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CHAPTER 1: Globalization and International Business

What is International Business?


Any commercial transaction between two or more countries is known as International
Business. The parties of the transaction could be either companies or Governments.

What is the need of International Business?


IB is needed because:
1) Raw materials are required from abroad
2) Processes are acquired from abroad. E.g.- Wal Mart
3) Advanced technologies are required from abroad
4) Competition: There will always be competition. Even if the company does not enter
into foreign territory, foreign companies will enter into the host country.
So baring some very local businesses, it is not possible to stay insulated from international
business because of the above mentioned reasons.

What are the features of International Business?


(DIFFERENCE BETWEEN IB AND DOMESTIC BUSINESS)
1) The world is the market
2) It involves a global scale of operations
3) Ample number of opportunities
4) World class products/services
5) International level of productivity
6) Efficient/Productive value chain
International Business by its very nature is a primary determinant of International Trade. One
of the reasons of the increasing success of international business ventures is globalization.

What are the competitions arising due to global opportunities?


There are four levels of competitions due to global opportunities:
1) From host country suppliers: If a company from India wants to manufacture or
export its products to the US then the existing US suppliers will have an advantage
over the Indian company in terms of zero customs tax, minimum transportation cost
and a popular brand name.
2) From domestic players of home countries: In home country, multiple companies
with similar products having the same pricing start competing.
3) Free trade agreements/ trade blocks: The advantage of manufacturers belonging to
a trade block is that they don't have to pay any custom duty. The only cost incurred by
them is the transportation cost. E.g. NAFTA.
4) International Players - Apart from the company from home country, a number of
other companies across the world would also like to sell their product in a particular
host country. So there exists competition from international players.

Why do companies engage in International Business?


The following are the factors for companies engaging in International Business:
1) To increase sales i.e. Sales Expansion:
a) Larger canvas along with the convention of Scale Economy in which the unit cost
comes down
b) Companies leverage IPLC (International Product Life Cycle). It involves 4 stages:
i) Induction: Company cashes in on the unmet market needs
ii) Growth
iii) Maturity
iv) Decline
As the stage in the PLC changes, the place of production/manufacture changes around
the world. IPLC stages followed by a product are different in different countries. These
differences provide different market opportunities in different countries. Innovation first
spreads into developed countries, due to their high purchasing power. The critical success
factor is cost. So, developing countries become the manufacturing hub. So, they become the
main exporter and the developed country where the innovation began along with the other
developed countries becomes the main importer.

c) Following the Customer to other countries: Every company has some core
customers. Companies follow their core customers where ever they go in the
international arena. However Govt. forces the MNC to have local suppliers. E.g. In
the case of GE, the GE or home suppliers come along with GE to the host country
where GE is operating. The main threat is when GE finds the local suppliers to be
more cost effective than the home country suppliers and prefers working with the
former.
d) Lead Market: Companies want to be leaders in some market and just want to be
present in some other lead markets. Lead markets tell the future of the industry. If a
company wants to be global, then it needs to have a presence in the lead market to
know the product trend. A company might not make profit and lose, but will learn or
find a probable alliance, so it goes to the lead market. E.g. Perfume and fashion
market in France, car market in Japan or Germany

2) To acquire resources:
a) Better quality or competitive resources
b) Resources available at lower cost
c) Resources (Technology, HR) might be scarce in the host country
d) Global Sourcing: Companies prefer not to depend on a few countries. They want to
spread the risk in acquiring resources.
E.g. BOSCO comes to India for Iron Ore

3) Reducing Risk: Companies try to reduce risk by spreading operations around the
world.
a) Business Cycles: There are ups and downs in the economy, but all countries are not
equally affected. If there is more spread it can average out returns.
b) Overdependence on a particular country for market and resources can be a problem,
especially during sensitive situations like war times. E.g. Gulf War. Thus for a
country it was better during that period to have other sources of oil.
c) Cross patrolling: Divert the competition posed by a company by trying to compete
with them in their home country. It is an offensive but very effective, as sometimes
offense is the best form of defense. If you follow your competitors, you may get the
second mover advantage. E.g. Caterpillar of USA expanded to UK first and then tried
to enter Japan. COMADSO of Japan was giving stiff competition. Then COMADSO
attacked Caterpillar in USA, thereby diverting Caterpillar from the Japanese market to
its home country.
d) Defensive reason: Companies want to counter advantages gained by competitors in
foreign markets that might hurt them elsewhere.
What is Globalisation?
It is the transformation of national and regional market into one common world/global market
for free flow of goods, services, capital, people and technology across nations.

What are the Drivers of Globalisation?


1) Progress i.e. increase in and expansion of technology. (Advances in communication
and transportation)
2) Liberalization of cross border trade (exports/imports), investment (FDI) policy by the
government and resource movements
3) Development of IB related services
4) Increasing consumer pressure
5) Increased global competitors and competition
6) Improving political relations among countries
7) Increased cross border cooperation. E.g. Copenhagen Summit
8) Increased availability of capital worldwide seeking optimal long term returns.

What are the disadvantages of Globalization?


1) Growing Income inequality/ Economical inequality: Small local players suffer.
Larger companies and consumers get benefitted by Globalization. The rich get richer
and the poor get poorer.
2) Threat to national and economical sovereignty: More dependence on external
inputs. (Question of local objectives and policies, local overdependence and cultural
homogeneity)
3) Faster ecological degradation: As high competition due to globalization spurs
industrialization which hampers the environment.

What are the modes of International Business?


There are basically three aspects of international business:
1) Manufacturing in home country
2) Manufacturing in host country
3) Project/Services in host country

1) Manufacturing in home country: In this case the products are manufactured in


home country and then exported to host country. E.g. GE manufactures in USA and
exports in the host country. It is feasible when:
a) Excess capacity in home country
b) Quality allowed by host country
c) The labor costs are low in home country
d) Transportation costs are not high
e) No tariff barriers to exports.
The advantage of this method is scale economy and excess capacity utilization.

# Exports can be Direct or Indirect.


Direct Exports involves independent distributors where company is in direct touch with the
customers. Distributors buy the goods from the manufacturer in large quantities. They sell the
product, know the country market well. A partnership happens between client and customer.
Sales people are trained and sent for missionary distribution. It also involves investing in
your ace staff to help with the sales of the product. Feedback is possible in this.
Indirect Exports is through agents in the home country and trading houses in other countries.
Agents do not have ownership, but act on behalf of the client. They generally have a good
track record of sales. The cost incurred by agents in sales is not reimbursed by the company,
but it is contained in the commission they get. In the case of non-exclusive agencies, the
agents can work for other manufacturers as well. Agents get paid only when the contract is
bagged. Thus it leads to economies of scale and scope. However the disadvantage is that here
feedback is not available, since no interaction with the customer and it is meant for short term
gains. This poses a sustainability issue for the manufacturer as it might be dumped as soon as
a cheaper manufacturer is found. Thus companies find it convenient to sell through trading
houses and one stop shops, as it helps in entering different markets and risk is not present.
E.g. Mitsubishi sells through one stop shops. #

#Piggy Back: When other companies use the distribution of a particular company. E.g.
Voltas. It has an excellent distribution network in India. Other companies approach Voltas for
distribution. They are non-competing products. Voltas gets paid for it. Foreign companies
pay Voltas for distribution. E.g. Fiat is using Tatas distribution now. Tata uses Fiats engine.
They are mutually helping each other. #

2) Manufacturing in host country: The manufacturing in the host country can be done
either by contract manufacturing or by licensing.

a) Contract Manufacturing: In contract manufacturing the company gives a contract to


local manufacturers to manufacture the product instead of setting up a factory. E.g.
Nike has done contract manufacturing with Chinese manufacturers for 1 year. As
knowhow would be shared, only strong brands like Nike can do it.
The advantages are:
i) The companies will have a low level of involvement and in turn get a taste of
the market first.
ii) No labour issues
iii) Control of the market as it is the company that sells and interacts with the
customer.
iv) Low risk option as company can terminate the contract and switch.
The disadvantages are:
i) Dependency
ii) Sharing of profits thus lesser margins
iii) No control over quality, manufacturer may not be loyal
iv) It makes the local manufacturers strong and they can turn into competitors as
they know the technique, style and design and take over the market.

b) Licensing: In licensing the licensor permits the use of technology for a certain period
of time to the licensee for the manufacturing of licensed products and sale of the
licensed products in the licensed territories. Here the licensor owns the technology.
The licensee is permitted to use the technology. For this the licensee pays down-
payment as well as royalty to the licensor. Royalty is always on sales and not on
production. Host country Govt. sets the guidelines and rules.
Companies get into licensing as there is a pressure to shorten the PLC. Once the
license is over, the licensee can use the technology, but it is not possible for licensor
to enter into the market. Licensing is good when the political risk is high. Licensor
can use the royalty on R & D and create next generation product in accordance with
the market need.
Licensee is using depreciated assets, but licensor works with todays costs, i.e. cost
factor is higher for the licensor. No customer relations exist so licensor starts from the
beginning. Thus there is higher risk in licensing than contract manufacturing.
The advantages are:
i) Recovery of R & D investment as fast as possible
ii) Lesser capital investment
iii) Brand value is known
iv) No labour issues
The disadvantages are:
i) Creating a competition, as the licensee is in touch with the customer.

3) Projects/services in host Country:

a) BOT (Build, own and transfer)


b) BOOT (Build, own , operate & transfer)
c) Turnkey Project (Build and transfer): Client in host country. Entire responsibility
from concept to commission is given to the expert company, including design, global
procurement, testing stage up to product being switched on. Global bidding takes
place. E.g. Bechtel is a leading US based company in the infrastructure construction
sector, which designs and executes projects in Machine technology. It sources funds
from World Bank and Asian Bank, and is actively involved in the planning of where
the plant should be located and what its capacity should be. It acts as a consultant and
takes commission. The client of Bechtel only turns the key i.e. starts using it. Hence
they are called turnkey projects or turnkey contracts.
The advantages are:
i) It gets references for other projects in host country and in countries around it.
ii) Increases the domain knowledge
iii) It gets fees and part of profit. Payment is received in installments at different
milestones. It is called progress payment
d) Management Contract: Unlike the turnkey contract, management contract has the
asset. But here the company is not confident to run the plant alone (market/operation).
One company provides personnel to perform general or specialized management
functions for another. It is recurring. The company gets profit, increases its captive
capacity. E.g. Wholesim was paid money by local Dubai Cement Company for
management contract. Wholesim increases capacity in terms of infrastructure and
technology transfer and marketing strategies. So, after few years it can become
independent. They can expand to the international market. They can understand
market demand and competition to be faced.
The money received / paid in management contract is:
i) Base Fee + certain no. of expatriates
ii) If capacity of production/sales is higher than that agreed, pay more, and if
lower than agreed, penalty is charged.

What are the various Foreign Country Entry Strategies?

NON FDI BASED:


1) Exports
2) Contract Manufacturing
These also include turnkey projects, management contracts and R & D
# R & D: Critical part of R & D at home. No technology diffusion. Stand alone modules are a
part of R & D contract. Country should be compliant with IPR#

FDI BASED:
1) Licensing
2) Assembly
3) Joint Venture
4) Wholly owned subsidiary
5) Acquisition/ Merger
They are named in increasing order of risk.

1) Exports:
The Company goes for exports because it has higher competitive advantage. The
transportation costs are low. The tariff rates are also low.
2) Contract Manufacturing:
In contract manufacturing the parent/hiring company approaches a firm known as
contract manufacturer with a design/formula. Once the contract is finalized then the
contract manufacturer manufactures the components/products for the hiring company.
Freedom from managing the labour, tech/design diffusion will occur but only for
manufacturing part. There is no FDI and there is flexibility of switching.
3) Licensing:
In licensing, first the licensor searches for a potential licensee. Then the licensor
permits the use of technology for manufacturing a component/product to the licensee
for a definite period at a certain location. The role of the licensee is to both
manufacture and market.
A contract manufacturer only produces products where as a licensee produces as
well as sells for the licensor.

Boundary conditions of licensing:


a) It applies to a particular territory. E.g. big country like Brazil sells and manufactures
only in that territory. Economically small country like Bangladesh, Sri Lanka,
manufactures at home, sells to neighbouring countries.
b) License product: License need not cover all products. A particular product or a group
of products are licensed.
c) Period of license: Normally 5 years. Can be varied or extended.
d) Expenditure for licensee:

i) Royalty set by the host country based on the percentage of sales. Royalty is
always on sales and not on production.
ii) Lump sum payment for documentation, process manuals and opportunity
costs. It is negotiable.
iii) Training purposes

Lump sum payment up to 8 % of projected sales is easily accepted by the Indian Govt. It is
paid only once. R & D cost has to be recovered in 3 years on an average.
The advantages are:
a) Lesser capital investment
b) Good income and faster R & D recovery which can be invested to come up with
newer versions
c) Right capacity to license
d) Licensor gets tie ups with best distributors, knows local market and has cost
advantage
e) Licensor can cover many countries in the world at faster speed.
f) Brand value of licensor increases.
g) No labour laws issues.
If licensor is ready with the new version, and the host country is also ready for it, then
licensing is profitable, else it is not.

The disadvantages are:


a) Diffusion of technology
b) Losing the market to licensee, as customer contact is lost.
c) Increase in competition, as at the expiry of the licensing agreement the licensee will
become the competitor to the licensor. So the market presence increases with
licensing.

While licensing deals with products, franchising refers to services. E.g. Mc Donalds.
It involves not the use of technology but the trade mark or brand name. The territory will not
cover countries. Royalty is lower compared to licensing. Customization/Adaptation is
required for each country.

4) Assembly:
In case of assembly, different parts of the product are manufactured in different countries.
The assembly of the parts takes place in the host country. Over a period of time the
product becomes local to the host country. It involves local labour.
The advantages are:
a) Host country likes it, as it creates employment, causes technology upgradation, and
causes increase in indirect and corporate tax collection resulting from profits.
b) Scale economies as there is no transportation cost.
c) Customization is easier and can be done as per host country rules
d) Employment generation
e) Government will ask manufacturers to manufacture parts in host country. Tax benefits
can be demanded for backward integration in this case.
f) Local procurement: Host country suppliers get better prices.

The disadvantages are:


a) Huge investment
b) Irreversible process. Exit is difficult as Govt. will not allow you to exit.
c) Hassles with labour laws
d) Difficulty in understanding companies dynamics, such as languages, culture etc.
e) Risk increases because of political situations.

5) Joint Venture:
In a Joint Venture, both the parties contribute a certain amount of equity and form a
new company. It involves sharing risk and cost with local partner. E.g. Tata and
Honeywell
The advantages are:
a) Local market familiarity i.e. suppliers, distributors, employers and established channel
partners etc can be known through the local company
b) Labor management
c) Host country relation / relation with banks
d) Reduces risk as sharing risk and cost in unknown market
e) Cultural bridge
f) Local JV company having good political contacts can be leveraged upon
g) Synergy
h) Liability in host country is responsibility of JV. So parent company is insulated. E.g.
Union Carbide- Bhopal Gas Tragedy
The disadvantages are:
a) Cross-cultural differences/ Cultural mismatch due to environmental changes, guard
technology
b) Change in company strategies may lead to Divergence E.g. Tata decided it does not
want to explore instrumentation. Honeywell offered to buy Tatas share without legal
hassles.
c) No intended technology transfer but technology gets diffused.
d) Synergy issues
e) Loss of interest by one party.
f) Due to high profits, the company wants to become independent and leave the sleeping
partner.

# When one partner is government, it is called Mixed Venture #

The reasons for engaging in Joint Venture are:


a) To enter into a foreign country
b) Suppliers, Distributors and established channel partners
c) Good brand name and relations
d) Sharing risks as well as costs
e) Cultural Bridge
f) Only way to get 100% FDI otherwise not possible due to government restrictions
g) Joint ventures are a necessity by government
h) Profit sharing/market sharing

The reasons for the failure of Joint Venture are:


a) Change in external environment
b) Conflict of vision/interest
c) Both parties not contributing equally
d) Sharing of market leading to market contraction
e) Global competitiveness requires control, which is not entirely present with either
party.
f) JV might be due to govt. regulations so might be a compulsion.

# In UAE, local partnership is 51% except in Jabel Ali Free Zone: 100% free zone in Dubai
1) Connectivity advantage as it is the gateway to Europe, Africa, South-East Asia and
West Asia
2) Volatile, politically unsafe (frequent way)
3) Distance from equator #

6) Wholly Owned Subsidiary:


A wholly owned subsidiary is a subsidiary whose parent company owns 100 percent
of its common stock and there are no minority owners. There is 100% control, no
local partners. Risk involved as there are no local partners and political risk is high.
Features MNEs should have to be WOS:
a) Global Brand
b) Innovative product
c) Access to distribution channels
d) Host country government wants the company in the country
e) Effective customer reach, good CRM
f) Product knowledge, core competency, retailer is ready to fill his shelf with the
product
g) Good adaptable workforce
h) Adaptable market (market ready for product or market can be created)

The advantages are:


1) Freedom in designing the plant
2) No dilution of brand image
3) No dilution of profits
4) Total control over operations in the host country
5) No dilution of system processes
6) Processes are standardized
7) If govt. likes the company, it will have concession in most of the agenda points.
8) Whole operation can be integrated with global operations

The disadvantages are:


1) Total risk ownership. No risk sharing
2) Less knowledge of the market
3) Degree of competition increases

7) Acquisition:
Acquisition may be defined as a corporate action in which a company buys most, if
not all, of the target companys ownership stakes in order to assume the control of the
target firm.
The advantages are:
1) Acquiring the entire target company
2) Saves time as it is quick to reach the market
3) Ease of access in the market, due to well established distribution and sales channel
4) The competition in the market remains unchanged
5) Company has a good domain knowledge and benefits from local technology

The disadvantages are:


1) Getting obsolete technology in parts
2) Resources might not be best in class
3) Processes and practices might not be world class
4) Cultural mismatch
5) Parent company has to take over the liabilities of the acquired company.
6) Actual worth of the company can only be known after acquiring it.

# In case of acquisition or merger, as in Tata and Corus, the capacity of Tata + Corus remains
unchanged, rivalry remains same. In wholly owned subsidiary, new capacity is created,
rivalry increases #

# In JV, companies choose location, in merger companies choose only the time of it. #
# Expropriation vs. Nationalisation:
If the government of any country takes over any foreign company, then it is known as
expropriation whereas if the government takes over any localised company, then it is known
as Nationalisation. Wholly owned subsidiaries are exposed to expropriation where as joint
venture agreements protect firms from expropriation. #

What distinguishes International Business from Domestic Business?

The following factors distinguish International business from domestic business:

1) World market
2) Political environment
3) Legal system
4) Cultural difference
5) Communication
6) Distance are higher
7) Diversity
8) Uncertainty-Political, economical and currency risks
9) Uncontrollability-The degree of Uncontrollability is higher in host countries
10) Competitions
11) Competence-people in different countries are at different levels of competence.

Why is IB complex?

1) Distances are large, which increases risk


2) Diversity of host nations (political, social, environmental and economical systems of
nations are diverse)
3) Uncertainty of political situation in the host country
4) Uncontrollable conditions in the host country. At home, the industrial policies are
clear. The company can influence Govt. policy through lobbying. It is not possible in
host country.

What is a Multinational Enterprise (MNE)?


Multinational Enterprise is a firm that has engaged in foreign direct investment (FDI).
Equivalently, an MNE is a company that owns (a significant part of) and operates facilities in
nations other than the one in which it is based.

Types of MNEs:
1) Global
2) Multi-domestic
3) International
4) Transnational

1) Global Company:
a) Integrates its operations around the world
b) Produces for the world market
c) Utilises best resources
d) Operates on scale economies
e) It has a global brand
f) No customization of global brands so might lose some segment of the market
E.g. Mc Donalds, Intel

2) Multi Domestic Company:


a) Operates in different countries
b) Customises its product for different countries to the extent necessary
c) Better customer loyalty
d) Larger scales and better margins/profitability.
e) Takes into account cultural differences, temperature variations
f) Greater and long term market share
E.g. Unilever, P&G

3) International Company:
a) Runs on core competency
b) Less pressure for adaptation or customization and low cost
E.g. IBM

4) Transnational Company:
a) World is the market
b) Learns the best practices from anywhere in the worldwide operations
c) Leverages learning
d) Integrates operations worldwide to reduce cost.
e) Lower the cost of customization
E.g. Caterpillar, GE

What is a Multinational company (MNC)?


MNC is a company which has its own presence in at least two countries. MNEs are
partnerships. MNEs include MNCs but not vice-versa.
The importance of MNCs to host country is:
1) FDI
2) Creates employment
3) Technological improvement
4) Could create competition to local companies
5) Might improve imports. Crude Oil, Edible Oil, Fertilizers and other engineering
equipment are the major imports for India.
6) Taxes:
a) Direct: MNEs, expatriates, companies based on corporate profit
b) Indirect: VAT, excise, import duties

# FDI (Foreign Direct Investment): is made by the company for the control of operations. It is
a long term investment. Govt. welcomes FDI. Exit is difficult.

FPI (Foreign Portfolio Investment): no control. Hedge (balancing risks), currency risks, better
returns are the main incentives. It is for short term gains and has moderate risks. Liquidity is
an important consideration for FPI. Foreign Institutional Investors are the major players of
FPI.

For the home country, FDI brings dividends; FPI brings both interest and dividends. #

DIAGRAM 1: TYPES OF MNES