Global Business

Management
 Global Business
Management
• Globalisation
• International Trade Theories
• The Political Economy of International Trade
• Foreign Direct Investment (FDI)
• Entry Strategies and Strategic Alliances
• Regional Economic integration
• Foreign Exchange Market
• Culture
 Introduction
• Global or International business is the study of
transactions taking place across national borders for
the purpose of satisfying the needs of individuals and
organisations.
• These economic transactions consist of trade
(importing and exporting) and foreign direct
investment (companies investing funds in operations in
other countries)
• Multinational enterprises (MNEs) are companies that
are headquartered in one country and have operations
in one or more other countries
Global Business
People experience international
transactions daily

Imports/exports reach people

even in remote areas

Technology and e-business

promote trade

Global talent contributes to

efficiency/competitiveness
Key Players

Multinational Small Businesses Born Global Firm

Corporations and Entrepreneurs
Business that has Small companies and Adopts a global
direct investments individuals becoming perspective and engages
abroad in multiple increasingly active in in international business
countries international trade from or near its inception
and investment
 Global Firms vs. Nations
Comparing
revenue of
the world's
10 most
global firms
to the gross
domestic
product of
nations

Source: Based on
data obtained from
“Fortune Global 500:
The World’s Largest
Corporations,”
Fortune, July 23,
2012, pp. F1–F7;
World Bank data set
available at
data.worldbank.org.
 The multinational enterprise and its
environment
Home Country Stakeholders Host Countries
Competitors Customers
Customers Competitors
Multinational
Domestic Foreign
enterprise
affiliates affiliates
Suppliers Suppliers
Government Banks Government
 The Four Risks of Global Business
• Harmful or unstable political system
• Unfavourable laws and regulations
•Cultural differences
Cross-Cultural • Inadequate legal system
• Negotiation patterns • Bureaucracy and red tape
• Decision-making styles Risk • Corruption
• Ethical practices • Government intervention, protectionism
and barriers to trade and investment
• Mismanagement or failure of national
economy

Risks in Country
Commercial
International Risk
Risk
Business
•Weak partner
• Operational problems
• Timing of entry
• Competitive intensity
• Poor execution of strategy Currency •Currency exposure
(Financial) •Asset valuation
Risk • Foreign taxation
• Inflationary and transfer pricing

Cavusgil, Knight and Riesenberger, 2012:47

 Why do firms Internationalise?
• Seek opportunities for growth through market diversification

• Earn higher margins and profits

• Gain new ideas about products, services and business methods

• Better serve key customers

• Be closer to supply sources, benefit from global sourcing advantages, or gain

flexibility in product sourcing

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

• Develop economies of scale in sourcing, production, marketing and research and

development.

• Confront international competitors more effectively or thwart the growth of

competition in the home market

• Invest in a potentially rewarding relationship with a foreign partner

 Managing in the Global Marketplace
An International or Global Business is any firm that engages
in international trade or investment.

Managing an international business is

different from managing a domestic business:

1. Countries are different.

2. Problems are more complex.
3. Must work within government regulations.
4. Currency conversion presents unique
problems.
Managing an international business is different from
managing a purely domestic business

Four reasons:
• Countries are different,
• The range of problems confronted by a manager
in an international business is wider, and the
problems more complex,
• An international business must find ways to work
within the limits imposed by government
intervention in the international trade and
investment system
• International transactions involve converting
money into different currencies (Hill, Ch 1)
 EVOLUTION OF MULTINATIONAL ENTERPRISES

LOCAL ENTERPRISE

1. International/ overseas enquiries

2. Appointment of export manager

3. Establishment of export department

and direct overseas sales

4. Establishment of overseas branches and

subsidiaries

5. Overseas assembly

6. Overseas manufacturing
MULTINATIONAL
7. Integration of overseas subsidiaries ENTERPRISE
 Process by which a local enterprise might
develop into a multinational enterprise

LOCAL ENTERPRISE

International/ overseas enquiries

Establishment of export department

Establishment of overseas branches

and subsidiaries

Overseas assembly Overseas manufacturing MULTINATIONAL

ENTERPRISE
 Four International Strategies
International
High
Strategy
 Import/export or
Cost Reduction Considerations

license existing
product
Examples
Harley Davidson

Low
Low High
Local Responsiveness Considerations
(Quick Response and/or Differentiation)
 Four International Strategies
High
Cost Reduction Considerations

International Strategy
 Import/export or
license existing
product

Examples
Harley Davidson

Low
Low High
Local Responsiveness Considerations
(Quick Response and/or Differentiation)
 Four International
Global
Strategies
High Strategy
 Standardized product
 Economies of scale
Cost Reduction Considerations

 Cross-cultural learning
Examples
Texas Instruments
Caterpillar
International Strategy
 Import/export or
Otis Elevator
license existing
product

Examples
U.S. Steel
Harley Davidson

Low
Low High
Local Responsiveness Considerations
(Quick Response and/or Differentiation)
 Four International Strategies
High
Global Strategy
 Standardized product
 Economies of scale
Cost Reduction Considerations

 Cross-cultural learning

Examples
Texas Instruments
Caterpillar
Otis Elevator

International Strategy
 Import/export or
license existing
product

Examples
U.S. Steel
Harley Davidson

Low
Low High
Local Responsiveness Considerations
(Quick Response and/or Differentiation)
 Four International
MultidomesticStrategies
Strategy
High
 Use existing domestic
Global Strategy
model globally
 Standardized product
 Economies of scale
 Franchise, joint
Cost Reduction Considerations

 Cross-cultural learning

Examples
ventures, subsidiaries
Texas Instruments
Caterpillar
Otis Elevator
Examples
Heinz
International Strategy
 Import/exportMcDonald’s
or
license existing
product The Body Shop

Examples
U.S. Steel
Hard Rock Cafe
Harley Davidson

Low
Low High
Local Responsiveness Considerations
(Quick Response and/or Differentiation)
 Four International Strategies
High
Global Strategy
 Standardized product
 Economies of scale
Cost Reduction Considerations

 Cross-cultural learning

Examples
Texas Instruments
Caterpillar
Otis Elevator

International Strategy Multidomestic Strategy

 Use existing
 Import/export or domestic model globally
license existing  Franchise, joint ventures,
product subsidiaries
Examples Examples
U.S. Steel Heinz The Body Shop
Harley Davidson McDonald’s Hard Rock Cafe

Low
Low High
Local Responsiveness Considerations
(Quick Response and/or Differentiation)
 Four International Operations
Strategies
Transnational
High Strategy
 Move material,
Global Strategy
 Standardized product
people, ideas across
 Economies of scale
Cost Reduction Considerations

 Cross-cultural learning

Examples national boundaries

Texas Instruments
 Economies of scale
Caterpillar
Otis Elevator
 Cross-cultural learning
Examples
International Strategy Multidomestic Strategy
 Use existing
 Import/export or
Coca-Cola
license existing
product
domestic model globally
 Franchise, joint ventures,
subsidiaries
Examples Nestlé Examples
U.S. Steel Heinz The Body Shop
Harley Davidson McDonald’s Hard Rock Cafe

Low
Low High
Local Responsiveness Considerations
(Quick Response and/or Differentiation)
 Four International Operations
Strategies
High
Global Strategy Transnational Strategy
 Standardized product  Move material, people, ideas
 Economies of scale across national boundaries
Cost Reduction Considerations

 Cross-cultural learning  Economies of scale

 Cross-cultural learning
Examples
Texas Instruments Examples
Caterpillar Coca-Cola
Otis Elevator Nestlé

International Strategy Multidomestic Strategy

 Use existing
 Import/export or domestic model globally
license existing  Franchise, joint ventures,
product subsidiaries
Examples Examples
U.S. Steel Heinz The Body Shop
Harley Davidson McDonald’s Hard Rock Cafe

Low
Low High
Local Responsiveness Considerations
(Quick Response and/or Differentiation)
 INTERNATIONAL STRATEGIES
• International strategy
– Create value by transferring valuable skills and products to foreign
markets.
– There is a tendency of centralising R&D functions at home.
– There is also a tendency of establishing manufacturing and
marketing functions in each major country in which business is
done.
• Multidomestic strategy
– These organisations try to achieve maximum local responsiveness.
– There is also a tendency of transferring skills and products
developed at home to foreign markets.
• Global strategy
– Pursuing standardised product worldwide
• Transnational strategy
– Low-cost and differentiation drive.
 ADVANTAGES AND DISADVANTAGES OF
THE INTERNATIONAL STRATEGIES
Strategy Advantages Disadvantages

Global • Exploit experience curve • Lack of local

effects responsiveness
• Exploit location
economies

International • Transfer core • Lack of local

competencies to foreign responsiveness
markets. • Inability to realise
location economies.
• Failure to exploit
experience curve
effects.
Strategy Advantage Disadvantage
Multi- • Customise product offerings and • Inability to realise location
marketing according to local economies.
domestic responsiveness. • Failure to exploit
experience curve effects.
• Failure to transfer core
competencies to foreign
markets

Transnational • Exploit experience curve effects • Difficult to implement due

• Exploit location economies to organisational problems.
• Transfer core competencies to
foreign markets.
• Reap benefits of global learning.
 What is “Globalisation”?

Markets
“The shift
toward a more
integrated and
interdependent
world economy.” Production
 1 DRIVERS OF MARKET GLOBALISATION Cavusgil,
Knight and
• Worldwide reduction of barriers to trade and investment Riesenberger,
•Market liberalisation and adoption of free markets 2012:47
•Industrialisation, economic development and modernisation
• Integration of world financial markets
• Advances in technology

2 DIMENSIONS OF MARKET GLOBALISATION

• Integration and interdependence of national economies
• Rise of regional economic integration blocs
• Growth of global investment and financial flows
• Convergence of buyer lifestyles and preferences
• Globalisation of production activities
• Globalisation of services

3A SOCIETAL CONSEQUENCES OF MARKET 3B FIRM-LEVEL CONSEQUENCES

GLOBALISATION OF MARKET GLOBALISATION
• Contagion: Rapid spread of financial or • Countless new business opportunities
monetary crises from one country to another • New risks and intense rivalry from
• Loss of national sovereignty foreign competitors
• Offshoring and the flight of jobs • More demanding buyers
• Effect on the poor • Greater emphasis on proactive
• Effect on the natural environment internationalisation
• Effect on national culture • Internationalisation of firm’s value chain
Globalisation
• Trade and investment barriers
are disappearing.
• Perceived distances are
shrinking due to advances in
transportation and
telecommunications.
• Material culture is beginning to
look similar.
• National economies merging
into an interdependent global
economic system.
 Globalisation: Pros and Cons

• Pros • Cons
– Increased revenue – Different nations =
opportunity through different problems.
global sales. – Similarities between
– Reduced costs by nations may be
producing in ‘low cost’ superficial.
countries. – Global planning may be
easy, but global
execution is not.
 Two Facets of Globalisation
1. Globalisation of markets
• Merging of distinct and separate national markets into one huge
global marketplace
• No “German market” or “American market” but a global market

2. Globalisation of production
• Developed due to sourcing of goods and services from locations around
the globe
• Need to take advantage of national differences in the cost and quality
of factors of production like land, labor and capital
• Companies competitive advantage:
 Lowering their overall cost structure
 Improving quality
 Ensuring functionality of their product offering
 Benefits of Global Markets

Reduces
marketing costs

Creates new market

opportunities

Levels income
stream
Benefits of Global Production

Lower-cost labour

Technical expertise

Production inputs
 Drivers of Globalisation

Technology Global norms,

innovation/ standards, tastes,
Internet preferences

Free Trade
Transport – flow of goods,
cheaper and services, capital
quicker (FDI) between
countries

End of Cold Creation of a global

War/East block market – basic
opens its borders products are offered
worldwide
 Globalisation Drivers
Falling Barriers

Remove barriers to trade

and investment
GATT

WTO

Regional trade
agreements
 Globalisation Drivers
Technological Innovation

Email and Internet, intranets, Transportation

videoconferencing and extranets advancements

Better Improved More efficient,

coordination communications and dependable
and control management shipping

1 - 34
 Globalisation problems
Common challenges for Resulting problems due to
globalisation:
global enterprise:
1. Former fixed limitations of
1. Problems that cannot be territory of state, state power
solved but must be and the nation state is
managed becoming eroded, i.e. EU
2. Organisational success 2. Environmental destruction like
increasingly is derived global warming
from intangibles that 3. Gulf between rich and poor
4. Social dumping - reducing
organisations cannot
social benefits in order to
own reduce payroll fringe costs to
3. Organisations increase global
increasingly manage competitiveness
many forms of diversity 5. Provides business with options
4. Business managers and migrate to 'low wage
organisations assume countries‘ and people in these
new roles for which the countries are not receiving a
good wage
past has not prepared
them
 Globalisation
Global Institutions emerged to:

• Help manage, regulate, and police the global marketplace

• Promote the establishment of multinational treaties to govern the global
business system
Institutions created over the past half century include:

• The General Agreement on Tariffs and Trade (GATT)

• The World Trade Organization (WTO)
• The International Monetary Fund (IMF)
• The World Bank
• The United Nations (UN)
 Globalisation – change in demographics of world
economy in last 30 years

Four trends are important:

• The Changing World Output and World Trade Picture

 1960s –US accounted for over 40% of world economic activity
 By 2006 - US accounted for less than 20% of world economic
activity
 The share of world output accounted for by developing nations is
rising
 Share by developing countries expected to be more than 60% of
world economic activity by 2020

• The Changing Foreign Direct Investment Picture

 1960s, U.S. accounted for about two-thirds of worldwide FDI flows
 Today, U.S. accounts for less than one-fifth of worldwide FDI flows
 In contrast, FDI accounted for by developing countries has risen
from less than 2% in 1980 to almost 12% in 2005
 Developing countries, especially China, have also become
popular destinations for FDI
 Globalisation – change in demographics of world
economy in last 30 years

• The Changing Nature of the Multinational Enterprise

 A multinational enterprise (MNE) is any business that
has productive activities in two or more countries
 Since the 1960s, there has been a rise in non-U.S.
multinationals, and a growth of mini-multinationals

• The Changing World Order

 Many former Communist nations in Europe and Asia are
now committed to democratic politics and free market
economies and so, create new opportunities for
international businesses
 China and Latin America are also moving toward
greater free market reforms
 Jobs and Wages

Opponents Supporters

 Eliminates jobs in  Increases wealth and

developed nations efficiency everywhere

 Generates labour market

 Lowers wages in
developed nations flexibility in developed
countries
 Exploits workers in  Advances economies
developing nations of developing nations
 Labour, Environment, and Markets

Opponents Supporters

– Globalisation lowers + Investment raises

labour standards labour standards

– Weakens protection of + Open economies most

the environment environment friendly

– Exploits workers in + Companies concerned

poor nations for future markets
 Income
Inequality withinInequality
Nations debate

Rich get richer in wealthy nations?

or
Poor get richer in developing nations?
Inequality between Nations
Gap widens between rich and poor nations?
or
Poor trading nations grow faster than rich ones?
Global Income
InequalityInequality debate

Gap between rich and poor greater everywhere?

or
Inequality has fallen but extent unknown?
 Impact on Culture

Opponents Supporters

• Destroys cultural • Spécialise and trade to

diversity obtain other goods
• Homogenises our • Import cultural goods
world from other nations
• Bankrupts local • Protect deeper moral
small businesses and cultural norms

1 - 44
 National Sovereignty

Opponents Supporters

Supranational
Globalisation has
institutions reduce
benefited societies by
autonomy of national,
helping to spread
regional, and local
democracy worldwide
governments

1 - 45
 Globalisation
Globalisation also brings risks like the financial crisis that swept
through South East Asia in the late 1990s and now again

There are three main implications for international businesses:

• Location implications
• First-mover implications
• Policy implications

Views on future of international business and globalisation

• Further globalisation is inevitable.
• International business will grow primarily along regional rather
than global lines.
• Forces working against further globalisation and
international business will slow down both trends.
 The evolution of international trade theory
Adam Smith Raymond Vernon
Absolute Advantage Product Cycle Theory
(1776) (1966)

David Ricardo Krugman and Others

Comparative Advantage New Trade Theory
(1817) (1980)

Hecksher – Olin Michael Porter

Factor Proportions Competitive Advantage
Theory Of Nations
(1877 - 1949) (1990)
The Leontief Paradox
(1950)
Raymond Vernon
Product CycleTheory
(1966)
 An Overview of Trade Theory
• Free Trade occurs when 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.
• The Benefits of Trade allow a country to specialize in the
manufacture and export of products that can be produced most
efficiently in that country.
• The Pattern of International Trade displays patterns that are
easy to understand (Saudi Arabia/oil or China/crawfish). Others
are not so easy to understand (Japan and cars).
• The history of Trade Theory and Government Involvement
presents a mixed case for the role of government in promoting
exports and limiting imports. Later theories appear to make a
case for limited involvement.
 David Hume - 1752
• Increased exports leads to inflation and higher
prices.
• Increased imports lead to lower prices.
• Result: Country A sells less because of high prices
and Country B sells more because of lower prices.
• In the long run, no one can keep a trade surplus.
 Theory of Absolute Advantage
• Adam Smith: Wealth of Nations (1776).
• Capability of one country to produce more of a product
with the same amount of input than another country.
• Produce only goods where you are most efficient,
trade for those where you are not efficient.
– Trade between countries is,therefore, beneficial.
• Assumes there is an
absolute advantage balance among
nations.
• Ghana/cocoa.
 Theory of Comparative Advantage

• David Ricardo: Principles of Political Economy (1817).

– Extends free trade argument
– Efficiency of resource utilization leads to more
productivity.
– Should import even if country is more efficient in the
product’s production than country from which it is
buying.
• Look to see how much more efficient. If only
comparatively efficient, than import.
• Makes better use of resources
• Trade is a positive-sum game.
 Heckscher (1919)-Olin (1933) Theory

• Factor endowments: extent to which a country is endowed

with such resources as land, labor, and capital.
• Export goods that intensively use factor endowments which
are locally abundant.
– Corollary: import goods made from locally scarce factors.
• Patterns of trade are determined by differences in factor
endowments - not productivity.
• Remember, focus on relative advantage, not absolute
advantage.
 The Leontief Paradox, 1953

• Disputes Heckscher-Olin in some instances.

• Factor endowments can be impacted by
government policy - minimum wage.
• US tends to export labour-intensive products,
but is regarded as a capital intensive country.
 Product Life-Cycle Theory
(Raymond Vernon, 1966)

• As products mature, both location of sales and

optimal production changes.
• Affects the direction and flow of imports and
exports.
• Globalisation and integration of the economy
makes this theory less valid.
 The New Trade Theory
• Began to be recognized in the 1970s.
• Deals with the returns on specialization where
substantial economies of scale are present.
– Specialization increases output, ability to enhance
economies of scale increase.
• In addition to economies of scale, learning effects
also exist.
– Learning effects are cost savings that come from
“learning by doing”.
 Porter’s Diamond
Determinants of National Competitive Advantage

Firm Strategy,
Structure and
Rivalry

Factor Endowments Demand Conditions

Related and
Supporting
Industries
 POLITICAL ECONOMY OF
INTERNATIONAL TRADE
“It’s called political economy because it has
nothing to do with either politics or
economy.”
Stephen Leacock
 The Political Economy of
International Trade
Governments intervene in international trade to protect the interests
of politically important groups

The main instruments of trade policy are:

• Tariffs - taxes levied on imports
• Subsidies - government payments to domestic producers
• Import Quotas – restrictions on quantity imported
• Voluntary Export Restraints - quotas on trade imposed by the
exporting country
• Local Content Requirements - demands that some specific
fraction of a good be produced domestically
• Administrative Policies - bureaucratic rules designed to make
it difficult for imports to enter a country
• Antidumping Policies - designed to punish foreign firms that
engage in dumping and protect domestic producers from
“unfair” foreign competition
 The 7 Instruments of Trade Policy

Tariffs Subsidies Local

Content
Voluntary Requirements
Exports Antidumping
Restraints Duties
Administrative
Import
Policies
Quotas
 The Political Economy of
International Trade
• Political arguments - protecting the interests of certain groups within a nation
(normally producers), often at the expense of other groups (normally consumers)
• Economic arguments - boosting the overall wealth of a nation (benefit both
producers and consumers)
Political arguments for government intervention include:
• Protecting jobs - most common political reason for trade
restrictions
• 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
• Results from political pressures by unions or industries
that are "threatened" by more efficient foreign producers
 The Political Economy of
International Trade
Economic arguments for intervention include:

• Infant industry argument

 Protect industry while it develops, until viable and competitive internationally
 Accepted as a justification for temporary trade restrictions under the WTO
 However, difficult to gauge when an industry has “grown up”
 Critics – if country has the potential to develop a viable competitive position,
its firms should be capable of raising necessary funds without additional
support from the government

• Strategic trade policy

In cases where there may be important first mover advantages, governments
can help firms from their countries attain these advantages
Governments can help firms overcome barriers to entry into industries where
foreign firms have an initial advantage
 The Political Economy of
International Trade

Governments may intervene in markets to protect consumers

Foreign policy objectives can be supported through trade policy

• Preferential trade terms - granted to countries that

government wants to build strong relations with
• Trade policy can also be used to punish rogue states that do
not abide by international laws or norms
• However, it might cause other countries to undermine
unilateral trade sanctions
Political Arguments for Intervention

Protect
Industry
and Jobs. Retaliation
Further
Protect Foreign Policy
National Human Objectives
Security Rights
Protect
Consumers
 The Political Economy of
International Trade

Managers need to consider how trade barriers affect the strategy of the firm and the
implications of government policy on the firm

• Trade barriers raise the cost of exporting products

• Voluntary export restraints (VERs) may limit a firm’s ability to serve a country
from locations outside that country
• To conform to local content requirements, a firm may have to locate more
production activities in a given market than it would otherwise

Policy implications

• International firms have an incentive to lobby for free trade, and keep
protectionist pressures from causing them to have to change strategies
• Short run - benefits to having governmental protection
• Long run - can backfire and other governments can retaliate
 FOREIGN DIRECT INVESTMENT
(FDI)

“FDI plays an extraordinary and growing role in global

business. It can provide a firm with new markets and
marketing channels, cheaper production facilities, access to
new technology, products, skills and financing.”
Jeffrey P. Graham and R. Barry Spaulding
 Foreign Direct Investment
• FDI occurs when a firm invests directly in facilities to
produce and/or market a product in a foreign country.
– Once a firm undertakes FDI, it becomes a multinational
enterprise (multinational = more than one country).
• FDI takes two forms:
– Green-field investment: establishing a wholly new operation
in a foreign country.
– Acquiring or merging with an existing firm in the foreign
country.
• Investing in foreign financial instruments (Portfolio
Investment) IS NOT FDI.
 Flow and Stock of FDI

• Flow: • Stock:
– The amount of FDI – Total accumulated value
undertaken over a given of foreign-owned assets
period of time (usually at a given time.
one year).
 Reasons for FDI Growth
• FDI circumvents potential future trade
barriers.
• Dramatic political and economic changes
occurring in developing countries.
 The Form of FDI: Acquisitions versus
Green-Fields
• The majority of • Why the preference for
investments is in the mergers &
form of mergers & acquisitions?
acquisitions:
– Quicker to execute.
– Represents about 77%
of all flows in – Foreign firms have
developed countries. valuable strategic
– Represent about 33% assets.
of all flows in – Believe they can
developing countries. increase the efficiency
• Fewer target firms. of the acquired firm.
 FDI and Risk
FDI is expensive and risky compared to exporting or
licensing:
• Costs of establishing facilities.
• Problems with doing business in a different
• Culture.
Horizontal Direct Investment: FDI in the same
industry as the firm operates at home.
Factors to consider:
Transportation Costs.
Market Imperfections.
Following Competitors.
Strategic Competitors
Location Advantages.
 Vertical FDI

• Two forms:
– Backward: Providing inputs (raw materials, parts)
for a firm’s domestic production processes.
– Forward: An industry abroad sells the outputs of
the firm’s domestic production processes.
 Why Do Companies Engage in FDI?
• Strategic Behaviour: Can raise entry
barriers or shut out new competitors, or
circumvent barriers established by
companies already doing business in the
foreign country.
• Market Imperfections: Need to overcome
lack of know-how or the firm must invest
in specialized assets whose value depends
on inputs provided by a foreign supplier.
 A Decision Framework
How high are Low Export
transportation costs
and tariffs?
High
No
Is know-how amenable Horizontal FDI
to licensing?
Yes
Is tight control over Yes
Horizontal FDI
foreign operation
required?
No
No
Can know-how be protected Horizontal FDI
by licensing contract?
Yes
Then license
 Benefits of FDI to Host Countries

Direct

Resource-Transfer Employment
Effects Effects Indirect

Capital
Technology
Balance-of-Payments
Effects

Management
 FDI and Balance-of-Payments
• Current Account Deficit • 3 B-of-P Consequences:
occurs when imports are – When MNE establishes its
greater than exports. foreign subsidiary, the host
country benefits from
• Current Account Surplus
initial capital inflow.
occurs when exports are
– If the FDI is a substitute for
greater than imports. imports, it improves the
• Capital Account records host country’s balance of
transactions that involve payments.
the purchase or sale of – Subsidiary is used for
assets. exports.
 Costs of FDI to Host Countries

Adverse Effects
on Adverse Effects
Competition on the
Balance of Adverse Effects
Payments on
Drive out Sovereignty
local and
competitors Autonomy
Earnings and
imports hurt Key economic
capital decisions made
account by „foreigners‟
 Government Policy Instruments and FDI

Home Country Policies

• Encourage Outward FDI • Restricting Outward FDI

– Government backed risk – Limit capital outflows.
insurance. – Use tax code to encourage
– Government loans. companies to stay home.
– Eliminate double – Prohibitions against
taxation. investing in certain
– Political persuasion to countries (Cuba, Libya,
relax restrictions on Iran).
inbound FDI.
Government Policy Instruments and FDI
Host Country Policies

Encourage Inward FDI Restricting Inward FDI

– Offer investment – Ownership restraints.
• Excluded from specific
incentives. fields.
• Tax concessions. – National security.
• Low-interest loans. – Competition.
• Restrictions on amount of
• Grant/subsidies. ownership.
– Attempt to attract – Performance
investment away from requirements.
other countries. • Local content.
• Technology transfer.
• Local participation in
management
 Foreign Direct Investment
FDI allows companies to accomplish several tasks:

• Avoiding foreign government pressure for local

production
• Circumventing trade barriers
• Making the move from domestic export sales to a
locally- based national sales office
• Capability to increase total production capacity
• Opportunities for co-production, joint ventures with
local Previously Now
• FDI spent on developed countries • South, East, Southeast Asia and China, are
partners,
• US favourite joint marketing arrangements,
now seeing an increaselicensing,
of FDI inflows etc
• FDI inflows until early 2000s for US and • Latin America is also emerging as an
European Union mainly important region for FDI
• Since World War II, the U.S. has been the • Africa is receiving FDI
What changes happened
largest source country for FDI over the past 30 years?
 FDI
•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

FDI can be:

•greenfield investments - the establishment of a
wholly new operation in a foreign country
•acquisitions or mergers with existing firms in the
foreign country
 Foreign Direct Investment
In The World Economy
•The flow of FDI refers to the amount of FDI
undertaken over a given time period
•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
•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

FDI has grown more rapidly than world trade and world
output because:
•firms still fear the threat of protectionism
•the general shift toward democratic political institutions
and free market economies has encouraged FDI
•the globalization of the world economy is having a
positive impact on the volume of FDI as firms undertake
FDI to ensure they have a significant presence in many
regions of the world
 The Direction Of FDI
•Most FDI has historically been directed at the
developed nations of the world, with the United
States being a favorite target
•FDI inflows have remained high during the early
2000s for the United States, and also for the
European Union
•South, East, and Southeast Asia, and particularly
China, are now seeing an increase of FDI inflows
•Latin America is also emerging as an important
region for FDI
 The Direction Of FDI
•Gross fixed capital formation summarizes the
total amount of capital invested in factories,
stores, office buildings, and the like
•All else being equal, the greater the capital
investment in an economy, the more favorable
its future prospects are likely to be
•So, FDI can be seen as an important source of
capital investment and a determinant of the
future growth rate of an economy
 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

Firms prefer to acquire existing assets because:

•mergers and acquisitions are quicker to execute than
greenfield investments
•it is easier and perhaps less risky for a firm to acquire
desired assets than build them from the ground up
•firms believe that they can increase the efficiency of an
acquired unit by transferring capital, technology, or
management skills
 The Shift To Services
•FDI is shifting away from extractive industries and
manufacturing, and towards services

The shift to services is being driven by:

• the general move in many developed countries
toward services
•the fact that many services need to be produced
where they are consumed
•a liberalization of policies governing FDI in services
•the rise of Internet-based global
telecommunications networks
Theories Of Foreign Direct Investment
•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 - producing goods at home and then
shipping them to the receiving country for sale
or
•licensing - granting a foreign entity the right to
produce and sell the firm’s product in return for
a royalty fee on every unit that the foreign entity
sells
 Why Foreign Direct Investment?
•An export strategy can be constrained by
transportation costs and trade barriers
•Foreign direct investment may be undertaken
as a response to actual or threatened trade
barriers such as import tariffs or quotas
 Why Foreign Direct Investment?
Internalization theory (also known as market imperfections
theory) suggests that licensing has three major drawbacks:
•licensing may result in a firm’s giving away valuable
technological know-how to a potential foreign competitor
•licensing does not give a firm the tight control over
manufacturing, marketing, and strategy in a foreign country
that may be required to maximize its profitability
•a problem arises with licensing when the firm’s competitive
advantage is based not so much on its products as on the
management, marketing, and manufacturing capabilities that
produce those products
 The Pattern Of Foreign
Direct Investment
•Firms in the same industry often undertake foreign
direct investment around the same time and tend
to direct their investment activities towards certain
locations
•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
•The theory can be extended to embrace the
concept of multipoint competition (when two or
more enterprises encounter each other in different
regional markets, national markets, or industries)
 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 a
host
country:
1. resource transfer effects - FDI can make a positive
contribution to a host economy by supplying
capital, technology, and management resources
that would otherwise not be available
2. employment effects - FDI can bring jobs to a host
country that would otherwise not be created there
 Host-Country Benefits
3. balance of payments effects - a country’s balance-of-
payments account is a record of a country’s payments to
and receipts from other countries.
•The current account is a record of a country’s export and
import of goods and services
•Governments typically prefer to see a current account
surplus than a deficit
•FDI can help a country to achieve a current account
surplus if the FDI is a substitute for imports of goods and
services, and if the MNE uses a foreign subsidiary to
export goods and services to other countries
 Host-Country Benefits
4. effects on competition and economic growth -
FDI in the form of greenfield investment
increases the level of competition in a market,
driving down prices and improving the welfare
of consumers
•Increased competition can lead to increased
productivity growth, product and process
innovation, and greater economic growth
 ENTRY and ALLIANCE
STRATEGIES
“What do you want to achieve or avoid? The answers to this
question are objectives. How will you go about achieving your
desire results? The answer to this you can call strategy.”
William E. Rothschild
 Entry Strategies and Alliance Strategies
Firms expanding internationally must decide:
• which markets to enter
• when to enter them and on what scale
• 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
• acquiring an established enterprise

Several factors affect the choice of entry mode including:

• transport costs
• trade barriers
• political and economic risks
• costs
• firm strategy
 Firms entering foreign markets make three
basic decisions
Which market to When to enter? On what scale?
enter?
Early or late 1. Firms that enter a market
1. Depend on long run on a significant scale make
1. First mover advantages
profit potential •Ability to pre-empt rivals & a strategic commitment to
2. Desirable: Politically capture demand the market (the decision
stable, developed & •Ability to build up sales has a long term impact
developing nations with volume and is difficult to reverse)
free market systems, •Gain cost advantage over later
relatively low inflation entrants 2. Small-scale entry has the
rates and private sector •Ability to create switching advantage of allowing a
debt, product in question costs that tie customers into firm to learn about a
products or services making it
not widely available and foreign market while
difficult for later entrants to
satisfies an unmet need win business simultaneously limiting
3. Less desirable: politically the firm’s exposure to that
unstable, developing 2. First mover disadvantages market
nations, mixed or •pioneering costs – foreign
command economies, business system different Decisions are
from firm’s home market that based on the
developing nations with levels of risk and
excessive levels of firm must devote much time, reward
borrowing effort and expense to learn
the rules of the game
 Entry Strategies and Alliance
Strategies
Strategic Alliances
• Strategic alliances refer to cooperative agreements between potential or actual
competitors
• Strategic alliances range from formal joint ventures to short-term contractual agreements

The Advantages Of Strategic Alliances:

• Facilitate entry into a foreign market
• Firms share fixed costs & risks of developing new products or processes
• Bring together complementary skills and assets that neither could develop on its own

The Disadvantages Of Strategic Alliances

• Can give competitors low-cost routes to new
technology and markets
 Which Foreign Markets ?

Favorable benefit-cost-risk trade-off

No dramatic upsurge
Politically stable nations. in inflation or
private sector debt.

Free market systems

Politically unstable
developing nations.

Speculative financial
Mixed or command
bubbles have led to
economies.
excess borrowing.
 Timing of Entry
• First-mover advantage.
– Preempt rivals and capture demand.
– Build sales volume.
– Move down experience curve before rivals and
achieve cost advantage.
– Create switching costs.
• Disadvantages:
– First mover disadvantage - pioneering costs.
– Changes in government policy.
Costs early entrant
bears that later
entrant can avoid.
 What is a first-mover?
First-mover advantage exists
where an organisation is better off
than its competitors as a result of
being first to market with a new
product, process, or service.
However there are also some
disadvantages.
First-mover advantages

Experience curve
benefits

Pre-emption
Scale
of scarce
benefits
resources

Buyer
Reputation switching costs
Late-mover advantages

Free-riding – imitating Learning – from the

pioneer’s strategies mistakes made
but more cheaply by pioneers
 First or second?
Three contextual factors in
choosing between innovating and
imitating:
 Capacity for profit capture
 Complementary assets
 Fast-moving arenas
 Entry Modes

Joint
Exporting Ventures
Licensing

Turnkey
Projects
Wholly Owned
Subsidiaries
Franchising
 Exporting
• Advantages:
– Avoids cost of establishing manufacturing operations.
– May help achieve experience curve and location
economies.
• Disadvantages:
– May compete with low-cost location manufacturers.
– Possible high transportation costs.
– Tariff barriers.
– Possible lack of control over marketing representatives.
 Developing an Export Strategy
Step 1 Step 2 Step 3 Step 4

Identify a potential Match needs to Initiate Commit

market abilities meetings resources
 Degree of Export Involvement

Direct exporting Indirect exporting

(sell to buyers) (sell to intermediary)

• Sales representative • Agent

• Export management company
• Distributor • Export trading company
 Avoiding Export Blunders

Conduct market research

Obtain export advice

Hire a freight forwarder

 Contractor agrees
Turnkey Projects to handle every
detail of project
for foreign client.
• Advantages:
– Can earn a return on knowledge asset.
– Less risky than conventional FDI.
• Disadvantages:
– No long-term interest in the foreign country.
– May create a competitor.
– Selling process technology may be selling
competitive advantage as well.
 Turnkey Project
Company designs, constructs, and tests
a production facility for a client

+ Firms specialize in competency

Advantages
+ Nations obtain infrastructure

– Politicised process
Disadvantages
– Create competitor
 Agreement where
licensor grants rights to
Licensing intangible property to another
entity for a specified period
of time in return
• Advantages: for royalties.
– Reduces development costs and risks of establishing foreign
enterprise.
• Lack capital for venture.
• Unfamiliar or politically volatile market.
– Overcomes restrictive investment barriers.
– Others can develop business applications of intangible
property.
Risk Reduction
• Disadvantages:  Cross-licensing
– Lack of control. Joint venture

– Cross-border licensing may be difficult.

– Creating a competitor.
 Licensing
Company owning intangible property (licensor) grants
another firm (licensee) the right to use it for a specific time
+ Finance expansion
+ Reduce risks
Advantages + Reduce counterfeits
+ Upgrade technologies

– Restrict licensor’s activities

Disadvantages – Reduce global consistency
– Lend strategic property
 Franchiser sells
intangible property
and insists on rules
for operating business.
Franchising

• Advantages:
– Reduces costs and risk of establishing enterprise.
• Disadvantages:
– May prohibit movement of profits from one
country to support operations in another
country.
– Quality control.
 Franchising
Company (franchiser) supplies another (franchisee)
with intangible property over an extended period

+ Low cost and low risk

Advantages + Rapid expansion
+ Local knowledge

– Cumbersome
Disadvantages – Lost flexibility
 Joint Ventures
• Advantages:
– Benefit from local partner’s knowledge.
– Shared costs/risks with partner.
– Reduced political risk.
• Disadvantages:
– Risk giving control of technology to partner.
– May not realize experience curve or location
economies.
– Shared ownership can lead to conflict.
 Joint Venture
Company created and jointly owned by two or more
entities to achieve a common objective

Advantages Disadvantages
 Reduce risk level  Partner conflict
 Penetrate markets  Lose control
 Access channels
Joint Venture Configurations
 Wholly Owned Subsidiary

Greenfield
Acquisition
• Advantages:
– No risk of losing technical competence to a
competitor.
– Tight control of operations.
– Realize learning curve and location economies.
• Disadvantage:
– Bear full cost and risk.
Wholly Owned Subsidiary
Facility entirely owned and controlled by
a single parent company

Advantages
+ Day-to-day control
+ Coordinate subsidiaries

Disadvantages
– Expensive
– High risk
 Selecting an Entry Mode
Technological Know-How Wholly owned subsidiary, except:
1. Venture is structured to reduce
risk of loss of technology.
2. Technology advantage is
transitory.
Then licensing or joint venture OK.
Management Know-How Franchising, subsidiaries
(wholly owned or joint
venture).

Pressure for Cost Combination of exporting and

Reduction wholly owned subsidiary.
 Strategic Alliances
Cooperative agreements between
potential or actual competitors.

• Advantages:
– Facilitate entry into market.
– Share fixed costs.
– Bring together skills and assets that neither
company has or can develop.
– Establish industry technology standards.
• Disadvantage:
– Competitors get low cost route to technology
and markets.
 Strategic Alliance

Entities cooperate (but do not form a separate

company) to achieve strategic goals of each

Advantages Disadvantages
Share project cost Partner conflict
Tap competitors’ strengths Create competitor
Gain channel access
 Strategic Factors

Cultural environment

Political/Legal environments

Market size

Production and shipping costs

International experience
 Entry Modes (Wild and Wild, 2012)
Contractual entry modes Investment entry modes
• Licensing • Wholly owned subsidiary
• Franchising • Joint ventures (forward
• Turnkey project (build- integration or backward
operate-transfer) integration)
• Management contract (one • Strategic alliances
company supplies another
with managerial expertise)
High
Joint Venture Foreign Foreign
branch subsidiary

Licensing / Joint venture Foreign

contract branch
manufacturing
Export Licensing / Joint venture
contract
manufacturing
Low High
Market complexity
 Mergers/ Acquisition and
Greenfield Ventures
Mergers and Acquisitions
Greenfield Ventures
Merge or acquire existing company
Pros: Build a subsidiary from the ground up
• Quick to execute Pros
• Enable firms to preempt their competitors
• Gives the firm a greater ability to build the
• Less risky than Greenfield ventures
Cons: kind of subsidiary company that it wants
• Overpayment for acquired firm Cons
• Cultures of the acquiring & acquired firm • Slower to establish
clash • Risky
• Attempts to realize synergies run into
roadblocks and take much longer than
Greenfield Or Acquisition?
forecast
The choice depends on the situation confronting the
• Inadequate pre-acquisition screening
firm
• Acquisition better when market has well-
To avoid these problems, firms should:
established competitors or when global
• Carefully screen the firm to be acquired
competitors are interested in building a market
• Move rapidly to implement an integration
presence
plan
• A Greenfield venture better when the firm needs
to transfer organizationally embedded
competencies, skills, routines and culture
 Profiting from Global Expansion
Firms operating internationally are able to:
• Realize location economies.
• Realize greater cost economies.
• Earn a greater return from the firm’s
distinctive skills or core competencies.
• Earn a greater return by leveraging valuable
skills developed in foreign operations and
transferring them to the firm’s other
operations.
Profitability is constrained by product customization and
the “imperative of localization”.
Pressures for Cost Reduction and Local
Responsiveness
High
Company
C

Generally reflects
Cost the position of most
pressures companies
Company
B
Low
Low High
Pressures for local responsiveness
 Local Responsiveness
Taste and
preference Distribution
channels
Infrastructure
Delegate production And Delegate marketing to
and marketing to practice national subsidiaries.
national subsidiaries

Delegate manufacturing
and production to foreign
subsidiaries.
Host
government
Manufacture
locally.
 Four Basic Strategies

High
Global Transnational
Strategy Strategy

Cost
pressures
International Multi domestic
Strategy Strategy
Low

Low High
Pressures for local responsiveness
Strategic Choices

International Global
create value by increase profitability through
transferring skills to local cost reductions from
markets where skills are experience curve effects and
not present. location economies.

Multidomestic
oriented toward Transnational
achieving maximum Exploit experienced based
local responsiveness. cost and location economies,
transfer core competencies
within the firm, and pay
attention to local
responsiveness needs.
REGIONAL ECONOMIC
INTEGRATION
“Regional Economic Integration is of benefit
to all the worlds' nation and not just for the
member countries of the trade
agreements." Matt Vossler
 Regional Economic Integration
Regional economic integration

Regional trade agreements designed to promote free trade

Agreements between countries in a geographic region

Reduced tariff and non-tariff barriers

Five levels of economic integration
1. Free trade area
2. Customs Union
3. Common Market
4. Economic Union
5. Political Union
Levels of Economic Integration
 Levels Of Economic Integration
1. Free trade area
• No barriers to trade among member countries,
• Members determine own trade policies for nonmembers
 European Free Trade Association (Norway, Iceland, Liechtenstein, and
Switzerland)
 North American Free Trade Agreement (U.S., Canada, and Mexico)

2. Customs Union
• No trade barriers between member countries and adopts a common external trade
policy
 Andean Pact (Bolivia, Columbia, Ecuador and Peru)

3. Common Market
• No barriers between member countries, a common external trade policy and free
movement of the factors of production
 MERCOSUR (Brazil, Argentina, Paraguay and Uruguay) aims for common market
status
 Levels Of Economic Integration
4. Economic Union
• Free flow of products and factors of production between members
• A common external trade policy, a common currency, a harmonized tax rates
and a
common monetary and fiscal policy
 European Union (EU) is an imperfect economic union

5. Political Union
• Central political apparatus that coordinates the economic, social and foreign
policy of
member states
 United States is an example of even closer political union
 Opportunities and Threats
Opportunities Threats

1. Opens new markets 1. Within each grouping, the business

2. Make it possible to realize potentially environment becomes competitive
enormous cost economies by 2. EU companies are becoming more
centralizing production in those capable
locations where the mix of factor 3. There is a risk of being shut out of the
costs and skills is optimal single market by the creation of a
3. Link countries together, making them “trade fortress”
more dependent on each other 4. The EU is becoming more willing to
4. Creates incentives for political intervene and impose conditions on
cooperation and reduces the companies proposing mergers and
likelihood of violent conflict acquisitions which could limit the
ability of firms to follow the strategy of
their choice
 Case for Regional Integration
• Economic • Political
– Allow countries to – Creates incentive for
specialize in products they political cooperation.
produce efficiently. • Reduces potential for
violent confrontation.
– Easier to gain agreement – Enhanced clout to deal
than GATT/WTO. with ‘superpowers’.
– Role of FDI is enhanced.
– Exploit gains from free
flow of goods and services
and investment.
Impediments to Integration

• Although a nation may

benefit, groups within a
nation may be hurt.
• Concerns about
national sovereignty.
• Debate:
– Trade creation.
– Trade diversion.
 EU Evolution
• Product of two political factors:
– Devastation of WWI and WWII and desire for peace.
– Desire for European nations to hold their own,
politically and economically, on the world stage.
• 1951 - European Coal and Steel Community.
• 1957- Treaty of Rome establishes the European
Community.
• 1994 - Treaty of Maastricht changes name to the
European Union.
 NAFTA
Jan. 1, 1994 North American Free
Remove Trade Area
Abolish cross-border
tariffs flow of
services
Protect
intellectual
property Remove FDI
restrictions
Apply
national
environmental Two commissions
standards to enforce treaty
 ANCOM: Andean Pact
• Bolivia, Colombia, Ecuador, Peru, Venezuela
• Cartagana Agreement, 1969. One of oldest
still in existence.
• Nearly failed. Rejuvenated in 1990 in the
Galápagos Declaration.
– Changed from FTA to customs union in 1992.
• Still has many political and economic
problems.
 The Mercosur
• 1988: Argentina, Brazil. 1990: Paraguay,
Uruguay
• 1995: Agreed to move toward a full
customs union.
• Trade quadrupled between 1990-1998.
• Economic problems, first in Brazil (1999),
then in Argentina (2001) put plans for the
customs union on hold.
 Association of Southeast Asian
Nations
• Created in 1967.
• Economic, political and social
cooperation.
• Brunei, Indonesia, Laos, Malaysia, the
Philippines, Myanmar, Singapore,
Thailand and Vietnam.
Asia Pacific Economic Cooperation
• Founded in 1990 to ‘promote open trade and
practical economic cooperation’.
– ‘Promote a sense of community.’
– 18 members.
– 50% of world’s GNP.
– 40% of global trade.
• APEC “is in danger of shrinking into
irrelevance as a serious forum.”
 Regional Trade Blocs in Africa
• 9 trade blocs on the continent.
– Many countries are members of more than one group.
• Progress has been slow.
– Political turmoil.
– Deep suspicion of free trade.
• Less developed, less diversified economies need
“protection”.
FOREIGN EXCHANGE
MARKET
“The purpose is to facilitate trade and investment.
The need for a foreign exchange market arises
because of the presence of multifarious international
currencies such as US Dollar, Pound Sterling, etc.,
and the need for trading in such."
 Foreign Exchange Markets
• Foreign Exchange Market:
– A market for converting the currency of one
country into the currency of another.
• Exchange Rate:
– The rate at which one currency is converted
into another.
• Foreign Exchange Risk:
– The risk that arises from changes in exchange
rates.
 Foreign Exchange Market

Market that converts Exchange rates are

currency of one Conversion is done by determined by demand
country into that of using an exchange and supply for different
another country rate currencies

Firm’s sales, profits and

strategy are affected by Provide some insurance
events in foreign against foreign exchange
exchange market risk

3 factors impact on
3 types of foreign exchange rates:
exchange risk: • Country’s price
• Transaction exposure inflation
• Translation exposure • Country’s interest rate
• Economic exposure • Market psycho-
logy
Functions of the Foreign Exchange Market

Currency Conversion Insuring Against FX Risk

– Companies receiving payment – Spot exchange rate: rate of
in foreign currencies need to currency exchange on a particular
convert to their home currency. day.
– Companies paying foreign – Forward exchange rate: two
businesses for goods or parties agree to exchange
services. currencies on a specific future
date.
– Companies invest spare cash
for short terms in money – Currency swap:simultaneous
market accounts. purchase and sale of a given
amount of FX for two different
– Speculation: taking advantage
changing exchange rates. value dates.
 The Foreign Exchange Market
• It is a 24/7 market.
• The markets are integrated. Connected by
high-speed computers, it creates one virtual
market.
• London’s dominance is explained by:
– History (capital of the first major industrialized
nation).
– Geography (between Tokyo/Singapore and New
York).
 Factors Influencing Currency Value
Economic Factors
1. Balance of Payments
2. Interest Rates
3. Inflation
4. Monetary and Fiscal Policy
5. International Competitiveness
6. Monetary Reserves
7. Government Controls and Incentives
8. Importance of Currency in World
Political Factors
9. Political Party and Leader Philosophies
10. Proximity of Elections or Change in leadership
Expectation Factors
11. Expectations
12. Forward Exchange Market Prices
 Economic Theories of Exchange Rate
Determination

• Base level: rates are determined by the

demand/supply of one currency relative to the
demand/supply of another.
• Interest Rates and Exchange Rates.
• Investor Psychology and Bandwagon Effects.
 Money Supply and Inflation
• PPP* theory predicts that changes in
relative prices will result in a change in
exchange rates.
– A country with high inflation should expect its
currency to depreciate against the currency of
a country with a lower inflation rate.
– Inflation occurs when the money supply
increases faster than output increases.
*Purchasing Power Parity.
 Foreign Exchange Market
International companies use the foreign exchange market when:
• Receive payments in foreign currencies for exports
• Receive income in foreign currencies from foreign investments
• Receive income in foreign currencies from licensing agreements with foreign firms
• When they must pay a foreign company for its products or services in its country’s
currency
• When they have spare cash that they wish to invest for short terms in money
markets
• When they are involved in currency speculation (the short-term movement of
funds from one currency to another in the hopes of profiting from shifts in
exchange rates)
 Foreign Exchange Market
Firms need to understand the influence of exchange rates on the profitability of trade and
investment deals

There are three types of foreign exchange risk:

1. Transaction exposure
•Extent which income from individual transactions is affected by fluctuations in foreign
exchange values
•Includes obligations for purchase or sale of goods and services at previously agreed
prices & borrowing or lending of funds in foreign currencies

2. Translation exposure
•Impact of currency exchange rate changes on the reported financial statements
•Present measurement of past events

3. Economic exposure
•Extent to which future international earning power is affected by changes in exchange
rates
•Economic exposure is concerned with long-term effect of changes in exchange rates on
future prices, sales, and costs
 International Monetary System

• The role of the IMF was to maintain order in the

international monetary system (1) to avoid a
repetition of the competitive devaluations of the
1930s and (2) to control price inflation by imposing
monetary discipline on countries.
• An important debate is occurring over the
appropriateness of IMF mandated macro economic
policies. Critics charge that the IMF often imposes
inappropriate conditions on developing nations that
are the recipients of these loans.
The role of the IMF was heavily influenced by
worldwide financial collapse, competitive devaluations,
trade wars, hyper inflation and unemployment and
general economic disintegration that occurred
between the two world wars. IMF was set up to avoid
the chaos that followed WWI and to do so by:
Firstly. Discipline: Maintaining a fixed exchange regime
so as to curtail inflation by imposing a monetary
discipline on countries.
Second, the fixed exchange regime puts a brake on
competitive devaluations and brings stability to the
world trade environment
• Exchange rates determine the value of one currency
in terms of another. While dealing in multiple
currencies is a requirement of doing business
internationally, it also creates risks and significantly
alters the attractiveness of different investments and
deals over time. The foreign exchange market is used
for:
1. Currency conversion , 2. Currency hedging
3. Currency arbitrage 4.Currency speculation
Firms can use the foreign exchange market to minimize
the risk of adverse changes, but this can prevent
them from benefiting from favourable changes.
 The International Monetary System

• The institutional arrangements that countries

adopt to govern exchange rates.
• Dollar, Euro, Yen and Pound “float” against
each other.
– Floating exchange rate:
• Foreign exchange market determines the relative value
of a currency.
• Some countries use other institutional
arrangements to fix their currency’s value.
 • Some countries use:
– Pegged exchange rate.
• Value of currency is fixed relative to a
Require some reference currency.
degree of
government – Dirty float.
intervention. • Hold currency value within some range of
a reference currency.
– Fixed exchange rate.
• Set of currencies are fixed against each
other at some mutually agreed upon
exchange rate.
 The Gold Standard

Pegging
currencies
to gold and Roots in
guaranteeing mercantile Inconvenient to ship
convertibility. trade. gold, changed to
paper - redeemed
for gold.

Seeking a
“balance of trade”
equilibrium.
 Bretton Woods
• 1944:
– 44 countries meet in New Hampshire.
– Fixed exchange rates deemed desirable.
• Agree to peg currencies to US dollar that is
convertible to gold at $35/oz.
– Promise not to devalue currency for trade
purposes and will defend currencies.
– Created:
• World Bank
• International Monetary Fund.
 The Role of the IMF
• Want to avoid problems following WWI.
– Discipline:
• Fixed rate imposes discipline:
– Need to maintain rate stops competitive devaluations.
– Imposes monetary discipline, curtailing inflation.
– Flexibility:
• Lending facility:
– Lend foreign currencies to countries having balance-
of-payments problems.
• Adjustable parities:
– Allow countries to devalue currencies more than 10%
if B of P was in “fundamental disequilibrium’.
 The Role of the World Bank
• International Bank for Reconstruction and
Development (IBRD).
• Rebuild Europe’s war-torn economies.
– Overshadowed by the Marshall Plan.
• Turns to ‘development’.
– Lending money to Third World nations.
• Agriculture.
• Education. IBRD raises money in bond
• Population control. market and lends at ‘market rate’.

• Urban development. International Development Agency

raises money through subscriptions
and lends to very poor countries.
 The Floating Exchange Rate
Regime

• Jamaica Agreement - 1967

– Floating rates acceptable.
– Gold abandoned as reserve asset.
– IMF quotas increased.
• IMF continues role of helping countries cope with
macroeconomic and exchange rate problems.
 Fixed versus Floating Exchange Rates
• Floating: • Fixed:
– Monetary policy autonomy. – Monetary discipline.
– Speculation.
• Restores control to
• Limits speculators.
government.
– Uncertainty.
– Trade balance adjustments.
• Predictable rate
• Adjust currency to movements.
correct trade – Trade balance adjustments.
imbalances. • Argue no linkage between
exchange rates and trade.
– Linkage between savings
Which system is better? and investment.
Evidence is unclear.
Interest Rates and Exchange Rates
• Theory says that interest rates reflect
expectations about future exchange rates.
– Fisher Effect (I = r+l).
– International Fisher Effect:
• 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 the two countries.
 Exchange Rate Forecasting
• Efficient market: where prices reflect all available public information.
– Early studies seem to confirm the efficient market
theory, but recent studies have challenged it.
• Inefficient market: where prices do not reflect all available
information.
– Use fundamental (economic theory) or technical
(price/volume data) analysis to predict the
exchange rates.
– Analysis suggest that professional forecasters are
no better than forward exchange rates in
predicting future spot rates.
 Currency Convertibility
• Freely convertible.
• Externally convertible.
• Not convertible.
– Preserve foreign exchange reserves.
• Service international debt.
• Purchase imports.
• Government afraid of capital flight.
• Political decision.
• Many countries have some kind of restrictions.
• Countertrade.
– Barter-like agreements where goods/services are traded for goods/services.
– Helps firms avoid convertibility issue.
 CULTURE

“Culture is more often a source of conflict

than of synergy. Cultural differences are a
nuisance at best and often a disaster."
Prof. Geert Hofstede
What is Culture?
A system of
values
and norms
shared
among a group of
people and, when
taken together,
constitute a
design
for living.
 Culture, Society and the Nation-state
Successful international managers need
cross-cultural literacy –

IT IS VITAL to understand how cultural

differences across and within nations
can affect the way in which business is
practiced

What is culture?

 Observed behavioural regularities

when people interact
 Norms that evolve in working groups
 Dominant values in a society Values = Ideas about what is right, good,
 Systems of shared values or honourable and desirable
meanings Norms = social rules and guidelines that
 The way we do things around here spell out acceptable behaviour in a situation
 Culture, Society and the Nation-state

Values Norms Culture

Abstract ideas Social rules and

guidelines that System of values
about what a and norms
group believes prescribe
appropriate shared among a
to be good, right group of people
and desirable behavior in
particular
situations
 Norms and Values
Norms: Values:
– Social rules and guidelines – Abstract ideas about
that prescribe appropriate what a group believes
behavior in particular to be good, right, and
situations. desirable.
– Folkways: – The bedrock of culture.
• Routine conventions of – Have emotional
everyday life. significance.
– Mores:
• Central to functioning of
society and its social life.
 Culture, Society and the Nation-state
What is national culture?

Culture changes over a period of time as determinants of culture change

Social
Structure
Religion Language
2 types:  Spoken &
4 dominate:
Individual unspoken
Christianity
Group  Define
Islam
Hinduism culture
Buddhism  Perception

Culture
Education
 Learn
Political Economic languages,
Philosophy Philosophy conceptual &
2 types: 3 major mathematical
Democracy systems: skills
Totalitarianism Communism  Socializing
Socialism  Citizenship
Capitalism
 Determinants of Culture

Economic
Philosophy

Political
Education
Philosophy
Culture:
Norms and
Value
Systems
Language Social
Structure

Religion
 Religion
• Shared beliefs and rituals concerned with the
realm of the sacred.
• Ethical Systems:
– Moral principles or values used to guide
and shape behavior.
• Shapes attitudes toward work and
entrepreneurship and can affect the cost of
doing business.
 Language
• Allows people to communicate.
• Structures the way the world is
perceived.
• Directs attention to certain features of
the world rather than others.
• Helps define culture.
• Creates separatist tendencies?
 Education

Formal education For global business, it is a

supplements family role determinant of national
in teaching values competitive advantage
and norms
Medium to learn
language, conceptual,
and math skills
Cultural norms such as
respect, obedience, honesty

Focus on facts of social

Value of personal and political nature
achievement and of society
competition
Obligations of
citizenship
 Culture, Society and the Nation-state
What is organisational culture?

 General pattern of behaviour, shared beliefs and

values that members have in common
 Observed from what people say or do
 Culture involves the learning and training of
knowledge, beliefs and patterns of behaviour over a
period of time
 Sets the tone of the company and establish rules
 Reflects the vision or mission of the founders
 Three fundamental levels
 Observable artifacts
 Values
 Assumptions

 Effectiveness of organisation is influenced

by organisational culture
Culture as
An Iceberg Classical Cultural make-up
Fine Arts Music that is visible
Literature
Drama HIGH CULTURE
Humour
Diet Popular
Music Rites of Cultural make-up
Dress we are aware of
FOLK CULTURE passage
Religion Etiquette
Courtship practice
Folk dancing
DEEP CULTURE
Gender roles Greeting rituals
Superior-subordinate relationships
Family relationships
Conversational patterns Cultural make-up
Nonverbal communications we are unaware of
Belief on Right vs Wrong
Concepts of beauty
Decision making patterns
Methods of problem solving
...and much more...
 Implications For Managers
There are three important implications that flow from these differences for
managers:

1. There is a 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 is critical to the success of international businesses

• Companies that are ill informed about the practices of another culture are
unlikely to succeed in that culture
• Managers must also beware of ethnocentric behavior, or a belief in
the superiority of one's own culture
 Implications of Culture for
international business
• Culture and competitive advantage
• Culture and business ethics (whose
ethical systems are used?
• Cross-cultural literacy
• Culture and entrepreneurial orientation
 Culture and Strategic Management
• Management Styles
• Work attitudes – organisational
commitment
• Achievement motivation
• Time and the future
• Ethics
 The Global Manager

Ethnocentric Polycentric Regiocentric

Home Individual Integrated

Market Foreign Worldwide
Orientation Markets Marketing

190
 Success Factors for
Global Managers
• Cross-cultural sensitivity • Takes risks

• Business knowledge • Uses feedback

• Courage • Culturally adventurous

• Motivates others • Willing to learn

• Personal integrity • Open to criticism

• Insight • Seeks feedback

• Commitment to success • Maintains flexibility

191
The Economic Environment

Economic Exchange
System Rates

Economic
Development

192
The Political and Legal Environment

Trade Barriers Tariffs

Subsidies Quotas

Political Risks Legal Systems

193
 The Socio-Cultural
Environment

Values Language Customs

194
 The Technological
Environment
Suitable Social
Technology Conditions

Economic Willingness
Conditions and Ability

195
QUESTIONS