/library/Enc/bios/Ricardo.html}.
Students might also consult
{http://cepa.newschool.edu/het/alphabet.htm} for information on numerous philosophers, and
{http://cepa.newschool.edu/het/profiles/ricardo.htm}for Ricardo specifically.
The Samuelson Critique
Samuelson argues that in some cases, the dynamic gains from trade may not be so beneficial.
He argues that the ability to off-shore services jobs that were traditionally not internationally
mobile may have the effect of a mass inward migration into the United States, where wages
Pamela A. Ochieng
Page 26

fall.
Heckscher-Olin Theory
The Heckscher-Ohlin theory predicts that countries will export those goods that make intensive use of
factors of production which are locally abundant, while importing goods that make intensive use of
factors that are locally scarce. It focuses on differences in relative factor endowments rather than
differences in relative productivity.
A more complete description of the

{http://cepa.newschool.edu/het/alphabet.htm}.
Heckscher-Ohlin
theory
is
available
at
The Leontief Paradox
Using the Heckscher-Ohlin theory, Leontief, in 1953 postulated that since the U.S. was
relatively abundant in capital compared to other nations, the U.S. would be an exporter of
capital intensive goods and an importer of labor-intensive goods. To his surprise, however,
he found that U.S. exports were less capital intensive than U.S. imports. Since this result was
at variance with the predictions of the theory, it has become known as the Leontief Paradox.
A more extensive description of
{http://cepa.newschool.edu/het/alphabet.htm}.
the
Leontief
Paradox
is
available
at
The Product Life Cycle

Raymond Vernon suggested that as products mature, both the location of sales and the optimal
production location will change, affecting the direction and flow of imports and exports. Globalization
weakens this theory.
New Trade Theory
New trade theory suggests that because of economies of scale and increasing returns to
specialization, in some industries there are likely to be only a few profitable firms. Firms with first
mover advantages will develop economies of scale and create barriers to entry for other firms.
New trade theory does not contradict the theory of comparative advantage, but instead identifies a
source of comparative advantage.
Increasing Product Variety and Reducing Costs
A nation may be able to specialize in producing a narrower range of products than it would in
the absence of trade, yet by buying goods that it does not make from other countries, each
nation can simultaneously increase the variety of goods available to its consumers and lower
the costs of those goods.
Economies of Scale, First Mover Advantages, and the Pattern of Trade
The pattern of trade we observe in the world economy may be the result of first mover
advantages (economic and strategic advantages that accrue to early entrants into an industry)
Pamela A. Ochieng
Page 27

and economies of scale.
Implications of New Trade Theory
New trade theory suggests that nations may benefit from trade even when they do not differ
in resource endowments or technology.
The theory also suggests that a country may predominate in the export of a good simply
because it was lucky enough to have one or more firms among the first to produce that good.
Theory of National Competitive Advantage
Michael Porter hypothesizes that a nations competitiveness depends on the capacity of its industry to
innovate and upgrade. Porter's study tried to explain why a nation achieves international success in a
particular industry. This study found four broad attributes that promote or impede the creation of
competitive advantage: factor endowments, demand conditions, relating and supporting industries,
and firm strategy, structure, and rivalry. These attributes form Porters diamond.
Factor Endowments
These are the nations relative position in factors of production. They are divided into basic and
advanced.
Demand Conditions
The nature of home demand for the industries product or service influences the development
of capabilities. Sophisticated and demanding customers pressure firms to be competitive.
Related and Supporting Industries
The presence in a nation of supplier industries and related industries that are internationally
competitive can spill over and contribute to other industries.
Firm Strategy, Structure and Rivalry
The conditions in the nation governing how companies are created, organized, and managed,
and the nature of domestic rivalry impacts firms' competitiveness.
Firms that face strong domestic competition will be better able to face competitors from other
firms.
Evaluating Porters Theory
In addition to these four main attributes, government policies and chance can impact any of
the four.
Government policy can affect demand through product standards, influence rivalry through
regulation and antitrust laws, and impact the availability of highly educated workers and
advanced transportation infrastructure.
Pamela A. Ochieng
Page 28

There are at least three main implications of the material discussed in this chapter for
international businesses: location implications, first-mover implications, and policy
implications.
Location
From a profit perspective, it makes sense for a firm to disperse its various productive
activities to those countries where, according to the theory of international trade, they can be
performed most efficiently.
Being a first mover can have important competitive implications, especially if there are
economies of scale and the global industry will only support a few competitors. Firms need
to be prepared to undertake huge investments and suffer losses for several years in order to
reap the eventual rewards.
First Mover Advantages
Being a first mover can have important competitive implications, especially if there are
economies of scale and the global industry will only support a few competitors.
Firms need to be prepared to undertake huge investments and suffer losses for several years
in order to reap the eventual rewards.
Government Policy
One of the most important implications for businesses is that they should work to encourage
governmental policies that support free trade.
If a business is able to get its goods from the best sources worldwide, and compete in the sale
of products into the most competitive markets, it has a good chance to survive and prosper. If
such openness is restricted, a businesss long-term survival will be in greater question.
TOPIC 6: THE POLITICAL ECONOMY OF INTERNATIONAL TRADE
Introduction
Free trade refers to a situation where a government does not attempt to restrict what its citizens can
buy from another country or what they can sell to another country.
Instruments of Trade Policy
The main instruments of trade policy are:
tariffs
subsidies
import quotas
voluntary export restraints
local content requirements
antidumping policies
administrative policies
Pamela A. Ochieng
Page 29

Tariffs
Tariffs are the oldest form of trade policy. The principal objective of most tariffs is to protect
domestic producers and employees against foreign competition. Tariffs also raise revenue for the
government. Domestic producers gain, because tariffs afford them some protection against foreign
competitors by increasing the cost of imported foreign goods. Consumers lose because they must pay
more for certain imports. Tariffs reduce the overall efficiency of the world economy.
Subsidies
Subsidies take many forms (cash grants, low-interest loans, tax breaks, and government equity
participation in domestic firms). By lowering production costs, subsidies help domestic producers in
two ways: they help them compete against foreign imports and they help them gain export markets.
Subsidy revenues are generated from taxes. Governments typically pay for subsidies by taxing
individuals. Therefore, whether subsidies generate national benefits that exceed their national costs is
debatable.
Subsidies encourage over production, inefficiency and reduced trade. In practice, many subsidies are
not that successful at increasing the international competitiveness of domestic producers. Rather, they
tend to protect the inefficient and promote excess production.
Quotas and Voluntary Export Restraints
Quotas and Voluntary Export Restraints (VER) are direct restrictions on the quantity of some good
that may be imported into a country. The quota restriction is usually enforced by issuing import
licenses to a group of individuals or firms. A VER is a quota on trade imposed by the exporting
country, typically at the request of the importing countrys government.
Local Content Requirements
Local content regulations have been widely used by developing countries to shift their
manufacturing base from the simple assembly of products whose parts are manufactured elsewhere
into the local manufacture of component parts. They have also been used in developed countries to try
to protect local jobs and industry from foreign competition.
From the point of view of a domestic producer of parts going into a final
product, local content regulations provide protection in the same way an
import quota does: by limiting foreign competition. The aggregate
economic effects are also the same; domestic producers benefit, but the
restrictions on imports raise the prices of imported components.
Administrative Policies
Governments sometimes use informal or administrative policies to restrict imports and boost exports.
Administrative trade policies are bureaucratic rules that are designed to make it difficult for imports to
enter a country.
Another Perspective: Information about U.S. trade is readily available on government sites. Visit
{www.business.gov} to access an array of links. You can also review the current U.S. tariffs at the
U.S. Office of Tariff Affairs and Trade Agreements, {www.usitc.gov/tata/index.htm}.
Pamela A. Ochieng
Page 30

Anti Dumping Policies
Dumping is defined as selling goods in a foreign market at below cost of production or at below
fair market value.
The Case for Government Intervention
There are two types of arguments for government intervention, political and economic.
Political Arguments for Intervention
Political arguments for government intervention include:
protecting jobs
protecting industries deemed important for national security
retaliating to unfair foreign competition
protecting consumers from dangerous products
furthering the goals of foreign policy
protecting the human rights of individuals in exporting countries
Protecting Jobs and Industries

The most common political reason for trade restrictions is "protecting jobs and industries."
Protecting National Security
Countries sometimes argue that it is necessary to protect certain industries because they are important
for national security. Defense-related industries often get this kind of attention (e.g., aerospace,
advanced electronics, semiconductors).
Retaliation
Government intervention in trade can be used as part of a "get tough" policy to open foreign markets.
Protecting Consumers
Consumer protection can also be an argument for restricting imports. Since different countries do
have different health and safety standards, what may be acceptable in one country may be
unacceptable in others.
Furthering Policy Objectives
Sometimes, governments use trade policy to support their foreign policy objectives.
Protecting Human Rights
Governments sometimes use trade policy to create pressure for improvement of human rights policies
of trading partners. For years the most obvious example of this was the annual debate in the United
States over whether to grant most favored nation (MFN) status to China. MFN status allows countries
to export goods to the United Status under favorable terms. Under MFN rules, the average tariff on
Pamela A. Ochieng
Page 31

Chinese goods imported into the United States is 8 percent. If Chinas MFN status were rescinded,
tariffs would probably rise to about 40 percent.
Another Perspective: In the United States, the Bureau of Export Administration enhances the
nation's security and its economic prosperity by controlling exports for national security,
foreign security, foreign policy, and short supply reasons. The Bureau of Export
Administration
maintains
a
web
site
at
{http://www.technology.gov/Reports/Compendium/doc.pdf}.
Economic Arguments for Intervention
Protecting infant industries and strategic trade policy are the main economic reasons for trade
restrictions.
The Infant Industry Argument
The infant industry argument has been considered a legitimate reason for protectionism, especially
in developing country contexts. Many economists criticize this argument: protection of manufacturing
from foreign competition does no good unless the protection helps make the industry efficient. Brazil
built up the worlds 10th largest auto industry behind tariff barriers and quotas. Once those barriers
were removed in the late 1980s, however, foreign imports soared and the industry was forced to face
up to the fact that after 30 years of protection, the Brazilian industry was one of the most inefficient in
the world.
Strategic Trade Policy
Strategic trade policy, where the existence of substantial scale economies suggests that the world
market will profitably support only a few firms, and may justify government intervention in industries
with possibly large economies of scale. Such intervention reduces the competitive effect of existing
first-mover advantage held by a foreign company.
Revised Case for Free Trade
While strategic trade policy identifies conditions where restrictions on trade may provide
economic benefits, there are two problems that may make restrictions inappropriate:
retaliation and politics.
Retaliation and Trade War
Krugman argues that strategic trade policies aimed at establishing domestic firms in a dominant
position in a global industry are beggar-thy-neighbor policies that boost national income at the
expense of other countries.
Domestic Policies
Special interest groups may influence governments.
Development of the World Trading System
How has todays world trade system evolved?
Pamela A. Ochieng
Page 32

From Smith to the Great Depression
Up until the Great Depression of the 1930s, most countries had some degree of protectionism.
Great Britain, as a major trading nation, was one of the strongest supporters of free trade.
Although the world was already in a depression, in 1930 the U.S. enacted the Smoot-Hawley
tariff, which created significant import tariffs on foreign goods. As other nations took similar
steps and the depression deepened, world trade fell further.
1947-79: GATT, Trade Liberalization, and Economic Growth
After WWII, the U.S. and other nations realized the value of freer trade, and established the
General Agreement on Tariffs and Trade (GATT).
The approach of GATT (a multilateral agreement to liberalize trade) was to gradually
eliminate barriers to trade. Over 100 countries became members of GATT, and worked
together to further liberalize trade.
Teaching Tip: A full review of GATT, containing an actual copy of the agreement, is
available at {http://www.ciesin.org/TG/PI/TRADE/gatt.html}.
1980-1993: Protectionist Trends
Calls for protectionism were motivated by 3 factors:
1. Japans success in such industries as automobiles and semiconductors coupled with the sense that
Japanese markets were closed to imports and foreign investment by administrative trade barriers.
2. The worlds largest economy, the United States, was plagued by a persistent deficit. The loss of
market share to foreign competitors in industries such as automobiles, machine tools, semiconductors,
steel, and textiles, and the resulting unemployment gave rise to renewed demands in the U.S.
Congress for protection against imports.
3. Many countries found ways to get around GATT regulations.
The Uruguay Round and the World Trade Organization
The Uruguay Round wrote the rules governing:
-the protection of intellectual property rights
-the reduction of agricultural subsidies
-the strengthening of GATTs monitoring and enforcement mechanisms
The WTO: Experience to Date
In addition to the impasse at the meetings over agricultural subsidies, the Seattle round was a
lightning rod for a diverse collection of organizations from environmentalists and human rights
Pamela A. Ochieng
Page 33

groups to labor unions that opposed free trade. All these organizations argued that the WTO is an
undemocratic institution that was usurping the national sovereignty of member states and making
decisions of great importance behind closed doors. They took advantage of the Seattle meetings to
voice their opposition.
The Future of the WTO: Unresolved Issues and the Doha Round
The Doha Round had several initiatives:
Cutting tariffs on industrial goods and services. In 2000, for example, the average tariff rates on nonagricultural products were 4.4% for Canada, 4.5% for the European Union, 4.0% for Japan, and 4.7%
for the United States. On agricultural products, however, the average tariffs rates were 22.9% for
Canada, 17.3% for the European Union, 18.2% for Japan, and 11% for the United States.
Phasing out subsidies. Subsidies introduce significant distortions into the production of agricultural
products. The net effect is to raise prices to consumers, reduce the volume of agricultural trade, and
encourage the overproduction of products that are heavily subsidized (with the government typically
buying up the surplus).
Reducing antidumping laws. WTO rules allow countries to impose antidumping duties on foreign
goods that are being sold cheaper than at home, or below their cost of production, when domestic
producers can show that they are being harmed.
WTO on intellectual property should allow for health protection in poorer nations. Rich countries
have to comply with the rules within a year. Poor countries, in which such protection generally was
much weaker, have 5 years grace, and the very poorest have 10 years.
Another Perspective: To see current issues at the WTO, go to {http://www.wto.org} and click
on News.
Managers need to consider how trade barriers affect the strategy of the firm and the implications of
government policy on the firm.
Trade Barriers and Firm Strategy
Trade barriers are a constraint upon a firms ability to disperse its productive activities.
Policy Implications
International firms have an incentive to lobby for free trade, and keep protectionist pressures from
causing them to have to change strategy.
Pamela A. Ochieng
Page 34

TOPIC7: FOREIGN DIRECT INVESTMENTS
Introduction
Foreign direct investment (FDI) occurs when a firm invests directly in new facilities to produce
and/or market in a foreign country. Once a firm undertakes FDI it becomes a multinational
enterprise.
Another Perspective: Each year Fortune magazine publishes a list of the 500 largest global
corporations in the world. Fortune calls its list the "Global 500." This list can be accessed at
{http://money.cnn.com/magazines/fortune/global500/2006/}.
The article contains an
excellent discussion of the role of global firms in the world economy.
FDI can take the form of a greenfield investment where a wholly new operation is established in a
foreign country, or it can take place via acquisitions or mergers with existing firms in the foreign
country.
Another Perspective: Another web site that provides an excellent discussion of the role of
multinational
corporations
in
the
world
economy
is
available
at
{http://www.oecdobserver.org/news/fullstory.php/aid/446/The_trust_business.html}.
Foreign Direct Investment in the World Economy
The flow of FDI refers to the amount of FDI undertaken over a given time period, while the stock of
FDI refers to the total accumulated value of foreign-owned assets at a given time. Outflows of FDI
are the flows of FDI out of a country, and inflows of FDI are the flows of FDI into a country.
Trends in FDI
There has been a marked increase in both the flow and stock of FDI in the world economy
over the last 30 years.
The Direction of FDI
While the United States remains a top destination for FDI flows, South, East, and Southeast Asia, and
particularly China, are now seeing an increase of FDI inflows, and Latin America is also emerging as
an important region for FDI.
The Source of FDI
Since World War II, the U.S. has been the largest source country for FDI. The United Kingdom, the
Netherlands, France, Germany, and Japan are other important source countries.
The Form of FDI: Acquisitions Versus Greenfield Investments

Most cross-border investment is in the form of mergers and acquisitions rather than greenfield
investments.
Pamela A. Ochieng
Page 35
The Shift to Services

FDI is shifting away from extractive industries and manufacturing, and towards services.
Theories of Foreign Direct Investment
Questions that need to be answered include:
Why do firms invest rather than use exporting or licensing to enter foreign markets?
Why do firms from the same industry undertake FDI at the same time?
How can the pattern of foreign direct investment flows be explained?
Why Foreign Direct Investment?

Why do firms choose FDI instead of :exporting or licensing? Internalization theory (also known as
market imperfections theory) suggests that licensing has three major drawbacks.
The Pattern of Foreign Direct Investment
Knickerbocker looked at the relationship between FDI and rivalry in oligopolistic industries
(industries composed of a limited number of large firms) and suggested that FDI flows are a reflection
of strategic rivalry between firms in the global marketplace.
Vernon argued that firms undertake FDI at particular stages in the life cycle of a product they have
pioneered.
According to the eclectic paradigm, in addition to the various factors discussed earlier, it is important
to consider:
location-specific advantages - that arise from using resource endowments or assets that are
tied to a particular location and that a firm finds valuable to combine with its own unique
assets
and
externalities - knowledge spillovers that occur when companies in the same industry locate in
the same area
Political Ideology and Foreign Direct Investment

Ideology toward FDI ranges from a radical stance that is hostile to all FDI to the non-interventionist
principle of free market economies. Between these two extremes is an approach that might be called
pragmatic nationalism.
The Radical View
The radical view argues that the MNE is an instrument of imperialist domination and a tool for
exploiting host countries to the exclusive benefit of their capitalist-imperialist home countries.
Pamela A. Ochieng
Page 36

The Free Market View
According to the free market view, international production should be distributed among countries
according to the theory of comparative advantage.
Pragmatic Nationalism
Pragmatic nationalism suggests that FDI has both benefits, such as inflows of capital, technology,
skills and jobs, and costs, such as repatriation of profits to the home country and a negative balance of
payments effect.
Shifting Ideology
Recently, there has been a strong shift toward the free market stance creating:
a surge in FDI worldwide
an increase in the volume of FDI in countries with newly liberalized regimes
Benefits and Costs of FDI
Government policy is often shaped by a consideration of the costs and benefits of FDI.
Host Country Benefits
There are four main benefits of inward FDI for host countries: resource transfer effects; employment
effects; balance of payments effects, and effects on competition and growth.
Host Country Costs
There are three mains costs from inward FDI for the host country: the possible adverse effects of FDI
on competition within the host nation; adverse effects on the balance of payments; and the perceived
loss of national sovereignty and autonomy.
Home Country Benefits
The benefits of FDI for the home country include: the effect on the capital account of the home
countrys balance of payments from the inward flow of foreign earnings; the employment effects that
arise from outward FDI; and the gains from learning valuable skills from foreign markets that can
subsequently be transferred back to the home country.
Home Country Costs
The home countrys balance of payments can suffer from the initial capital outflow required to
finance the FDI; if the purpose of the FDI is to serve the home market from a low cost labor location;
and if the FDI is a substitute for direct exports.
International Trade Theory and FDI
International trade theory suggests that home country concerns about the negative economic effects of
offshore production (FDI undertaken to serve the home market) may not be valid.
Government Policy Instruments and FDI
Home countries and host countries use various policies to regulate FDI.
Another Perspective: The World Bank has a wonderful site devoted to foreign direct
Pamela A. Ochieng
Page 37

investment.
Students
can
start
exploring
the
site
by
going
to
{http://rru.worldbank.org/Themes/ForeignDirectInvestment/}.
Then click on Doing
Business to see an option to download summaries on 175 countries, or to generate instant
reports comparing countries on various factors. The site is easy to navigate and contains a
wealth of information.
Home Country Policies
Governments can both encourage and restrict FDI
Host Country Policies
To encourage inward FDI, governments offer incentives to foreign firms to invest in their countries,
while they restrict inward FDI through ownership restraints and performance requirements.
International Institutions and the Liberalization of FDI

The World Trade Organization is trying to establish a universal set of rules designed to promote the
liberalization of FDI.

Managers need to consider what trade theory implies, and the link between government
policy and FDI.
The Theory of FDI
The direction of FDI can be explained through the location-specific advantages argument
associated with John Dunning.
Government Policy
A host governments attitude toward FDI is an important variable in decisions about where to locate
foreign production facilities and where to make a foreign direct investment.
TOPIC 8: REGIONAL ECONOMIC INTEGRATION
Introduction
Regional economic integration refers to agreements between countries in a geographic

region to reduce tariff and nontariff barriers to the free flow of goods, services, and factors of
production between each other.
Despite the rapid spread of regional trade agreements designed to promote free trade, there
are those who fear that the world is moving toward a situation in which a number of regional
trade blocks compete against each other. In this scenario of the future, free trade will exist
within each bloc, but each bloc will protect its market from outside competition with high
tariffs.
Levels of Economic Integration
The five levels of economic integration are: free trade area, customs union, common market,
economic union, and political union.
Pamela A. Ochieng
Page 38

The most enduring free trade area in the world is the European Free Trade Association. EFTA
currently joins four countries-Norway, Iceland, Liechtenstein, and Switzerland. Other free trade areas
include the North American Free Trade Agreement (NAFTA).
Another Perspective: A site with information and additional links on NAFTA is available at:
{http://www.fas.usda.gov/itp/Policy/NAFTA/nafta.asp}. The site includes downloadable power
point presentations on the benefits of NAFTA
Another Perspective: To find out more about EFTA, go to {http://www.efta.int/}, and click on
EFTA AELE. From here you can click on several icons to get quick facts, more in- depth
reports, information on the European Economic Area, and many other issues related to
EFTA.
Customs unions around the world include the current version of the Andean Pact (between
Bolivia, Columbia, Ecuador and Peru).
Currently, MERCOSUR, the South America grouping that includes Brazil, Argentina,
Paraguay, and Uruguay, is aiming to eventually establish itself as a common market.
The European Union (EU) is an economic union, although an imperfect one since not all
members of the EU have adopted the euro, the currency of the EU, and differences in tax
rates across countries still remain.
The Economic Case for Integration
Regional economic integration can be seen as an attempt to achieve additional gains from the
free flow of trade and investment between countries beyond those attainable under
international agreements such as the WTO.
The Political Case for Integration
The political case for integration has two main points: 1) by linking countries together,
making them more dependent on each other, and forming a structure where they regularly
have to interact, the likelihood of violent conflict and war will decrease, and 2) by linking
countries together, they have greater clout and are politically much stronger in dealing with
other nations.
Impediments to Integration
There are two main impediments to integration:

although a nation as a whole may benefit significantly from a regional free trade
agreement, certain groups may lose
concerns over national sovereignty
Slide 8-13 The Case Against Regional Economic Integration
Pamela A. Ochieng
Page 39
Whether regional integration is in the economic interests of the participants depends upon the
extent of trade creation as opposed to trade diversion. Trade creation occurs when low
cost producers within the free trade area replace high cost domestic producers. Trade
diversion occurs when higher cost suppliers within the free trade area replace lower cost
external suppliers. A regional free trade agreement will only make the world better off if the
amount of trade it creates exceeds the amount it diverts.
Regional Economic Integration in Europe
There are two trade blocks in Europe:

the European Union (EU)
the European Free Trade Association
The EU is by far the more significant, not just in terms of membership, but also in terms of
economic and political influence in the world economy.
Evolution of the European Union
The EU is the product of two political factors:

the devastation of two world wars on Western Europe and the desire for a lasting
peace
the European nations desire to hold their own on the worlds political and economic
stage.
The forerunner of the EU was the European Coal and Steel Community, which had the goal
of removing barriers to trade in coal, iron, steel, and scrap metal formed in 1951.
The EEC was formed in 1957 at the Treaty of Rome. While the original goal was for a
common market, progress was generally very slow.
Another Perspective: The EU web site is {http://europa.eu.int/index-en.htm}. The site contains
a broad array of information about the historical role and current activities of the EU in the
global economy.
Political Structure of the European Union
The five main institutions of the EU are:

the European Council (resolves major policy issues and sets policy directions)
the European Commission (responsible for implementing aspects of EU law and
monitoring member states to ensure they are complying with EU laws)
the Council of the European Parliament, (the ultimate controlling authority within
the EU)
the European Parliament, (debates legislation proposed by the commission and
forwarded to it by the council)
the Court of Justice, (the supreme appeals court for EU law).
Pamela A. Ochieng
Page 40
The Single European Act

The Single European Act called for the removal of border controls, mutual recognition of standards,
open public procurement, a barrier free financial services industry, no currency exchange controls,
free and open freight transport, and freer and more open competition.
The Establishment of the Euro
The Treaty of Maastricht, signed in 1991, committed the EU to adopt a single currency, the
euro, by January 1, 1999. The euro is used by 12 of the 27 member states. By adopting the
euro, the EU has created the second largest currency zone in the world after that of the U.S.
dollar.
Since its establishment January 1, 1999, the euro has had a volatile trading history with the
U.S. dollar. Initially, the currency fell in value relative to the dollar, but has since
strengthened.
Another Perspective: The European Union has a web page devoted to the euro
{http://ec.europa.eu/economy_finance/euro/our_currency_en.htm}. Students can explore the site
and click on the pages to see pictures of the coins and notes, the advantages of participating
in the euro zone, and frequently asked questions about the euro.
Another Perspective: The European Central Bank maintains a web site with current
information on the euro. The site is available at {http://www.euro.ecb.int/}.
Enlargement of the European Union
Several countries, particularly from Eastern Europe, have applied for membership in the EU.
In December of 2002, the EU formally agreed to accept the applications of 10 countries, and
they joined on May 1, 2004. Today, membership is up to 27 countries.
Slide 8-27 Regional Economic Integration in the Americas
The North American Free Trade Agreement (NAFTA) is the most significant attempt at economic
integration in the Americas. Other efforts include the Andean group and MERCOSUR. In addition,
there are plans to establish a hemisphere wide Free Trade Area of the Americas (FTAA.)
The North American Free Trade Agreement
The free trade agreement between the United States, Canada, and Mexico became law
January 1, 1994.
Another
Perspective:
The
NAFTA
Homepage
can
be
accessed
at
{http://www.mac.doc.gov/nafta/}.
Following approval of NAFTA by the U.S. Congress a number of other Latin American
countries indicated their desire to eventually join NAFTA. Currently the governments of both
Canada and the U.S. are adopting a wait and see attitude with regard to most countries.
Another Perspective: Many organizations are anxious to take advantage of the opportunities
offered by NAFTA. The NAFTA Register {http://www.naftaregister.com/}is a directory of
Pamela A. Ochieng
Page 41

export management companies, export service providers, and trading companies that want to
profit from NAFTA by helping buyers and selling take advantage of NAFTA related
opportunities.
Another Perspective: An interesting analysis of NAFTA after 10 years is available at
{http://www.ustr.gov/assets/Trade_Agreements/Regional/NAFTA/asset_upload_file606_3595.pdf}.
The Andean Community
The Andean Pact, originally formed in 1969, was based on the EU model, but was far less successful
in achieving its stated goals. In 1990, the Andean Pact was relaunched, and now operates as a
customs union.
Another Perspective: To see new developments with the Andean Community go to

{http://www.comunidadandina.org/endex.htm}.
MERCOSUR
In some industries MERCOSUR is trade diverting rather than trade creating, and local firms are
investing in industries that are not competitive on a worldwide basis.
Another Perspective: MERCOSUR's Homepage, which includes a broad array of useful

information, can be accessed at {http://www.sice.oas.org/trade/mrcsr/mrcsrtoc.asp}.
Another Perspective: Information of the EUs relations with MERCOSUR can be found at
{http://europa.eu.int/comm/external_relations/mercosur/intro/}.
Central American Common Market and CARICOM
There are two other trade pacts in the America, the Central American Trade Market and
CARICOM, although neither has made much progress as yet.
Free Trade of the Americas
If the FTAA is established, it will have major implications for cross-border trade and
investment flows within the hemisphere. The FTAA would create a free trade area of nearly
800 million people.
Another Perspective: Additional information on the Free Trade of the Americas can be found
at {http://www.ftaa-alca.org/alca_e.asp}.
Regional Economic Integration Elsewhere
Several efforts have been made to integrate in Asia and Africa The ECOWAS, EAC, AU, OPEC etc
One of the most successful is the Association of Southeast Asian Nations (ASEAN)
Association of Southeast Asian Nations
Formed in 1967, ASEAN currently includes Brunei, Indonesia, Malaysia, the Philippines, Singapore,
Thailand, and, most recently, Vietnam, Myanmar, Laos, and Cambodia. The basic objectives of
Pamela A. Ochieng
Page 42

ASEAN are to foster freer trade between member countries and to achieve some cooperation in their
industrial policies.
Asia Pacific Cooperation
APEC currently has 21 members including such economic powerhouses as the United States,
Japan, and China. The stated aim of APEC is to increase multilateral cooperation in view of
the economic rise of the pacific nations and the growing interdependence within the region.
Another Perspective: For more on APEC, go to its web site at {http://www.apecsec.org.sg/}.
Regional Trade Blocks in Africa
There are nine trade blocs on the African continent, however progress toward the establishment of
meaningful trade blocs has been slow.
The EU and NAFTA currently have the most immediate implications for business.
Opportunities
The greatest implication for MNEs is that the free movement of goods across borders, the
harmonization of product standards, and the simplification of tax regimes, makes it possible for them
to realize potentially enormous cost economies by centralizing production in those locations where the
mix of factor costs and skills is optimal. By specialization and shipping of goods between locations, a
much more efficient web of operations can be created.
Threats
Just as the emergence of single markets in the EU and North America creates opportunities for
business, so it also presents a number of threats.
TOPIC 9: THE FOREIGN EXCHANGE MARKET
Introduction
This chapter:
explains how the foreign exchange market works
examines the forces that determine exchange rates and discusses the degree to which
it is possible to predict exchange rate movements
maps the implications for international business of exchange rate movements and the
foreign exchange market
The foreign exchange market is a market for converting the currency of one country into
that of another country. The exchange rate is the rate at which one currency is converted into
another.
The Functions of the Foreign Exchange Market
Pamela A. Ochieng
Page 43

The foreign exchange market is used:
to convert the currency of one country into the currency of another

to provide some insurance against foreign exchange risk - the adverse consequences
of unpredictable changes in exchange rates
Slide 9-5 Currency Conversion
Companies use the foreign exchange market:

to convert payments it receives for its exports, the income it receives from foreign
investments, or the income it receives from licensing agreements with foreign firms
when they must pay a foreign company for its products or services in its countrys
currency
when they have spare cash that they wish to invest for short terms in money markets
for currency speculation - the short-term movement of funds from one currency to
another in the hopes of profiting from shifts in exchange rates
Another Perspective: XE.com {http://www.xe.com/} provides a real time currency cross-rate chart,
and an option to do currency conversions.
Insuring Against Foreign Exchange Risk
A second function of the foreign exchange market is to provide insurance to protect against
the possible adverse consequences of unpredictable changes in exchange rates, or foreign
exchange risk.
The spot exchange rate is the rate at which a foreign exchange dealer converts one
currency into another currency on a particular day.
A forward exchange occurs when two parties agree to exchange currency and
execute the deal at some specific date in the future. A forward exchange rate occurs
when two parties agree to exchange currency and execute the deal at some specific
date in the future.
A currency swap is the simultaneous purchase and sale of a given amount of foreign
exchange for two different value dates. Swaps are transacted between international
businesses and their banks, between banks, and between governments when it is
desirable to move out o one currency into another for a limited period without
incurring foreign exchange rate risk.
The Nature of the Foreign Exchange Market
The foreign exchange market is not a place, but a network of banks, brokers, and dealers that
exchange currencies 24 hours/day.
Economic Theories of Exchange Rate Determination
Three factors have an important impact on future exchange rate movements in a countrys currency:
the countrys price inflation

its interest rate
market psychology
Pamela A. Ochieng
Page 44

Another Perspective: To find out more about how various factors affect, or are affected by,
exchange
rates,
go
to
{http://www.fxcmtr.com/education/what-movesrates.html?engine=exchangerate+rostext2+text&CMP=SFS701300000003SF7AAM&keyword=01t031} and click on what moves rates.
Prices and Exchange Rates
The law of one price suggests that in competitive markets free of transportation costs and trade
barriers, identical products in different countries must sell for the same price when their price is
expressed in terms of the same currency.
A less extreme version of the PPP theory states that given relatively efficient markets that is,
markets in which few impediments to international trade and investment exist the price of a basket
of goods should be roughly equivalent in each country.
Interest Rates and Exchange Rates
The International Fisher Effect states that for any two countries the spot exchange rate should
change in an equal amount but in the opposite direction to the difference in nominal interest rates
between two countries.
Investor Psychology and Bandwagon Effects
Expectations on the part of traders can turn into self-fulfilling prophecies, and traders can joint the
bandwagon and move exchange rates based on group expectations.
Summary
International businesses should pay attention to countries differing monetary growth, inflation, and
interest rates.
Exchange Rate Forecasting
The efficient market school, argues that forward exchange rate do the best possible job of forecasting
future spot exchange rates, and, therefore, investing in forecasting services would be a waste of
money, while the inefficient market school, argues that companies can improve the foreign exchange
markets estimate of future exchange rates (as contained in the forward rate) by investing in
forecasting services.
The Efficient Market School
An efficient market is one in which prices reflect all available information.
The Inefficient Market School
In an inefficient market, prices do not reflect all available information.
Approaches to Forecasting
There are two approaches to forecasting exchange rates:
fundamental analysis - draws upon economic theories to predict future exchange

rates, including factors like interest rates, monetary policy, inflation rates, or balance
of payments information
technical analysis - chart trends, and believe that past trends and waves are
reasonable predictors of future trends and waves
Pamela A. Ochieng
Page 45
Currency Convertibility
A currency is said to be freely convertible when a government of a country allows both

residents and non-residents to purchase unlimited amounts of foreign currency with the
domestic currency. A currency is said to be externally convertible when non-residents can
convert their holdings of domestic currency into a foreign currency, but when the ability of
residents to convert currency is limited in some way. A currency is nonconvertible when
both residents and non-residents are prohibited from converting their holdings of domestic
currency into a foreign currency.
Free convertibility is the norm in the world today, although many countries impose restrictions on the
amount of money that can be converted. The main reason to limit convertibility is to preserve foreign
exchange reserves and prevent capital flight.
Countertrade refers to a range of barter like agreements by which goods and services can be traded
for other goods and services. It can be used in international trade when a countrys currency is
nonconvertible.
Another Perspective: The American Countertrade Association maintains a web site with information
for those interested in countertrade. The site is worth a visit. It is available at {http://schemaroot.org/commerce/associations/american_countertrade_association/}.
There are three types of foreign exchange risk:
1. Transaction exposure
2. Translation exposure
3. Economic exposure
Transaction Exposure
Transaction exposure is the extent to which the income from individual transactions is affected by
fluctuations in foreign exchange values.
Translation Exposure
Translation exposure is the impact of currency exchange rate changes on the reported financial
statements of a company.
Economic Exposure
Economic exposure is the extent to which a firms future international earning power is affected by
changes in exchange rates.
Reducing Translation and Transaction Exposure
Firms can minimize their foreign exchange exposure by:
buying forward
using swaps
Pamela A. Ochieng
Page 46
leading and lagging payables and receivables - paying suppliers and collecting payment from
customers early or late depending on expected exchange rate movements
Reducing Economic Exposure

Firms can reduce economic exposure by ensuring assets are not too concentrated in countries where
likely rises in currency values will lead to damaging increases in the foreign prices of the goods and
services they produced.
Other Steps for Managing Foreign Exchange Risk
To manage foreign exchange risk: (a) central control of exposure is needed to protect
resources efficiently and ensure that each subunit adopts the correct mix of tactics and
strategies; (b) firms should distinguish between transaction and translation exposure on the
one hand, and economic exposure on the other hand; (c) the need to forecast future exchange
rates cannot be overstated; (d) firms need to establish good reporting systems so the central
finance function can regularly monitor the firms exposure position; (e) the firm should
produce monthly foreign exchange exposure reports.
TOPIC 10: INTERNATIONAL MONETARY SYSTEM
Introduction
The international monetary system refers to the institutional arrangements that countries adopt to
govern exchange rates. Governments adopt various types of exchange rate systems including the
pegged rate, the dirty float and the fixed rate.
The Gold Standard
The system of exchange rates known as the gold standard dates back to ancient times when gold
coins were a medium of exchange, unit of account, and store of value.
Mechanics of the Gold Standard
Pegging currencies to gold and guaranteeing convertibility is central to the gold standard.
In the 1880s, most of the worlds trading nations followed this exchange rate system.
Strength of the Gold Standard
The gold standard provides a powerful mechanism to pull trade imbalances between countries back
into balanceof trade equilibrium.
Another Perspective: The Advantages Of The Gold Standard was the topic of a 1961 paper by
former Federal Reserve Board Chairman, Alan Greenspan. The paper is available at
{http://www.usagold.com/gildedopinion/Greenspan.html}.
The Period between the Wars, 1918-1939
The gold standard worked fairly well from the 1870s until the start of World War I in 1914, but by
1939, the gold standard had collapsed.
Pamela A. Ochieng
Page 47

The Bretton Woods System
The Bretton Woods system established a fixed exchange rate system where all currencies were fixed
to gold, but only the U.S. dollar was directly convertible to gold. Devaluations could not to be used
for competitive purposes and a country could not devalue its currency by more than 10% without IMF
approval.
The Bretton Woods system also provided for two multinational institutions the International
Monetary Fund (IMF) and the World Bank (IBRD).
Another Perspective: For more information about the Bretton Woods Agreement go to
{http://www.yale.edu/lawweb/avalon/decade/decad047.htm}
{http://www.econ.iastate.edu/classes/econ355/choi/bre.htm}.
and
also
at
The Role of the IMF

The IMF was charged with executing the main goal of the Bretton Woods agreement - avoiding a
repetition of the chaos that occurred between the wars through a combination of discipline and
flexibility.
Another Perspective: The homepage of the IMF is available at {http://www.imf.org}. Students can
click on either For First Time Visitors or on For Students to get a nice overview of the IMF and
its activities.
The Role of the World Bank
The World Bank is also known as the International Bank for Reconstruction and Development
(IBRD).
Another
Perspective:
For more information on the World Bank, go to
{http://www.worldbank.org/index.html}. Click on Data and Research to pull information on World
Bank activities, or on Countries to explore World Bank activities by country.
The Collapse of the Fixed Exchange System
The Bretton Woods worked well until the late 1960s, before collapsing.
The Floating Exchange Rate Regime
The Jamaica Agreement was signed in 1976 following the collapse of Bretton Woods. The rules that
were agreed on then, are still in place today.
The Jamaica Agreement
Under the Jamaican agreement:
floating rates were declared acceptable

gold was abandoned as a reserve asset
total annual IMF quotas were increased to $41 billion
Pamela A. Ochieng
Page 48

Exchange Rates since 1973
Exchange rates have become more volatile and less predictable than they were between 1945 and
1973.
Fixed Versus Floating Exchange Rates
The merit of a fixed exchange rate versus a floating exchange rate system continues to be debated.
The Case for Floating Exchange Rates
The case for floating exchange rates has two main elements:
1. monetary policy autonomy
2. automatic trade balance adjustments
The Case for Fixed Exchange Rates
Supporters of fixed exchange rates focus on monetary discipline, uncertainty, and the lack of
connection between the trade balance and exchange rates.
Who is Right?
There is no real agreement as to which system is better.
Exchange Rate Regimes in Practice
Currently:
14% of IMF members follow a free float policy

26% of IMF members follow a managed float system
28% of IMF members have no legal tender of their own
the remaining countries use less flexible systems such as pegged arrangements, or adjustable
pegs
Pegged Exchange Rates

A country following a pegged exchange rate system, pegs the value of its currency to that of another
major currency.
Currency Boards
Countries using a currency board commit to converting their domestic currency on demand into
another currency at a fixed exchange rate.
Crisis Management by the IMF
Today, the IMF focuses on lending money to countries experiencing financial crises.
Financial Crises in the Post-Bretton Woods Era
A currency crisis occurs when a speculative attack on the exchange value of a currency results in a
sharp depreciation in the value of the currency, or forces authorities to expend large volumes of
international currency reserves and sharply increase interest rates in order to defend prevailing
exchange rates.
Pamela A. Ochieng
Page 49

A banking crisis refers to a situation in which a loss of confidence in the banking system leads to a
run on the banks, as individuals and companies withdraw their deposits.
A foreign debt crisis is a situation in which a country cannot service its foreign debt obligations,
whether private sector or government debt.
Mexican Currency Crisis of 1995
The Mexican currency crisis of 1995 was a result of:
high Mexican debts

a pegged exchange rate that did not allow for a natural adjustment of prices
The Asian Crisis

The 1997 Southeast Asian financial crisis was caused by a series of events that took place in the
previous decade.
Evaluating the IMF Policy Prescriptions
Critics of the IMF worry:
the one-size-fits-all approach to macroeconomic policy is inappropriate for many

countries
the IMF is exacerbating moral hazard (when people behave recklessly because they know
they will be saved if things go wrong)
The IMF has become too powerful for an institution without any real mechanism for
accountability
The present floating rate system mandates that firms carefully manage their foreign exchange
transactions and exposures.
Currency Management
Managers must recognize that the current international monetary system is a managed float system in
which government intervention can help drive the foreign exchange market.
Business Strategy
Managers need strategic flexibility.
Corporate Government Relations
Companies should promote an international monetary system that facilitates international growth and
development.
TOPIC 11: GLOBAL CAPITAL MARKET
Introduction
The rapid globalization of capital markets facilitates the free flow of money around the world.
Traditionally, national capital markets have been separated by regulatory barriers.
Pamela A. Ochieng
Page 50

Benefits of the Global Capital Market
Global capital markets , while providing many of the same function of domestic markets, offer some
benefits not found in domestic capital markets.
Functions of a Generic Capital Market
Capital markets bring together investors (corporations with surplus cash, individuals, and non-bank
financial institutions) and borrowers (individuals, companies, and governments).
Attractions of the Global Capital Market
Borrowers benefit from the global capital markets lower cost of capital and greater investment
options.
Growth of the Global Capital Markets
Since 1990, the stock of cross-border bank loans has grown from just $3,600 billion to $17,875 billion
in 2006. The international bond market shows a similar pattern of growth.
The two factors behind the growth are advances in information technology and deregulation of the
financial services industry.
Another Perspective: McKinsey & Company have been following the growth of the global capital
markets. Detailed analysis can be found at
{http://www.mckinsey.com/mgi/publications/third_annual_report/index.asp}.
Global Capital Market Risks
A key risk of an unregulated capital market and looser control on cross-border capital flows is that
individual nations may be more vulnerable to the destabilizing effects of speculative capital flows.
The Eurocurrency Market
A eurocurrency is any currency banked outside of its country of origin.
Genesis and Growth of the Market
The eurocurrency market began in the 1950s when the Eastern bloc countries were afraid the United
States might seize their holdings of dollars. Today, London is the center of the market.
Attractions of the Eurocurrency Market
The eurocurrency market is attractive to depositors and borrowers because it is not regulated by the
government.
Drawbacks of the Eurocurrency Market
The eurocurrency market has two drawbacks. First, because the eurocurrency market is unregulated,
there is a higher risk of bank failure. Second, companies borrowing eurocurrencies can be exposed to
foreign exchange risk.
The Global Bond Market
There are two types of international bonds:
Pamela A. Ochieng
Page 51

1. foreign bonds are sold outside the borrowers country and are denominated in the currency of the
country in which they are issued.
2. eurobonds are underwritten by a syndicate of banks and placed in countries other than the one in
whose currency the bond is denominated.
Attractions of the Eurobond Market
The eurobond market is attractive because it lacks regulatory interference, because it has less stringent
disclosure requirements than domestic bond markets, and because it is more favorable from a tax
perspective.
The Global Equity Market
The largest equity markets are in the United States, Britain, and Japan.
Foreign Exchange Risk and the Cost of Capital
While it may initially seem attractive to borrow foreign currencies, when exchange rate risk is
factored in, that can change.
Firms can often borrow at a lower cost than in the domestic capital market. Firms must balance the
foreign exchange risk associated with borrowing in foreign currencies against the costs savings that
may exist.
TOPIC 12: THE STRATEGY OF INTERNATIONAL BUSINESS
Introduction
How can firms compete more effectively internationally?
Strategy and the Firm
A firms strategy can be defined as the actions that managers take to attain the goals of the firm.
Value Creation
If consumers perceive the value of a good to be much higher than the actual cost of producing that
good, profit margins will be higher. Porter emphasizes two basic strategies to create value and attain
competitive advantage: low cost and differentiation strategy.
Strategic Positioning
Not all positions on the efficiency frontier are viable. Firms must choose a strategic position that is
viable.
Global Expansion, Profitability, and Profit Growth
Expanding globally allows firms to increase their profitability and rate of profit growth in ways not
available to purely domestic enterprises.
Expanding the Market: Leveraging Products and Competencies
Pamela A. Ochieng
Page 52

The success of firms that expand internationally depends on the goods or services they sell, and on
their core competencies (skills within the firm that competitors cannot easily match or imitate).
Location Economies
Location economies are the economies that arise from performing a value creation activity in the
optimal location for that activity.
Experience Effects
Experience effects are systematic reductions in production costs over the life of the product. The
speed with which a firm moves down the Experience Curve will determine how much advantage it
has over its competitors
Leveraging Subsidiary Skills
A global corporation can find vital skills developed in one foreign subsidiary and leverage them in
another part of the world. In order to take advantage of subsidiary skills the company must have
sophisticated processes that identify new skills that could be of interest. Once these skills are
identified, managers must have the capability to transfer them elsewhere.
Summary
Managers need to keep in mind the complex relationship between profitability and profit growth when
making strategic decisions about pricing.
Cost Pressures and Pressures for Local Responsiveness
Firms that compete in the global marketplace typically face two types of competitive pressures:
pressures for cost reductions
pressures to be locally responsive
Pressures for Cost Reduction
International businesses often face pressures for cost reductions because of the competitive global
market.
Pressures for Local Responsiveness
Pressure for local responsiveness comes from differences in consumer tastes, infrastructure,
distribution channels, or host government demands.
Choosing a Strategy
There are four basic strategies to compete in the international environment:
global standardization
localization
transnational
International
Global Standardization Strategy
Pamela A. Ochieng
Page 53

The global standardization strategy focuses on increasing profitability and profit growth by reaping
the cost reductions that come from economies of scale, learning effects, and location economies.
TOPIC 13: THE ORGANIZATION OF INTERNATIONAL BUSINESS
Introduction
Organizational architecture refers to the totality of a firms organization, including formal
organization structure, control systems and incentives, processes, organizational culture, and people
Three consistency conditions must be satisfied for an organization to deliver profitability:
architecture must be internally consistent; strategy and architecture must be consistent; strategy and
architecture together must be consistent with the competitive environment of the firm.
Organizational Architecture
Organizational structure refers to:
the formal division of the organization into subunits

the location of decision-making responsibilities within that structure (centralized versus
decentralized)
the establishment of integrating mechanisms to coordinate the activities of subunits including
cross-functional teams or pan-regional committees
Control systems measure and evaluate managerial performance and the performance of sub-units.
Incentives connect to control systems, and processes need to be consistent with the strategic
objectives of the organization. Efforts to shape values and norms in an organization are intricately
linked to human resource practices, especially at the selection and recruitment stages.
Organizational Structure
Organizational structure has three dimensions:
1. Vertical differentiation - the location of decision-making responsibilities within a structure
2. Horizontal differentiation - the formal division of the organization into sub-units
3. The establishment of integrating mechanisms - the mechanisms for coordinating sub-units
Vertical Differentiation: Centralization and Decentralization
Vertical differentiation determines where decision-making power is concentrated.
Horizontal Differentiation: The Design of Structure
Horizontal differentiation is concerned with how the firm decides to divide itself into sub-units.
The typical entrepreneurial firm begins with no formal structure. As the firm grows, when the
decision load becomes too intense for one person to handle, the firm is split into functions
representing value creation activities. If growth continues, eventually the complexities of size push
for the re-structuring of the firm into a divisional form.
When firms expand internationally, they often group all of their international activities into an
international division.
Many firms that continue to expand will abandon their international division structure and move to
either a:
Pamela A. Ochieng
Page 54
Worldwide product divisional structure - tends to be adopted by diversified firms that have
domestic product division
Worldwide area structure - tends to be adopted by undiversified firms whose domestic
structures are based on functions
The global matrix structure is an attempt to minimize the limitations of the worldwide area structure
and the worldwide product divisional structure.
Integrating Mechanisms
Regardless of the type of structure, firms need a mechanism to integrate subunits.
The simplest formal integrating mechanism is direct contact between subunit managers, followed by
liaisons. The next level of formal integration is temporary or permanent teams composed of
individuals from each subunit. Finally, the matrix structure allows for all roles to be integrating roles.
Many firms are using informal integrating mechanisms. A knowledge network is a network for
transmitting information within an organization that is based not on formal organization structure, but
on informal contacts between managers within an enterprise and on distributed information systems.
Control Systems and Incentives
A firms leaders need to ensure that the actions of subunits are consistent with the firms overall
strategic and financial objectives. This is achieved through control and incentive systems.
Types of Control Systems
There are four main types of control systems:
1. Personal controls control by personal contact with subordinates
2. Bureaucratic controls control through a system of rules and procedures that directs the actions of
subunits
3. Output controls setting goals for subunits to achieve and expressing those goals in terms of
relatively objective performance metrics
4. Cultural controls exist when employees buy into the norms and value systems of the firm
Incentive Systems
Incentives are the devices used to reward behavior. Incentives are usually closely tied to performance
metrics used for output controls.
Control Systems, Incentives, and Strategy in the International Business
The key to understanding the relationship between international strategy, control systems and
incentive systems is performance ambiguity - which exists when the causes of a subunits poor
performance are not clear.
The costs of controlling transnational firms are higher than the costs of controlling firms pursuing
other strategies.
Pamela A. Ochieng
Page 55

Processes
Processes refer to the manner in which decisions are made and work is performed.
Organizational Culture
Organizational culture is a social construct, a system of values and norms shared among people.
Creating and Maintaining Organizational Culture
Organizational culture comes from:
founders and important leaders
national social culture
the history of the enterprise
decisions that resulted in high performance
Organizational culture can be maintained through:
hiring and promotional practices
reward strategies
socialization processes
communication strategies
Organizational Culture and Performance in the International Business
Managers in companies with a strong culture share a relatively consistent set of values and norms
that have a clear impact on the way work is performed.
Synthesis of Strategy and Architecture
What is the interrelationship between the four basic strategies (localization, international, global
standardization
Localization Strategy
Firms pursuing a localization strategy focus on local responsiveness, do not have a high need for
integrating mechanisms, have low performance ambiguity and control costs.
International Strategy
Firms pursuing an international strategy create value by transferring core competencies from home to
foreign subsidiaries. They have moderate needs for control and integrating mechanisms.
Performance ambiguity is relatively low and so is the cost of control.
Global Standardization Strategy
Firms pursuing a global standardization strategy focus on the realization of location and experience
curve economies. Headquarters maintains control over most decisions, the need for integrating
mechanisms is high, and strong organizational cultures are encouraged.
Transnational Strategy
Firms pursuing a transnational strategy focus on simultaneously attaining location and experience
curve economies, local responsiveness, and global learning. Some decisions are centralized and
others are decentralized, coordination needs are high, and an array of formal and informal integrating
mechanisms are used.
Pamela A. Ochieng
Page 56

Environment, Strategy, Architecture, and Performance
For a firm to succeed, two conditions must be met:
1. the firms strategy must be consistent with the environment in which the firm operates
2. the firms organization architecture must be consistent with its strategy
Organizational Change
Firms need to change their architecture to reflect changes in the environment in which they are
operating and the strategy they are pursuing.
Organizational Inertia
Sources of inertia include:
the existing distribution of power and influence
the current culture
senior managers preconceptions about the appropriate business model or paradigm
institutional constraints
Implementing Organizational Change
There are three basic principles for successful organization change:
1. Unfreeze the organization through shock therapy
2. Moving the organization to a new state through proactive change in architecture
3. Refreeze the organization in its new state
TOPIC 14: FOREIGN MARKET ENTRY STRATEGIES
Introduction
Firms expanding internationally must decide which markets to enter, when to enter them and on what
scale, and which entry mode to use. Entry modes include exporting, licensing or franchising to a
company in the host nation, establishing a joint venture with a local company, establishing a new
wholly owned subsidiary, or acquiring an established enterprise.
Basic Entry Decisions
The three basic decisions every firm must make when expanding internationally are:
1. which markets to enter
2. when to enter those markets
3. on what scale to enter those markets
Which Foreign Markets?
The choice of foreign markets will depend on their long run profit potential.
Pamela A. Ochieng
Page 57

Timing of Entry
Once attractive markets are identified, the firm must consider the timing of entry. Entry is early when
the firm enters a foreign market before other foreign firms, and late when the firm enters the market
after firms have already established themselves in the market.
First mover advantages are the advantages associated with entering a market early. First mover
disadvantages are disadvantages associated with entering a foreign market before other international
businesses.
Scale of Entry and Strategic Commitments
After choosing which market to enter and the timing of entry, firms need to decide on the scale of
market entry. Large-scale entry may keep rivals out and may stimulate indigenous competitive
response. Small-scale entry allows time to learn about the market and reduces risk exposure.
Summary
There are no right decisions when deciding which markets to enter, and the timing and scale of
entry, just decisions that are associated with different levels of risk and reward.
Entry Modes
The six entry modes are exporting, turnkey projects, licensing, franchising, joint ventures, and wholly
owned subsidiaries.
Exporting
Exporting avoid costs of investing in new location and may help achieve experience curve and
location economies. Exporting faces challenges from tariff barriers, transportation costs, control over
marketing, and local low-cost manufacturers.
Another Perspective: The Business Link provides information companies should know before they
begin exporting. The site is available at{http://www.cbsc.org/alberta/tbl.cfm?fn=export}.
Students can click on the various topics to learn more about export financing, export plans, dealing
with risk, and so on.
Turnkey Projects
Turnkey projects allow a company to get a return on their knowledge assets and are less risky than
conventional FDI. The disadvantages are that there is not long-term interest in the location, the
project may create a competitor, and process technology may be selling a competitive advantage.
Another Perspective: To learn more about companies that identify themselves as firms that engage in
"turnkey projects", go to the web site of Frigemaires Engineers {http://www.feprojects.com/}. A list
of projects the company is currently involved in is available, and you can click on various types of
factories and get visuals on each factory.
Licensing
Licensing does not bear the costs and risks of investment and avoids political/economic restrictions in
a country.
Franchising
Franchising reduces costs and risks, avoids political and economic restrictions, and allows for
quicker expansion. Disadvantages include loss of control over quality.
Pamela A. Ochieng
Page 58

Joint Ventures
Joint ventures benefit from local partner's knowledge, shared costs, and reduced risk.
Disadvantages include loss of control over technology and conflict between partners.
Another
Perspective:
1000ventures,
available
at
{http://www.1000ventures.com/business_guide/jv_main.html}, is a web site that offers a wealth of
information about joint ventures.
Wholly Owned Subsidiaries
Wholly owned subsidiaries offer the most control and the highest level of risk and cost.
Selecting an Entry Mode
The optimal choice of entry mode involves trade-offs.
Core Competencies and Entry Mode
The optimal choice of entry mode for firms pursuing a multinational strategy depends to some degree
on the nature of their core competencies.
Pressures for Cost Reductions and Entry Mode
When pressure for cost reductions is high, firms are more likely to pursue some combination of
exporting and wholly owned subsidiaries.
Greenfield Ventures or Acquisitions
Firms can establish a wholly owned subsidiary in a country through a greenfield strategy (building a
subsidiary from the ground up) or through an acquisition strategy.
Pros and Cons of Acquisitions
Pros: quick, preemptive, possibly less risky. Cons: disappointing results, overpay, optimism/hubris,
culture clash, failure of synergies
Pros and Cons of Greenfield Ventures
Greenfield ventures allow the firm to build the subsidiary it wants, but it is slow, risky, and may
involve preemption by competitors.
Greenfield or Acquisition?
Acquisition is quicker, so a consideration if there are competitors ready to enter.
Strategic Alliances
Strategic alliances refer to cooperative agreements between potential or actual competitors.
The Advantages of Strategic Alliances
Strategic alliances facilitate entry into a foreign market, allow firms to share the fixed costs (and
associated risks) of developing new products or processes, bring together complementary skills and
Pamela A. Ochieng
Page 59

assets that neither partner could easily develop on its own, can help a firm establish technological
standards for the industry that will benefit the firm.
The Disadvantages of Strategic Alliances
Strategic alliances can give competitors low-cost routes to new technology and markets, but unless a
firm is careful, it can give away more than it receives.
The firm must be certain that the partner is one that can help the firm achieve its goals and not act
opportunistically to exploit the alliance for purely its own ends.
Making Alliances Work
The success of an alliance is a function of partner selection, alliance structure, and manner in which
the alliance is managed.
Another Perspective: The Institute for Collaborative Alliances maintains a web site with
information on how to make alliances more successful. The site is available at
{http://www.icalliances.com/model/index.htm}.
Introduction
Exporting firms need to
identify market opportunities

deal with foreign exchange risk
navigate import and export financing
understand the challenges of doing business in a foreign market
The Problems and Pitfalls of Exporting

Exporting offers the opportunity to take advantage of a bigger market, and the economies of scale that
come with producing for a bigger market. However, it is also a more complex market.
Common pitfalls include poor market analysis, poor understanding of competitive conditions, a lack
of customization for local markets, a poor distribution program, poorly executed promotional
campaigns, problems securing financing, a general underestimation of the differences and expertise
required for foreign market penetration, an underestimation of the amount of paperwork and
formalities involved.
Improving Export Performance
There are various ways to gain information about foreign market opportunities and avoid the pitfalls
associated with exporting.
Another Perspective: The UK Trade and Investment office is devoted to helping companies
develop
their
export
business.
The
web
site
is
available
at
{https://www.uktradeinvest.gov.uk/ukti/appmanager/ukti/home?_nfls=false&_nfpb=true} Click on
Business Opportunities to see a sample of a trade lead, or click on Country Report to see
the types of information available in a typical report on a specific country.
An International Comparison
Pamela A. Ochieng
Page 60

A big impediment to exporting is the simple lack of knowledge of the opportunities available. To
overcome ignorance firms need to collect information.
Another Perspective: Your students may wonder how firms U.S. firms find buyers in foreign
countries. To find foreign customers, exporters often use '"trade leads" that are provided
by organizations dedicated towards the activity of matching "buyers" and "sellers" in an
international context. An example of a site that provides trade leads is the Export.gov at
{http://www.export.gov/index.asp}.
Information Sources
The U.S. Department of Commerce is the most comprehensive source of export information
for U.S. firms.
Another Perspective: Students may want to explore the U.S. Department of Commerces web
site {http://www.commerce.gov/}and click on Free Trade.
Another Perspective: The Small Business Administration (SBA) also has an extensive web
site {http://www.sba.gov/} with information about exporting to different countries, contacts
and leads, and so on.
Utilizing Export Management Companies
Export management companies (EMCs) are export specialists that act as the export marketing
department or international department for client firms.
Another Perspective: The FITA Directory of Export Management Companies web site
{http://www.fita.org/emc.html} provides information on export management companies, and also
trade leads and international market research.
Export Strategy
Firms can reduce risk by carefully choosing their export strategy, and following some basic
guidelines. Firms should firms should hire an EMC or export consultant, to help identify
opportunities and navigate through the tangled web of paperwork and regulations so often involved in
exporting, focus on one, or a few, markets at first, enter a foreign market on a fairly small scale in
order to reduce the costs of any subsequent failures, recognize the time and managerial commitment
involved, develop a good relationship with local distributors and customers, hire locals to help
establish a presence in the market, be proactive, consider local production.
Another Perspective: A great web site to visit to determine whether a company is ready to
export is the International Trade Centre, run by UNCTAD/WTO. If you go to the site
{http://www.intracen.org/ec/welcome.htm }you can use the interactive quiz to gauge export
readiness. Click on Export Fitness Checker, then on Use the Export Fitness Checker
online to see the quiz.
Export and Import Financing
Firms engaged in international trade face a problem - they have to trust someone who may be difficult
to track down if they default on an obligation.
Lack of Trust
Including a third party in a transaction adds an element of trust to the relationship.
Pamela A. Ochieng
Page 61

Letter of Credit
A letter of credit is issued by a bank at the request of an importer and states the bank will pay a
specified sum of money to a beneficiary, normally the exporter, on presentation of particular,
specified documents.
Draft
A draft is simply an order written by an exporter instructing an importer, or an importer's agent, to
pay a specified amount of money at a specified time.
Bill of Lading
The bill of lading is issued to the exporter by the common carrier transporting the merchandise.
A Typical International Trade Transaction
The typical international trade transaction involves 14 steps as outlined in Figure 15.4.
Export Assistance
There are two forms of government-backed assistance available to exporters:
1. Financing aid is available from the Export-Import Bank
2. Export credit insurance is available from the Foreign Credit Insurance Association
Export-Import Bank
The Export-Import Bank (Eximbank) is an independent agency of the U.S. government that
provides financing aid to facilitate exports, imports, and the exchange of commodities between the
U.S. and other countries.
Export Credit Insurance
Export credit insurance protects exporters against the risk that the importer will default on payment.
In the U.S., export credit insurance is provided by the Foreign Credit Insurance Association
(FICA).
Countertrade
Countertrade refers to a range of barter-like agreements that facilitate the trade of goods and services
for other goods and services when they cannot be traded for money.
The Incidence of Countertrade
Countertrade began in the 1960s primarily in the Soviet Union and Eastern bloc countries. Its
popularity increased during the 1980s when many developing countries that were short of hard
currencies used countertrade instead. More recently, its use increased after the 1997 Asian financial
crisis.
Types of Countertrade
There are five distinct versions of countertrade:
Pamela A. Ochieng
Page 62

1. barter
2. counterpurchase
3. offset
4. compensation or buyback
5. switch trading
Pros and Cons of Countertrade.
The main attraction of counter trade is that it gives a firm a way to finance an export deal when other
means are not available. Countertrade is unattractive because it may involve the exchange of
unusable or poor-quality goods that the firm cannot dispose of profitably.
TOPIC 16:STRATEGY, PRODUCTION AND LOGISTICS
Introduction
Where should foreign production be located? How should a globally dispersed supply chain be
managed?
Strategy, Production and Logistics
Firms need to identify how production and logistics can be conducted internationally to:
lower the costs of value creation
add value by better serving customer needs
To increase product quality, most firms today use the Six Sigma program which aims to reduce
defects, boost productivity, eliminate waste, and cut costs throughout a company.
Another Perspective: To extend the discussion on TQM and Six Sigma go to

{http://www.isixsigma.com/sixsigma/six_sigma.asp}and
{http://home.att.net/~iso9k1/tqm/tqm.html}.
Where to Produce?
Three factors are important when making location decisions:
1. country factors
2. technological factors
3. product factors
When fixed costs are substantial, the minimum efficient scale of production is high, and/or flexible
manufacturing technologies are available, the arguments for concentrating production at a few choice
locations are strong.
Country Factors
Country factors that can affect location decisions include:
Pamela A. Ochieng
Page 63
the availability of skilled labor and supporting industries

formal and informal trade barriers
expectations about future exchange rate changes
transportation costs
regulations affecting FDI
Another Perspective: The United States Central Intelligence Agency maintains a country
profile on each country in the world. The country profiles provide useful information to a
companies contemplating doing business in a particular country. The country profiles,
{https://www.cia.gov/cia/publications/factbook/index.html}, are available to the public. Students
can use the reports as a basis for comparing different production locations.
Another Perspective: For additional information about a particular country, Yahoo provides
an easy-to-search bank of linked sources that provide information about almost every country
in the world. The site, {http://www.yahoo.com/Government/Countries/}, is useful to make quick
comparisons between countries to gauge their relative attractiveness as production locations.
Technological Factors
The type of technology a firm uses in its manufacturing can affect location decisions.
Three characteristics of a manufacturing technology are of interest:
1. the level of fixed costs
2. the minimum efficient scale
3. the flexibility of the technology
Product Factors
Two product factors impact location decisions:
1. the product's value-to-weight ratio:
2. whether the product serves universal needs:
Locating Production Facilities
There are two basic strategies for locating manufacturing facilities:
1. concentrating them in the optimal location and serving the world market from there
2. decentralizing them in various regional or national locations that are close to major markets
The Strategic Role of Foreign Factories
The strategic role of foreign factories and the strategic advantage of a particular location can change
over time.
Improvement in a facility comes from two sources:
1. pressure to lower costs or respond to local markets
2. an increase in the availability of advanced factors of production
Pamela A. Ochieng
Page 64

Outsourcing Production: Make-or-Buy Decisions
Should an international business make or buy the component parts to go into their final product?
Make-or-buy decisions are important factors in many firms' manufacturing strategies.
The Advantages of Make
1. lower costs
2. facilitates investments in highly specialized assets
3. protects proprietary technology
4. facilitate the scheduling of adjacent processes
The Advantages of Buy
Buying component parts from independent suppliers:
1. gives the firm greater flexibility
2. helps drive down the firm's cost structure
3. helps the firm capture orders from international customers
Trade-Offs
The benefits of manufacturing components in-house are greatest when:
highly specialized assets are involved
vertical integration is necessary for protecting proprietary technology
the firm is more efficient than external suppliers at performing a particular activity
Strategic Alliances with Suppliers
Firms can capture the benefits of vertical integration without the associated organizational problems
by forming long-term strategic alliances with key suppliers. However, these commitments may
actually limit strategic flexibility.
Managing the Global Supply Chain
Logistics encompasses the activities necessary to get materials to a manufacturing facility, through
the manufacturing process, and out through a distribution system to the end user
Another Perspective: Stanford University maintains a web site that is a forum for the dissemination
of research and practical advice in the area of global supply chain management. The site supplies
current information that can help embellish a lecture on global materials management. The site is
available at {http://www-leland.standford.edu/group/scformu/}.
The Role of Just-in-Time Inventory
The basic philosophy behind just-in-time (JIT) systems is to economize on inventory holding costs
by having materials arrive at a manufacturing plant just in time to enter the production process, and
not before
Pamela A. Ochieng
Page 65

The Role of Information Technology and the Internet
Web-based information systems play a crucial role in materials management. They allow firms to
optimize production scheduling according to when components are expected to arrive.
TOPIC 17: GLOBAL MARKETING RESEARCH AND DEVELOPMENT

Introduction
The marketing mix (the choices the firm offers to its targeted market) is comprised of product
attributes, distribution strategy, communication strategy, and pricing strategy.
The Globalization of Markets and Brands
Culture and consumer tastes drive the need to localize. Globalization seems to be the exception rather
than the rule in many markets.
Market Segmentation
Market segmentation involves identifying distinct groups of consumers whose purchasing behavior
differs from others in important ways. Segments can be based on: geography, demography, sociocultural factors and psychological factors.
Product Attributes
A product is like a bundle of attributes. Products sell well when their attributes match consumer
needs.
Cultural Differences
While there is some cultural convergence among nations, Levitts vision of global markets is still a
long way off.
Economic Development
Consumers in highly developed countries tend to demand a lot of extra performance attributes, while
consumers in less developed nations tend to prefer more basic products.
Product and Technical Standards
Differences in product and technical standards may require the firm to customize products.
Distribution Strategy
A firms distribution strategy (the means it chooses for delivering the product to the consumer) is a
critical element of the marketing mix.
Differences between Countries
There are four main differences in distribution systems:
1. retail concentration
2. channel length
3. channel exclusivity
Pamela A. Ochieng
Page 66

4. channel quality
Choosing a Distribution Strategy
The optimal strategy depends on the relative costs and benefits of each alternative.
Communication Strategy
Communication channels available to a firm include direct selling, sales promotion, direct marketing,
and advertising via different media.
Barriers to International Communication
The effectiveness of a firm's international communication can be jeopardized by cultural barriers,
source and country of origin effects, and noise levels.
Another Perspective: The class can be stimulated to think of some positive and negative
source effects (German autos vs. German wine, Italian cuisine vs. British cuisine).
Push Vs. Pull Strategy
Firms have to choose between two types of communication strategies:
a push strategy emphasizes personnel selling

a pull strategy emphasizes mass media advertising
The choice between push and pull strategies depends upon product type and consumer sophistication,
channel length, and media availability.
Global Advertising
Standardized advertising makes sense when it has significant economic advantages, creative talent is
scarce and one large effort to develop a campaign will be more successful than numerous smaller
efforts, and brand names are global. Standardized advertising does not make sense when cultural
differences among nations are significant, and country differences in advertising regulations block the
implementation of standardized advertising.
Pricing Strategy
There are three issues to consider price discrimination, strategic pricing and regulatory influence on
prices.
Price Discrimination
Price discrimination occurs when firms charge consumers in different countries different prices for
the same product. The price elasticity of demand is a measure of the responsiveness of demand for
a product to changes in price.
Strategic Pricing
Strategic pricing has three aspects:
1. predatory pricing - involves using the profit gained in one market to support aggressive pricing
designed to drive competitors out in another market.
Pamela A. Ochieng
Page 67

2. multi-point pricing - a firms pricing strategy in one market may have an impact on a rivals
pricing strategy in another market.
3. experience curve pricing - price low worldwide in an attempt to build global sales volume as
rapidly as possible, even if this means taking large losses initially.
Regulatory Influences on Prices
A firms ability to set its own prices may be limited by:
1. antidumping regulations
2. competition policy
Configuring the Marketing Mix
Differences in culture, economic conditions, competitive conditions, product and technical standards,
distribution systems, government regulations, and the like may require variation in product attributes,
distribution strategy, communications strategy, and pricing strategy.
Another Perspective: Fun sites to visit with students include Cadbury Schweppes
{http://www.cadburyschweppes.com/EN http://www.cadburyschweppes.com/EN} and Kraft
{http://www.kraft.com/default.aspx}. Both companies sell their products in many countries
around the world, and by clicking on the various country locations, students can get a feel for
which elements of the marketing mix have been standardized, and which have not.
New Product Development
Firms today need to make product innovation a priority. This requires close links between R&D,
marketing, and manufacturing.
The Location of R&D
New product ideas come from the interactions of scientific research, demand conditions, and
competitive conditions.
Integrating R&D, Marketing and Production
A firms new product development efforts need to be closely coordinated with the marketing,
production, and materials management functions.
Cross Functional Teams
Effective cross functional teams should be led by a heavyweight project manager with status in the
organization, include members from all the critical functional areas, have members located together,
establish clear goals, develop an effective conflict resolution process.
Building Global R&D Capabilities
To adequately commercialize new technologies, firms need to integrate R&D and marketing.
Pamela A. Ochieng
Page 68

TOPIC 18: GLOBAL HR MANAGEMENT
Introduction
Human resource management (HRM) refers to the activities an organization carries out to utilize its
human resources effectively. The four major tasks of HRM are staffing, management training and
development, performance evaluation, and compensation.
The Strategic Role of International HRM
Firms need to ensure there is a fit between their human resources practices and strategy.
Staffing Policy
A firms staffing policy is concerned with the selection of employees who have the skills required to
perform a particular job.
Types of Staffing Policy
Three staffing policy choices at the international level are: ethnocentric, polycentric, and geocentric.
1. The ethnocentric approach to staffing policy fills key management positions with parent-country
nationals
2. The polycentric staffing policy recruits host country nationals to manage subsidiaries in their own
country, and parent country nationals for positions at headquarters
3. The geocentric staffing policy seeks the best people, regardless of nationality for key jobs
Expatriate Managers
Expatriate failure is the premature return of an expatriate manager to his or her home country.
Expatriate failures impact the company, as do near-failures.
Another Perspective: Until the advent of the Internet, expatriates often felt isolated. Today
numerous sites exist where expatriates can communicate with each other and share their
experiences. One example of this type of site is {http://www.expat-online.com/}. Students can
explore the site, or it can be an in-class activity to see some of the issues facing expatriates.
The Global Mindset
A global mindset may be the fundamental attribute of a global manager.
Training and Management Development
Training focuses upon preparing the manager for a specific job. Management development is
concerned with developing the skills of the manager over his or her career with the firm.
Training for Expatriate Managers

Cultural training (seeks to foster an appreciation for the host country's culture), language
training (an exclusive reliance on English diminishes an expatriate manager's ability to
Pamela A. Ochieng
Page 69

interact with host country nationals), and practical training (helps the expatriate manager
and her family ease themselves into day-to-day life in the host country) have all help reduce
expatriate failure.
Another Perspective: Numerous companies offer expatriate training services. One great
example is Kwintessential {http://www.kwintessential.co.uk/cultural-services/articles/expatcultural-training.html}. The companys web site includes a wealth of information on the
expatriate process, country profiles, and even an online quiz on cultural awareness. Consider
using the site in-class, or asking students to explore it on their own.
Repatriation of Expatriates
HRM needs to develop good programs for re-integrating expatriates back into work life within their
home country organization once their foreign assignment is over, and for utilizing the knowledge they
acquired while abroad. The benefits from foreign assignments can be lost by firms if they are not
careful in the repatriation of the expatriates.
Management Development and Strategy
Management development is often used as a strategic tool to build a strong unifying culture and
informal management network, both of which are supportive of a transnational and global strategy.
Performance Appraisal
Evaluating expatriates can be especially complex.
Performance Appraisal Problems
Typically, both host nation managers and home office managers evaluate the performance of
expatriate managers. Both types of managers are subject to unintentional bias.
Guidelines for Performance Appraisal
Firms need to seek ways to reduce bias in performance appraisals.
Compensation
Should executive pay in different countries reflect the standards in each country or be equalized on a
global basis? How should expatriates be paid?
National Differences in Compensation
Expatriate Pay
An expatriates compensation package is made up of:
1. base salary
2. a foreign service premium
3. various allowances
Pamela A. Ochieng
Page 70

4. tax differentials
5. benefits
International Labor Relations
The key issue in international labor relations is the degree to which organized labor is able to limit the
choices available to an international business.
Another Perspective: The International Labor Organization (ILO) supports worker issues
throughout the world. To see some of the issues the ILO is currently involved in, go to
{http://www.ilo.org/}.
The Concerns of Organized Labor
The bargaining power of unions comes from their ability to threaten to disrupt production by striking
or protesting.
Strategy of Organized Labor
Organized labor has responded to the increased bargaining power of multinational corporations by:
setting-up their own international organizations; lobbying for national legislation to restrict
multinationals; and trying to achieve regulations of multinationals through international organization
such as the United Nations. However, none of those efforts has been very successful.
Approaches to Labor Relations
Many firms are recognizing that the way in which work is organized within a plant can be a major
source of competitive advantage.
TOPIC 19: ACCOUNTING IN ITERNATIONAL BUSINESS

Introduction
Accounting is the language of business it is the way firms communicate their financial positions.
Country Differences in Accounting Standards
Accounting is shaped by the environment in which it operates. In each country the accounting system
has evolved in response to the nature of the demands for accounting information.
Determinants of National Accounting Standards
Five main factors influence the development of a countrys accounting system: 1) the relationship
between business and the providers of capital, 2) political and economic ties with other countries, 3)
levels of inflation, 4) the level of a country's development, and 5) the prevailing culture in a country.
Relationship between Business and Providers of Capital
Three main external sources of capital for business enterprises are: (1) individual investors, (2) banks,
and (3) government.
Pamela A. Ochieng
Page 71

Political and Economic Ties with Other Countries
Similarities in accounting systems across countries can reflect political or economic ties.
Inflation Accounting
The historic cost principal assumes the currency unit used to report financial results is not losing its
value due to inflation.
Level of Development
Developed nations tend to have more sophisticated accounting systems than developing countries.
Culture
The extent to which a culture is characterized by uncertainty avoidance (the extent to which cultures
socialize their members to accept ambiguous situations and tolerate uncertainty) impacts the countrys
accounting system.
National and International Standards
Accounting standards are rules for preparing financial statementsthey define useful accounting
information. Auditing standards specify the rules for performing an auditthe technical process by
which an independent person gathers evidence for determining if financial accounts conform to
required accounting standards and if they are also reliable.
Lack of Comparability
Because of national differences in accounting and auditing standards, comparability of financial
reports from one country to another is difficult.
International Standards
There has been a substantial effort recently to harmonize accounting standards across countries. The
International Accounting Standards Board (IASB) is a major proponent of standardization.
Another Perspective: To see a complete summary of the accounting standards already set forth, and
current efforts at developing new standards, go to the IASBs web site at
{http://www.iasb.org/Home.htm}.
Multinational Consolidation and Currency Translation
Subsidiaries of multinationals are separate legal entities but not separate economic entities. A
consolidated financial statement combines the separate financial statements of two or more
companies to yield a single set of financial statements as if the individual companies were really one.
Consolidated Financial Statement
The IASB requires firms to prepare consolidated financial statements, as do most industrialized
nations.
Pamela A. Ochieng
Page 72

Currency Translation
There are two methods to determine what exchange rate should be used when translating financial
statement currencies:
1. the current rate method
2. the temporal method
The Current Rate Method
Under the current rate method, the exchange rate at the balance sheet date is used to translate the
financial statements of a foreign subsidiary into the home currency of the multinational firm. This can
cause problems due to exchange rate fluctuations.
The Temporal Method
Under the temporal method, assets valued in a foreign currency are translated into the home
currency using the exchange rate that existed when the assets were originally purchased. One
problem with this approach is that the balance sheet of the multinational may no longer balance.
Current US Practice
Under US FASB regulations, a self-sustaining subsidiary is said to have its own local currency as its
functional currency. The balance sheet for such subsidiaries is translated into the home currency
using the exchange rate in effect at the end of the firm's financial year, while the income statement is
translated using the average exchange rate in effect during the firm's financial year. On the other
hand, an integral subsidiary has US dollars as its functional currency.
Another Perspective: The Financial Accounting Standards Board (FASB) and the IASB have made a
commitment to work together to harmonize accounting standards. More on this agreement is
available at the FASB web site at {http://www.fasb.org/intl/convergence_iasb.shtml}.
Accounting Aspects of Control Systems
The control process in most firms is usually conducted annually and involves three steps:
1. subunit goals are jointly determined by the head office and subunit management
2. the head office monitors subunit performance throughout the year
3. the head office intervenes if the subsidiary fails to achieve its goal, and takes corrective actions if
necessary
Exchange Rate Changes and Control Systems
Most international firms require budgets and performance data to be expressed in the corporate
currency-normally the home currency.
The Lessard- Lorange Model
Lorange and Lessard suggest that firms use the projected spot exchange rate (usually the forward
exchange rate) to translate budget and performance figures into the corporate currency.
Pamela A. Ochieng
Page 73

Transfer Pricing and Control Systems.
The price at which goods and services transferred within the firm is the transfer price.
Transfer prices can critically affect the performance of two subsidiaries that exchange goods or
services and can also introduce significant distortions into the control process. Transfer prices must
be taken into account when setting budgets and evaluating a subsidiary's performance.
Separation of Subsidiary and Manager Performance.
The evaluation of a subsidiary should be kept separate from the evaluation of its manager.
TOPIC 20: FINANCIAL MANAGEMENT IN THE INTERNATIONAL BUSINESS
Introduction
Financial management focuses on three types of decisions: investment, financing, and money
management. In international business, currencies, tax regimes, regulations on capital flows, norms
for the financing of business, levels of economic and political risk all influence these decisions.
Investment Decisions
Financial managers must quantify the benefits, costs, and risks associated with an investment in a
foreign country.
Capital Budgeting
Capital budgeting quantifies the benefits, costs, and risks of an investment.
Project and Parent Cash Flows
For the parent company, the key figure is the cash flows it will receive, not the cash flows the project
generates because received cash flows are the basis for dividends, other investments, repayment of
debt, and so on.
Adjusting for Political and Economic Risk
The analysis of a foreign investment opportunity includes an assessment of political and economic
risk. Political risk is the likelihood that political forces will cause drastic changes in a countrys
business environment that hurt the profit and other goals of a business. Economic risk is the
likelihood that economic mismanagement will cause drastic changes in a countrys business
environment that hurt the profit and other goals of a business.
Financing Decisions
Firms must consider two factors when considering financing options:
1. how the foreign investment will be financed
2. how the financial structure of the foreign affiliate should be configured
Pamela A. Ochieng
Page 74

Source of Financing
The cost of capital is typically lower in the global capital market than in many domestic markets.
Financial Structure
The mix of debt and equity used to finance a business varies across countries. Japanese firms rely far
more on debt financing than do most US firms.
Global Money Management
Money management decisions attempt to manage global cash resources efficiently.
Minimizing Cash Balances
Firms face a dilemma - when they invest in money market accounts they have unlimited liquidity, but
low interest rates, and when they invest in long-term instruments they have higher interest rates, but
low liquidity.
Reducing Transaction Costs
Transaction costs are the cost of exchange. Every time a firm changes cash from one currency to
another, they face transaction costs. Most banks also charge a transfer fee for moving cash from one
location to another.
Global Money Management: The Tax Objective
Double taxation occurs when the income of a foreign subsidiary is taxed by the host-country
government and by the home-country government.
Another Perspective: The US offers extraterritorial tax credit for multinational companies with
offshore operations. The European Union has protested against this subsidy stating that it creates
unfair competition. The WTO ruled that the FSC/ETI provisions of the U.S. Internal Revenue Code
constitute a prohibited export subsidy and are in violation of WTO rules. To learn more, go to
{http://www.buyusa.gov/france/en/263.html}.
A tax credit allows an entity to reduce the taxes paid to the home government by the amount of taxes
paid to the foreign government. A tax treaty between two countries is an agreement specifying what
items of income will be taxed by the authorities of the country where the income is earned. A deferral
principle specifies that parent companies are not taxed on foreign source income until they actually
receive a dividend.
A tax haven is a country with a very low, or no, income tax firms can avoid income taxes by
establishing a wholly-owned, non-operating subsidiary in the country.
Moving Money Across Borders: Attaining Efficiencies and Reducing Taxes
Firms transfer liquid funds across borders as dividend remittances, royalty payments and fees, transfer
prices, and fronting loans.
Dividend Remittances
The most common method of transferring funds from subsidiaries to the parent is through dividends.
Pamela A. Ochieng
Page 75

Royalty Payments and Fees
Royalties represent the remuneration paid to the owners of technology, patents, or trade names for the
use of that technology or the right to manufacture and/or sell products under those patents or trade
names.
A fee is compensation for professional services or expertise supplied to a foreign subsidiary by the
parent company or another subsidiary.
Transfer Prices
Transfer prices can be used to position funds within an international business.
Fronting Loans
Fronting loans circumvent host government restrictions on the remittance of funds and have certain
tax advantages.
Techniques for Global Money Management
Two techniques used by firms to manage their global cash resources are:
centralized depositories
multilateral netting
Centralized Depositories
Most firms prefer the cash depositories for three reasons:
1. by pooling cash reserves centrally, firms can deposit larger amounts, and therefore earn higher rates
of interest
2. when centralized depositories are located in major financial centers, the firm has access to a greater
variety of investment opportunities than a subsidiary would have
3. by pooling cash reserves, firms can reduce the total size of the readily accessible cash pool, and
invest larger amounts in longer-term, less liquid accounts that have higher interest rates
Multilateral Netting
Multilateral netting is an extension of bilateral netting.
Localization Strategy
The localization strategy focuses on increasing profitability by customizing the firms goods or
services so that they provide a good match to tastes and preferences in different national markets.
Transnational Strategy
The transnational strategy tries to simultaneously:
achieve low costs through location economies, economies of scale, and learning effects
Pamela A. Ochieng
Page 76
differentiate the product offering across geographic markets to account for local
differences
foster a multidirectional flow of skills between different
International Strategy
The international strategy involves taking products first produced for the domestic market and then
selling them internationally with only minimal local customization.
The Evolution of Strategy
Strategy is an evolutionary process. Firms need to change their strategic approach as the environment
changes.
Pamela A. Ochieng
Page 77

Hcba 3221 International Bus MNGT Course Outline

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Hcba 3221 International Bus MNGT Course Outline

Uploaded by

Copyright:

Available Formats

HCBA TEACHING NOTES 2014

HCBA 3221: INTERNATIONAL BUSINESS MANAGEMENT

Understand international/global business activities, problems, techniques, and strategies.

Course Text books

HCBA TEACHING NOTES 2014

HCBA TEACHING NOTES 2014

Understand what is meant by the term globalization.

Be familiar with the main drivers of globalization.

Appreciate the changing nature of the global economy.

Appreciate how the process of globalization is creating opportunities and challenges

Factors that influenced the growth in globalization of international business

Technology is expanding, especially in transportation and communications.

Cross-national cooperation and agreements

HCBA TEACHING NOTES 2014

HCBA TEACHING NOTES 2014

HCBA TEACHING NOTES 2014

EXAMPLE DISCUSSION QUESTION 1.

HCBA TEACHING NOTES 2014

HCBA TEACHING NOTES 2014

HCBA TEACHING NOTES 2014

HCBA TEACHING NOTES 2014

HCBA TEACHING NOTES 2014

HCBA TEACHING NOTES 2014

HCBA TEACHING NOTES 2014

HCBA TEACHING NOTES 2014

QUESTION 2: A democratic political system is an essential condition for sustained

HCBA TEACHING NOTES 2014

HCBA TEACHING NOTES 2014

HCBA TEACHING NOTES 2014

HCBA TEACHING NOTES 2014

HCBA TEACHING NOTES 2014

CRITICAL THINKING AND DISCUSSION QUESTIONS

HCBA TEACHING NOTES 2014

HCBA TEACHING NOTES 2014

HCBA TEACHING NOTES 2014

HCBA TEACHING NOTES 2014

HCBA TEACHING NOTES 2014

HCBA TEACHING NOTES 2014

SECTION II: EVOLUTION OF INTERNATIONAL TRADE

Another Perspective: A historical perspective of Mercantilism is available at the following

HCBA TEACHING NOTES 2014

HCBA TEACHING NOTES 2014

A more complete description of the

The Leontief Paradox

The Product Life Cycle

HCBA TEACHING NOTES 2014

HCBA TEACHING NOTES 2014

HCBA TEACHING NOTES 2014

HCBA TEACHING NOTES 2014

Protecting Jobs and Industries

HCBA TEACHING NOTES 2014

HCBA TEACHING NOTES 2014

HCBA TEACHING NOTES 2014

HCBA TEACHING NOTES 2014

The Form of FDI: Acquisitions Versus Greenfield Investments

HCBA TEACHING NOTES 2014

The Shift to Services

Why Foreign Direct Investment?

Political Ideology and Foreign Direct Investment

HCBA TEACHING NOTES 2014

HCBA TEACHING NOTES 2014

International Institutions and the Liberalization of FDI

Implications for Managers