copyright © 2013 pearson education, inc. publishing as prentice hall 1-1 a framework for...

Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

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A Framework for International Business

by Cavusgil, Knight, & Riesenberger

Chapter 1: What is International Business?


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In this chapter, you’ll learn about:

1. What is international business?

2. What are the key concepts in international trade & investment?

3. How does international business differ from domestic business?

4. What motivates firms to go international?

5. Market globalization: An organizing framework

6. Regional integration and economic blocs

Learning Objectives


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What is International Business?

International Business includes:

• All value-adding activities—including sourcing, manufacturing, and marketing that are performed on an international scale

• Firms who seek foreign customers & engage in partnerships with overseas companies

• The exchange of physical & intellectual assets – including products, services, capital, technology, know-how, & labor

• Activity performed mainly by specific firms, but also by countries and non-governmental organizations & agencies


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Key International Business Definitions

• International business: Performance of any trade or investment activity by firms across national borders

• Globalization of markets: the ongoing process of economic integration & growing interdependency of countries worldwide

• International trade: Exchange of products & services across national borders, typically through exporting & importing


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Key Concepts in International Trade & Investment

• Exporting: Sale of products or services to customers abroad from a base in the home country or a third country. Boeing and Airbus export billions of dollars in commercial aircraft products every year

• Importing or Global Sourcing: getting products or services from suppliers abroad to be used at home or in a third country. Toyota imports many parts from China when it manufactures cars in Japan

• International investment: Passive ownership of foreign securities, such as stocks and bonds, in order to generate financial returns• Foreign Direct Investment: the transfer of assets to another country, or the acquisition of assets in that country such as capital, labor, land, plants, and equipment


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World Trade Is Growing Faster than GDP


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Foreign Direct Investment (FDI)

• The ultimate stage of internationalization

• Practiced by those firms who are most active internationally

• Encompasses the widest range of involvement in international business

• Usually engaged in for the long term

• Firms often retain partial or complete ownership of assets they acquire

• Huge growth of FDI into developing economies – ones with lower incomes, less developed industry base, & less capital than more advanced economies


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Foreign Direct Investment (FDI) Inflows into World Regions (in Billions of U.S. Dollars per yr.)


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The Role of Services in International Trade

• Services are actions performed or efforts put forward by people & firms to solve business problems

• Examples: those related to banking & finance, consulting, hospitality-related functions (e.g., reservations, food provision), retail, and many others

• The service sector accounts for about ¼ of all international trade and this percentage is rising

• Larger, more advanced economies account for the largest portions of service trade in the world; services often account for 2/3 of GDP in these larger economies


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How does International and Domestic Business Differ?

1. International business:

• is conducted across national borders;

• uses distinctive business methods;

• must adjust to countries that differ in culture, language, political

& legal system, economic situation, infrastructure, & other factors

2. When they venture abroad, firms encounter four major types of risk

• Cross-cultural risk

• Country risk

• Currency risk

• Commercial risk


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The Four Risks of International Business


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The Four Risks of International Business (cont.)


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Cross-Cultural Risk, Examples

• Cultural differences: Risks arise from differences in language, lifestyle, attitudes, customs, and religion, where a cultural miscommunication jeopardizes a culturally valued mindset or behavior.

• Negotiation patterns: Negotiations are required in many types of business transactions but differ in how they are conducted (e.g., Brazilians more likely to be aggressive; Americans don’t spend a lot of time on social niceties;

Japanese “sound out” partners via social interactions/events. Errors in understanding these styles can undermine business relations.


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Cross-Cultural Risk (cont.)

• Decision-making styles: Managers constantly make decisions about the operations and future direction of the firm. For example, Japanese take considerable time to make important decisions, whereas Canadians tend to be decisive and “shoot from the hip”

• Ethical practices: Standards of right and wrong vary considerably around the world. For example, bribery is relatively acceptable in some countries in Africa, but is generally unacceptable in Sweden and legally enforced by other countries (e.g., Germany, U.S.)


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Country Risk (Political Risk)

• Government intervention, protectionism, and barriers to trade and investment

• Bureaucracy, red tape, administrative delays, corruption

• Lack of legal safeguards for intellectual property rights

• Legislation unfavorable to foreign firms

• Economic failures and mismanagement

• Social and political unrest and instability


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Currency Risk (Financial Risk)

• Currency exposure: General risk of unfavorable exchange rate fluctuations• Asset valuation: Risk that exchange rate fluctuations will adversely affect the value of the firm’s assets and liabilities• Foreign taxation: Income, sales, & other taxes vary greatly worldwide, with implications for company performance & profitability• Inflation: High inflation, common in many countries, complicates business planning & the pricing of inputs and finished goods


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Commercial Risk

Commercial risk can be reduced by improving business strategy & tactics. The following should be avoided:

• Choice of weak partners

• Operational problems

• Poor timing of entry

• Competitive intensity

• Poor execution of strategy

.


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Summary of IB Risk

• These risks are always present but manageable

• Managers need to understand, anticipate, and take proactive action to reduce their effects

• Some risks are extremely challenging


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Who Participates in International Business?

• Multinational enterprises (MNE): Very large companies with extensive resources allowing them to conduct business activities worldwide via a network of subsidiaries and affiliates (e.g., Honda, Exxon-Mobil, Walmart, Samsung, P&G, & Disney)

• Small and medium-sized enterprises (SME): Companies with < 500 employees & more limited resources to devote to international activity. Yet, in most countries they constitute about 90% of all existing firms & are increasingly engaged in IB

• Born global firms: Newer, entrepreneurial SMEs that initiate substantial international business early after their founding

• Non-governmental organizations: Nonprofit organizations that pursue special causes and serve as advocates for social issues, education, politics, & research across borders


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What Motivates Firms to Go International?

• To seek opportunities for growth through market diversification - E.g., Harley-Davidson, Sony, Whirlpool

• To earn higher margins and profits- Often, foreign markets are more profitable

• To gain new ideas about products, services, & business methods

- E.g., GM refined its knowledge about small, fuel-efficient cars in Europe


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Why do Firms Participate in IB?

• To better serve key customers that have relocated abroad

- E.g., when Toyota launched its operations in Britain, many of its suppliers followed suit

• To be closer to supply sources, benefit from global sourcing advantages, or gain flexibility in the sourcing of products-E.g., Dell sources parts and components from the best suppliers worldwide

• To gain access to lower-cost or better-value factors of production

- E.g., Sony does much of its manufacturing in China


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Why do Firms Participate in IB? (cont.)

• To develop economies of scale in sourcing, production, marketing, and R&D-E.g., Boeing lowers overall costs by sourcing, manufacturing, & selling aircraft worldwide

• To confront international competitors more effectively or to thwart the growth of competition in the home market-E.g., Chinese appliance maker Haier built U.S. operations partly for competitive knowledge about Whirlpool (chief U.S. rival)

• To invest in a potentially rewarding relationship with a foreign partner

- French computer firm Groupe Bull partnered with Toshiba in Japan to gain insights for developing information technology


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The Drivers & Consequences of Market Globalization


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The Drivers of Market Globalization

• Worldwide reduction of barriers to trade and investment• Market liberalization and adoption of free markets• Industrialization, economic development, and

modernization• Integration of world financial markets• Advances in technology


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Five Societal Consequences of Market Globalization

• Loss of national sovereignty• Offshoring and the flight of jobs• Effect on the poor• Effect on the natural environment• Effect on national culture


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Societal Consequences of Globalization

• Loss of national sovereignty– MNE activities can interfere with governments’ ability to control their own

economies & social-political systems. Some firms are bigger than the economies of many nations (e.g., Walmart, Shell)

– Others argue that global competition in the context of global free trade makes MNEs less powerful (e.g., the U.S. auto industry declined as foreign rivals from Japan and Europe entered the U.S. market)

• Offshoring and the flight of jobs– Jobs are lost as firms shift production of goods & services abroad in order

to cut costs and obtain other advantages

– Firms benefit, but communities and industries are disrupted


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Societal Consequences of Globalization (cont.)

• Effect on the poor– In poor countries, globalization usually creates jobs & raises

wages, but tends to disrupt local job markets. MNEs may pay low wages but then seek other locations for plants once they do (e.g., wages in China are on the rise; MNEs are moving production facilities to cheaper locations)

– Some workers are exploited; child labor and other conditions difficult to monitor by MNE


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• Effect on the natural environment

– Can harm environment by promoting industrialization & other activities that

generate pollution, habitat destruction, & other environmental harm – But, as nations develop their economies, they tend to pass laws that protect the environment– This happened in Japan in the 1960/70’s & is occurring now in Mexico,

China, and India


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• Effect on National Culture– Globalization opens the door to foreign firms, global brands, unfamiliar

products, and new values

– Increasingly, consumers buy similar products, modeled according to Western countries, especially the U.S

– In this way, traditional norms, values, and behaviors may homogenize over time

– Some believe that national identity may be lost to “global” culture


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Regional Economic Integration

• Over 50% of world trade today occurs under the auspices of a preferential trade agreement entered into by groups of countries

• Cooperating nations obtain: increased product choices, productivity, living standards lower prices more efficient resource use

• Examples: European Union (EU) and the North American Free Trade Agreement (NAFTA)

When nations within a geographic region form an alliance aimed at reducing barriers to trade and investment &

increasing their economic interdependence


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1. Expand market size

2. Achieve economies of scale & greater productivity

3. Attract direct investment from outside region

4. Acquire a better defensive and political posture

Why Do Nations Pursue Economic Integration?


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1. Expand market size

• Increases size of market for firms inside the bloc. Belgium has only 10 million people, but EU has nearly 500 million

• Buyers can access larger selection of goods

2. Enhance productivity & economies of scale

• Bigger market facilitates economies of scale

• Internationalization inside bloc helps firms learn to compete outside bloc

• Competition & efficient resource usage inside the bloc leads to lower prices for bloc consumers

Why Pursue Regional Integration?


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3. Attract investment from outside the bloc

• Compared to investing in stand-alone countries, foreign firms prefer to invest in countries belonging to bloc

• General Mills, Samsung, & Tata have invested heavily in EU-member countries

4. Acquire stronger defensive & political posture

• Membership provides countries with a stronger defensive posture relative to other nations and world regions

• Key motive for formation of EU

Why Pursue Regional Integration? (cont.)


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Economic Bloc

A geographic area consisting of countries that agree to pursue economic integration by reducing tariffs & other barriers to cross-border flow of products, services, capital, and labor

• Bloc countries become party to free trade agreement that eliminates tariffs, quotas, & other trade barriers• Examples: European Union,

NAFTA, MERCOSUR, APEC, ASEAN, & many others


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Five Potential Levels of Regional Integration


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Levels of Regional Integration

• Free trade area: – Simplest, most common arrangement

– Member countries agree to gradually eliminate formal trade barriers within the bloc, while each member maintains an independent international trade policy with countries outside the bloc (e.g., GAFTA - Greater Arab Free Trade Area)

• Customs union: – Similar to a free trade area except the members harmonize trade policies toward nonmember countries via common tariff and nontariff barriers on imports from nonmember countries – Examples exist in Asia, Africa, the Middle East & more


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Levels of Regional Integration (cont.)

• Common market – Like a customs union, except products, services, & factors of production such

as capital, labor, & technology can move freely among the member countries

– For example, EU countries observe many common labor & economic policies

• Economic union: – Like a common market, but members also seek common fiscal and monetary policies & standardized commercial regulations – The EU illustrates this by, among other features, the use of a single currency - the

euro


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The EU: A Full-Fledged Economic Union

1. Market access. Tariffs and most nontariff barriers have been eliminated

2. Common market. Barriers to cross-border movement of production factors—labor, capital, and technology

3. Trade rules. Cross-national customs procedures and regulations have been eliminated, which has streamlined transportation and logistics within Europe

4. Standards harmonization. Technical standards, regulations, and enforcements have been harmonized


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Key Features of the European Union Member Countries


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EFTA – European Free Trade Association

• A free trade group comprised of 4 European countries: Iceland, Liechtenstein, Norway, & Switzerland

• Operates parallel to but is linked with the EU

• Established in 1960 as a trade bloc alternative for European states who were either unable to, or chose not to, join the EU

• They have preferential trade relations with 23 states and territories, in addition to the 27 member states of the EU


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NAFTA (Canada, Mexico, the U.S.)

• Passage of NAFTA in 1994 was facilitated by the maquiladora program, thru which U.S. firms located factories just south of the U.S. border to access low-cost labor without significant tariffs

• Eliminated tariffs and most nontariff barriers for products and services

• Established trade and investment rules, uniform customs procedures, and intellectual property rights

• Provided procedures for settling trade disputes


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El Mercado Comun del Sur (MERCOSUR)

• Launched in 1991, is the leading economic bloc in South America, accounting for nearly all of the region’s GDP

• 4 full members are Argentina, Brazil, Paraguay, and Uruguay; several other associate members & partners

• Provides free movement of products &services, common external tariff & tradepolicy, & coordinated monetary policies

• May be integrated with NAFTA and DR-CAFTA as part of a new proposed

Free Trade Area of the Americas


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Other Economic Blocs

• Caribbean Community and Common Market (CARICOM)

• Comunidad Andina de Naciones (CAN)

• Association of Southeast Asian Nations (ASEAN)

• Asia Pacific Economic Cooperation (APEC)

• Australia and New Zealand Closer Economic Relations Agreement (CER)


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Implications of Regional Integration for the Firm

• Internationalization by firms inside the economic bloc

– Regional integration facilitates company internationalization

• Rationalization of operations

– Restructuring company operations can help managers develop strategies tailored to region as a whole, not just individual countries

– Goal is to cut costs & increase efficiencies via scale economies. Firms centralize production and marketing, instead of decentralizing them to individual countries

• Mergers and acquisitions (M&A)

– Economic blocs lead to M&A, the tendency of one firm to buy another, or of two or more firms to merge and form a larger firm


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Implications for Integration (cont.)

• Regional products and marketing strategy – Firms cut costs by standardizing products & services

– Case Inc. reduced its line of tractors from 17 to only a few, following integration of the EU

• Internationalization by firms from outside the bloc – Because external trade barriers mainly affect exporting, many foreign

firms prefer to enter a bloc through FDI

– This is how Britain became the largest recipient of FDI from the U.S. after formation of the EU


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