Country Risk Analysis: Business Environment for Global Firms

Business Environment
Economic Environment; Political Environment; Legal and regulatory environment; Cultural Environment;

Economic Environment
Economic System :
Centrally Planned Economy : where decisions regarding production and distribution of goods is taken by a central authority. Market Based Economy: The decision of production and distribution is taken by individual firms based on market demand and supply.

 Mixed Economic System:

In this case public and private sectors exist side by side.

Whenever, a firm trades with any other country or whenever it tries to locate its manufacturing operations there, it takes into account the existing economic system in the host country and accordingly shapes the trade and foreign operation policies.

Consumer Behaviour
It is based on :
Preference for Price/Quality of the product; Propensity to save; (Rural areas where people have high propensity to save), Quality of People; (Educated) Existence of Social Security Scheme;

Level of Income and Distribution

Distribution of low, medium, and high incomes. Gross domestic product per capita.

In low income countries MNCs market or manufacturing low priced goods. However, MNCs would like to establish in a low income country where 10% population out of 500 million population capture 60% national income.

Inflation
Inflation has negative and positive impact Which is based on nature of activity. Such as,
High inflation has negative impact on salaried class people whereby Purchasing power of customer depends upon level of inflation. Higher the inflation lower the real income and lower the demand.

 It has negative impact on production of product when cost of production increases because of high inflation. Thus, when a multinational firm decides to set up manufacturing unit in a foreign country it has to take into account the rate of inflation.

Availability of Human and Physical Resources:

Human Resources:
It is not possible for MNCs to transport the entire labour force from the home country. Availability of skill manpower in host country is must.

 Physical Resources:

Raw Material: availability of various inputs necessary for the production. Example,vario us Indian firms have moved to Sri Lanka for production of rubber products and Nepal for production of herbal products.
Vocational theory of Foreign direct investment is based on this concept.

Network of Infrastructure
Availability and quality of infrastructure:
Rail traffic networks for distribution capabilities; Communication systems for marketing; Energy (electrical and fuel) consumption;

In India lack of proper infrastructure is the reason for gap between approved FDI and actual inflow of FDI.

Economic Policies
Monetary Policy : If restrictive or contractionary monetary policy (Rate of interest will be high) is implemented to stabiles the economy, it has negative impact on MNCs and business men because now credit is available at high rate of interest.

 Fiscal Policy : If corporate taxes are at higher side it will be taken into consideration as negative aspect by MNCs. If host country carries high fiscal deficit and budgetary deficit MNC will take it as negative point. Because it has negative impact on external sector and monetary sector.

 Trade Policy : Excise duties and import duties also cause of concern for MNCs.
Industrial Policy :
If industrial policies are liberal for MNCs it attracts more foreign investment.
If these polices are restrictive foreign investment is also restricted.

Strength of External Sector

MNCs are greatly interested in repatriating profits to their parent company. If it easier, MNCs will attract more towards that country. For liberal repatriation policy, situation of balance of Payment should be strong. Foreign exchange reserve should be large in size.

Level of Economic Integration

Free Trade Area

Eliminates tariff and quota barriers among member countries. Each country is free to set its own tariff and quota barriers against nonmember countries.

Customs Union Area

Tariff and quota barriers among member countries are eliminated.

Member countries establish common tariff and trade barriers against nonmember countries. .

Common Market Area

No trade barriers among member nations. No restriction on the movement of labor, capital, or technology across borders. Member countries establish common tariff and trade barriers against nonmember countries.

Economic Union
Has all the characteristics of a common market. Harmonizes taxation. Harmonizes monetary policies. Establishes a common currency.

NAFTA

The North American Free Trade Agreement (NAFTA) created the worlds largest free market.
390 million U.S., Canadian, and Mexican consumers and a total output of $10 trillion.

Integration in Asia
Association of Southeast Asian Nations (ASEAN) East Asia Economic Group Asia-Pacific Economic Cooperation (APEC) South Asian Association for Regional Cooperation (SAARC)

Integration in Africa and the Middle East

Economic Community of West African States (ECOWAS) The African Union (AU) The Arab Maghreb Union Gulf Cooperation Council (GCC)

Political and Legal Environment

Firms usually prefer to conduct business in a country with a stable government in conducive business environment.
In the host country environment both political and legal affects the international marketing and business operations of a firm in various ways.

 Resultantly, there is always some risk involved in account of differing political scenario, which is known as Political Risk. Political Risk :
It is the risk of loss in investment being made in a given country because of change in countrys political structure or policies. Such as:

Tax law, tariffs, and restriction in repatriation of profits.

 Currency Inconvertibility:
Sometimes the host government enacts law

prohibiting foreign companies from taking their money out of the country or exchanging the host country currency for any other currency. This is a financial form of political risk. The reasons are both economic and political. Economic factors are concerned mainly with balance of payment problem. Example: The govt. of Nigeria imposed such restrictions a couple of decade back in order to serve it economic and political objectives.

Credit Risk
Refusal to honor a financial contract with foreign

company or to honor foreign debt comes under the form of political risk.
Conflict of Interest: The interest of MNCs is normally different from interest of the host country. The MNCSs manifest in the maximization of corporate wealth; The host country is evident in the welfare of economy;

 Example :
Transfer of funds by MNCs may influence the money supply which may cause deflation; Similarly the payment of exorbitant amount of royalty and other such dues by subsidiary may worsen the balance of payment;

It is not economic issue that are the source of conflict but also non-economic such as national security;

Management of Political Risk

MNCs can pursue a strategy of either avoidance or insurance. Avoidance : Screening out political uncertain countries.

In this case, measurement and analysis of political risk is useful.

 Insurance:
It is a strategy to shift the risk to other parties. Insurance coverage can be obtained from a number of sources:
Private Insurance Government Insurance

Example
In 1993, Motorola won bid to install, operate and maintain cellular telephone service in Nicaragua. Nicaragua has a crumbling infrastructure and a very poor land-line telephone system. Motorolas cellular service was one of the biggest private foreign investor.

 Example :
Overseas Private Investment Corporation (OPIC), U.S. government agency, which is business oriented agency whose purpose is to support U.S. private investments. It receives no public funds. OPIC provided $ 8 million in insurance against political risk.

Legal Environment
From an international business perspective host countries may adopt a number of law that affect a companys ability to market. Such as :
Antidumping Law : It prohibits below cost

sales of product. Licensing: In this case company has to hold export and import license.

 Restriction on Genetic Modefied

ingly devising new rules that affect trade in genetically modified products. For example, Australia introduced a mandatory standards for food. Tariffication: In this case, tariff on those goods are high where govt. want to control the supply, such as, cigarettes and alcohol.

Food: At this front governments increas-

 Taxation :
This is very important legal issue for International firms which move from one country to other and adopts transfer pricing. Example: if any firm is established in the country where corporate tax rate is very high, firm adopts transfer pricing in order to siphon-off the profit or dividend before imposition of tax to the subsidiary which is located on tax heaven country. In this case host country with high corporate tax has to face loss.

 Corporate Governance and Responsibility:

In this system the decisions are made and interests are represented properly for all stake-holdrs. Key elements are :
Transparency of a firms operation; Transparency in financial results; Assurance of Stake-holder's Right;

 Safety, Environment and Labour Standards: In this case entry of those foreign goods which do not meet these standard are prohibited. Employment of child labour is also unethical issue as some developed countries. Example : Japan has particularly strict health standards which affect the import of Parmaceutical.

Sometime, Japanese government insists to conduct

its own test, which are time consuming and costly.

Issue of Corruption
In western countries bribery is highly unethical. In U.S., there is a foreign Corrupt Practices Act which prohibits companies from bribing any foreign official. However, international manager must carefully distinguish between reasonable ways of doing business internationally by maintaining balance. The problem for international marketers is how to maintain consistency because some of the ethical issues like, global warming and pollution but some issues do not have same standard rule in every country.

 Example:

In Brazil cutting down the rain forest may be acceptable to the Brazilian government but as per scientists and environmentalist it has affect on global warming and other climatic changes. China may use prison labour in producing products for export but U.S. law prohibits the importation of such products.

 Issue of Consumer Protection

Generally, in developed countries a lot of consumer protection activities take place. But in developing countries, they are lacking. Resultantly, a lot of Multinational companies sell harmful product in emerging economies. Example: Companies market a number of medicinal products that are banned in their home country. They should care for social responsibility wherever they operate.

Legal Environment
Ease of
Doing Business Starting a Business Dealing with Licenses Employing Workers Registering Property Getting Credit Protecting Investors Paying Taxes Trading Across Borders Enforcing Contracts Closing a Business

INDIA
120 111 134 85 112 36 33 165 79 177 137

CHINA
83 135 175 86 29 84 83 168 42 20 57

RUSSIA
106 50 177 101 45 84 83 130 155 19 80

BRAZIL
122 122 107 119 110 84 64 137 93 106 131

US
3 4 24 1 10 7 5 76 15 8 18

Source : World Bank Group (Ease of Doing Business rank (Out of 178)

Cultural Environment
International Business success is based on Cross-cultural literacy.
Cross Cultural literacy is based on :

1. Social Structure
Religious and Ethical System

Islam & economic Implication :

Koran supports earning of legitimate profit through trade and commerce. Those who hold property are assumed as trustee rather than owner. Trustees are entitled to receive profits from the property but should use it in a socially and prudent manner.

 One economic principle of Islam prohibits the payment or receipt of interest.

It is also becoming a matter of law. In 1992, Pakistans federal Shariat Court declared earning interest is illegal and Govt. should amend financial rule accordingly.

Cultural Implication : Islamic Banking

Koran clearly prohibits interest, which is called riba. There are now 170 Islamic financial institutions world-wide managing over $150 billion in assets and making an average return on capital of more than 16 percent.

 Two of the largest banks are entering into the market Citigroup and HSBC. Islamic Banking is based on two different methods :
Mudarabah : It is a profit sharing scheme. When Islamic bank lends money to a business, rather than charging interest on loan, it takes a share in the profits that are derived from that investment.

 Similarly, when a business (or individual) deposits money at an Islamic bank in a saving account, the deposit is treated as an equity investment in whatever activity the bank uses the capital for.

Thus the depositors receives a share in the profit from the banks investment.

 Second method is Murabaha Contract : When a firm wishes to purcahse any equipment that costs $ 1,000, the firm tells the bank after having negotiated the price with the manufacture. Initially, bank buys the equipment for $1,000 and later on borrowers buy back from bank in $ 1,100, it can be assumed as interest.

Confucianism and its Economic Implication : This was the ethical system in China, it has weakened since 1949 but still people follow this in China, Korea and Japan. Three values are central to the Confucian system of ethics: Loyalty, Reciprocal Obligation and honesty

2. Language
Competitiveness of any country for entry of MNC based on Language, if it has one spoken language, English, it is more competitive.

However, Competitiveness of MNC is based more on Multi language . some times blunder can be committed if local language is not known by marketing department.

Example
General Motor was troubled when they have launched their Carwith the name of Chevrolet Nova. Nova means STAR but in Spanish NO VA means It does not go resultantly GM changed the name of the car as Caribe. Come alive with Pepsi in German Come out of the grave, American Motors Matador become killer in Spanish

Why Cultural Diversity Exists?

A Dutch scientist, Greet Hofstede has developed a model to explain the cultural diversity.

His model is based on a study conducted for 1,17,000 employees in 88 countries. Greet Hofstede has explained that cultural diversity among nations has four dimensions.

Dimensions of Cultural Diversity

1. Individualism /Collectivism:
In individualistic countries (France, Germany, South Africa, Canada, etc.), people are expected to look out for themselves.
Typical values are personal time, freedom, and challenge.

Continue

In collectivist cultures (India, Japan, Mexico, Korea, Greece) individuals are bounded through strong personal and protective ties based on loyalty to the group during ones lifetime. Values and the use of skills.

Continue

2. Femininity versus Masculinity

Greet Hofstedes study suggested that mens goals were significantly different from womens goals.
Feminine values are more important in countries like Sweden, France, Israel, Denmark and Indonesia. Femininity tend to value a good working relationship, security and avoiding conflicts.

 Masculinity as a situation in which success, money and material things dominates the society. Masculine index is high in India, US, Japan, Mexico, Hong Kong, Italy, Great Britain People tend to value assertiveness and materialism. Promote competition, meritocracy, decisiveness and strong leadership.

3. Power distance
Power distance index measures how subordinates respond to power and authority. In high-power distance index countries (India, South Korea, Mexico and African countries), subordinates tend to be afraid of their bosses. In low-power distance countries (the US, Britain, most of the rest of Europe), subordinates are more likely to challenge bosses and bosses tend to use a consultative management style.

4. Uncertainty avoidance
When uncertainty avoidance is strong, a culture tends to perceive unknown situations as threatening so that people tend to avoid them. Examples include South Korea, Japan, and Latin America. In countries where uncertainty avoidance is weak (the US; the Netherlands; Singapore; Hong Kong, Britain) people feel less threatened by unknown situations. Therefore, they tend to be more open to innovations, and risk, etc.

Making Culture Work for Marketing Success

Adapt Products and process to Local Market :
Example : 3M is a United States based company in diversified area of home cleaning product, electronic and office product.

Before starting of marketing of home cleaning product (scotchbrite (cleaning pad)

they came to know that traditionally floors are scrubbed with the help of The rough shells of coconuts.
3M responded by making its cleaning pads brown and shaping them like foot.

Employ locals to gain cultural knowledge

As a matter of fact, of the 34,000 3M employees outside of the United States, only 1 percent are from home country.

Cultural Implication: Failure of Wal-Mart

The company had toiled for 8 years struggling to make its South Korean and German stores compete against strong, established local retailers. In July 2006, Wal-Mart announced its withdrawal of operations from Germany because the firm was losing some $250 million per year on sales of $2.5 billion.

Wal-Mart's 85 big-box stores were sold to German company METRO AG, a much bigger player with 550 stores in Germany. The sale of Wal-Mart's 85 German stores resulted in a $1-billion loss, Main problem was competitive prices from national discounters as well as German consumer rejection of Americanstyle signature features such as stores outside of town centers, employees required to smile and heartily greet customers.

On May 22, 2006, the American retailer withdrew from the South Korean market
when it agreed to sell all 16 of its Wal-Mart Korea stores to Shinsegae, South Korea's top discount chain.

The deal was for $882 million. Wal-Mart Korea had lost $10 million on sales of some $800 million in 2005. Wal-Mart's "warehousestyle" environment proved unfriendly to the needs of Korean shoppers. In particular, housewives were dissatisfied with food and beverage offerings.

Managerial Implications
If culture varies because of differences in social structure, language, education and economic philosophy, three important implications for International business are: Cross Culture Literacy:
The biggest dangers confronting a company that goes abroad for the first time of being ill-informed
To avoid mentioned problem international business should consider employing local citizens to help in Business and should move from ethnocentric approach .

Culture and Competitive Advantage

In International business there is important connection between culture and competitive advantage while making choice of location for production facilities.
Example : A and B two locations are given. Both are characterized by low labour costs, same population size and at similar stage of economic development. In country A the education system is under-developed, there are six major linguistic groups. In country B, education system is well developed, there is only one linguistic group. Which country is best investment site?

Culture and Business Ethics

Generally ethical principles are universal but some are culturally bound. If this is the case, International business may be confronted with difficult ethical dilemmas.

Example :
Chinese culture is based on guanxi, which is based on networking and supported by the idea of gift giving. On the other hand western culture assumed it as bribery.

How to go ethically in this condition?

There is thin line between corruption and legitimate gift giving to support business transaction.
Thomas Donaldson has suggested three guiding principles to deal with ethical dilemma in international business: 1. Respect for human rights which determines the absolute moral threshold for all business.

2.
3.

Respect for local tradition

The belief that context matters when deciding what is right and what is wrong.

Gift giving does not violate human rights and is important in the context of some cultures like China and Japan. Employing Child labour at less than minimum wages would be unethical.

Environment Threat and Opportunity Profile (ETOP) for a Bicycle Company

Envir. Nature Status of each sector Sect. Of Impact____________________

Economic Rising disposable income and Living Standard Organized sector a virtual oligopoly, buyers critical and better informed, overall industry growth not so encouraging, Growth rate for niche segment like sports, trekking and racing is high.

Market

 Envir. Nature Impact of each sector Sect. Of Impact

International India is second global exporter after China, Indias share is shrinking due to cheap Chinese imports.
Parts and components reserved for small scale industry, regulatory restrictions heavy, it is thrust area for exports.

Regulatory

 Envir. Nature Sect. Of Impact

Impact of each sector

Social

Environment and health friendly transportation. Wide usage for physical fitness equipment . Mostly ancillaries and associated companies in small scale sector supply parts and components, rising steel prices, increasing use of aluminum

Supplier

 Envir.
Sect.

Nature
Of Impact

Impact of each sector

Technological

Technological upgradation of industry in progress, import of machinery is simple, product innovations ongoing such as batteryoperated and lightweight foldable cycles.