International Business Review – F09
What is international Business?
The trade and investment activities by companies across national borders
exceeding some 10 trillion dollars
When did globalization start?
1st phase: 1830 – 1880: during the growth of efficient transportation, such as railroads, ocean transportation, invention of the telephone, and the rise of large manufacturing and trading companies
2nd Phase: 1900 – 1930: rise of electricity and steel production until the worldwide economic downturn starting 1929; western Europe was the most industrialized region, establishing some of the first international firms such as Nestle, BP, Shell and Siemens with foreign manufacturing
3rd Phase:1948 – 1970s: following WWII, Marshall Plan to rebuild Europe, US became world’s dominant economy (least harm during WWII), an era of high tariffs and trade barriers – General Agreement on Tariffs and Trade (GATT), later WTO [now 149 Nations], was formed to reduce international trade barriers; other important organizations fostering global cooperation are Int. Monetary Fund, World Bank, and United Nations. Forming MNE where companies like IBM, Boeing, Texas Instrument, Xerox, McDonalds seeking cost advantages by locating factories in countries with low cost labor/resources. Currency and capital started to flow freely across national borders. 1973 global oil crisis when OPEC proclaimed an oil embargo, followed by a stock market crash worldwide [Jan 73 – Dec 74], 70s recession, devaluation of the almighty USD [US (Nixon administration) stopped backing the USD with Gold reserves, also high inflation] – USD rose above and beyond the true value since most commodities around the world were traded in US currency - including the precious oil commodity, a corrective measure requested by Europeans [meaning: dollars would buy fewer yens and marks], 1975 the US began to float the dollar – fiat money: unbacked by any physical asset
4th Phase:1980 – Present: commercialization of the PC, Internet, low cost communication, modernization of manufacturing, liberalization in central and Eastern Europe, industrialization of East Asia (4 Asian Tigers [1960s – 90s]: HK, Singapore, South Korea and Taiwan), growing integration of mergers and acquisitions, “death of distance” – shrinking the world into a manageable marketplace. USA FDI inflows interrupted by the 9/11/2001 event
Why go international?
Living standards of billions of people are improved due to international trade and investment – wider selection of products and services at lower prices; accelerates development of latest technology
Business:
· Earn higher margins and profits,
· Global procurement: raw material (closer to supply sources)
· Low cost & skilled labor,
· Acquire knowledge, opportunities (proactive or reactive motives)
· Market diversification, gain new ideas, less intense competition, stronger market demands
· Better serve key customers that relocated overseas
· Economies of scale, production and marketing
· Confront international competitors
Nations:
· Facilitates industries and workers to be more productive
· Allows countries to achieve higher living standards
· Without international trade, most nations would be unable to feed, clothe, and house their citizens at current levels
· Not only do nations, companies, and stakeholders benefit from international trade, modern life would be virtually impossible without it
Steps of internationalization:
Domestic focus
Experimental export – asked to send product/services overseas
Export/Import: increased commitment
tangible merchandise (clothing, computers, cars) as well services (intangible) such as banking, consulting, etc.
FDI – Foreign direct investment, most committed involvement, long term, direct influence on production, distribution and service of one’s product, partial or complete ownership of acquired assets
Four risks in internationalization:
Cross-cultural risk: difference in language, lifestyle, mindset, customs, religion, etc.
Country risk: political risk – government intervention in companies operation and performance caused by political, legal and economic environment in a foreign country, Venezuela – Exxon Mobil example
Currency risk: adverse fluctuation in exchange rates causing the foreign denomination to rise sharply, or inflation, etc.
Commercial risk: potential loss or failure from poorly developed or executed business strategies or procedures
Advantage of Internationalization:
Developing new business opportunities
Access to foreign knowledge base
Reduce poverty - China
Disadvantage of Internationalization:
Loss of sovereignty – ability to govern own affairs: Wal-Mart, Coca Cola, Sony;
Complex business structures, either centralized or decentralized
Commitment of substantial funds
Sharing of technical know-how
Exchange Currency
Offshoring or outsourcing – results in job losses
Effect on the poor – child labor: 250 million around the world (Nike, sweat shops)
Effect on natural environment
Effect on national culture – McDonaldization, Coca-Colonization – erosion of local traditions, appetite for “Western” products – across the world the same habits: Hollywood
Participants of international business:
Focal firms – initialize international business transaction
Born Global firms – initiates international business very early, more adaptable to internationalization, despite limited funding – producing true international products
MNE – large companies with substantial resources, performing various international businesses through a network of subsidiaries located in multiple countries (170 located in the US, 70 in Japan, 35 in Germany)
SME – 500 or fewer employees – responsible of 25% of export from Europe and N. America
Freight forwarder: specialized logistics services – arrange international shipping
Logistics Service Provider: DHL, FedEx, UPS, etc.
Foreign distributor: foreign market-based intermediary that works under contract for an exporter – clearing products through customs, local advertising and distribution of products
Trading Companies: intermediary that engages in import and export of commodities (Cargill, Minneapolis, MN – 50 billion USD annually in sales, privately owned)
Theories of International Trade:
Absolute Advantage Principle: Adam Smith: 1776 - A country benefits by producing only those products in which it has absolute advantage, or can produce using fewer resources than another country. The country gains by specializing in producing those products, exporting them, and then importing the products it does not have an absolute advantage in producing.
Comparative advantage: David Ricardo: 1817 - It can be beneficial for two countries to trade without barriers as long as one is more efficient at producing goods or services needed by the other. What matters is not the absolute cost of production, but rather the relative efficiency with which a country can produce the product.
Competitive Advantage of Nations: Michael Porter: 1980 - the competitive advantage of a nation is dependent upon the collective competitive advantages of its firms. Over time, this relationship is reciprocal: the competitive advantages held by the nation tend to drive the development of new firms and industries with these same competitive advantages.
Porter’s Diamond Model: explains competitive advantage at the firm and nation levels as stemming from the presence and quality in the country of the following four major elements – Firm Strategy, Structure, and Rivalry / Factor Conditions / Demand Conditions / Related and supporting Industries
Industrial Cluster: A concentration of businesses, suppliers, and supporting firms in the same industry at a particular location, characterized by a critical mass of human talent, capital, or other factor endowments (Silicon Valley, Fashion Industry - Northern Italy)
International Value chain: A value chain is a chain of activities. Products pass through all activities of the chain in order and at each activity the product gains some value. The chain of activities gives the products more added value than the sum of added values of all activities! (Dell corporation)
Cultural Environment of International Business:
The challenge of crossing cultural boundaries- different cultural environments characterized by foreign languages and different values.
Culture refers to the learned, shared, and enduring orientation patterns in a society. People demonstrate their culture through values, ideas, attitudes, behaviors, and symbols.
Ethnocentric orientation: refers to a home-country mind-set
Polycentric orientation refers to a host-country mindset
Geocentric orientation refers to a global mindset where the manager is able to understand a business without regard to country boundaries
Low-context cultures rely on elaborated verbal explanations, putting much emphasis on spoken words (Europe, N. America)
High-context cultures emphasize nonverbal communications and a more holistic approach to communication that promotes harmonious relationships (Japan, China)
Monochronic cultures tend to exhibit a rigid orientation to time in which the individual is focused on schedules, punctuality, and time as a resource (US, Canada, Germany)
Polychronic cultures refer to a flexible, non-linear orientation to time in which the individual takes a long-term perspective and is capable of multi-tasking (Asia. Latin America, Middle East)
Stereotypes: are generalizations about a group of people that may or may not be factual, often overlooking real, deeper differences. (Latin Americans tend to procrastinate)
Government Interventions:
Protectionism refers to national economic policies designed to restrict free trade and protect domestic industries from foreign competition
Government intervention arises typically in the form of tariffs (duty), nontariff trade barriers (e.g. quota), and investment barriers (target FDI).
Governments impose trade and investment barriers to achieve political, social, or economic objectives.
Tariff (duty) - tax imposed by a government on imported products, thus increasing the cost to the customer
Quota - a quantitative restriction placed on imports of a specific product over a specified period of time
Investment barriers target FDI thus restricting foreign firm operations
National security - Countries impose trade restrictions on products viewed as critical to national defense and security, such as military technology and computers
National culture and identity - Governments seek to protect certain occupations, industries, and public assets that are considered central to national culture and identity- prohibit certain imports (Swiss – watch making)
International Monetary Environment:
Foreign exchange refers to all forms of money that are traded internationally
Foreign exchange market is the global marketplace for buying and selling currencies (~ 175 currencies) — mainly by banks and governments
Trade deficit refers to the amount by which a nation's imports exceed its exports for a specific period of time
Trade surplus is the amount by which a nation's exports exceed its imports for a specific period of time
Devaluation- government action to reduce the official value of its currency relative to other currencies (encourage foreign investors among other reasons, etc.), it specifically implies an official lowering of the value of a country's currency within a fixed exchange rate system. The opposite of devaluation is called revaluation.
Depreciation is used for the unofficial decrease in the exchange rate in a floating exchange rate system. The opposite of devaluation is called appreciation.
Exchange rate- the price of one currency expressed in terms of another- is constantly changing
Eurodollars: deposits denominated in US dollars at banks outside the United States, and thus are not under the jurisdiction of the Federal Reserve.
Fixed exchange rate, sometimes called a pegged exchange rate, is a type of exchange rate system wherein a currency's value is matched to the value of another single currency or to a basket of other currencies, or to another measure of value, such as gold.
A fixed exchange rate is usually used to stabilize the value of a currency, against the currency it is pegged to. This makes trade and investments between the two countries easier and more predictable, and is especially useful for small economies where external trade forms a large part of their GDP. It can also be used as a means to control inflation. However, as the reference value rises and falls, so does the currency pegged to it. Fixed exchange rates may be preferable for their greater stability and certainty. (China)
Floating exchange rate or fluctuating exchange rate is a type of exchange rate system wherein a currency's value is allowed to fluctuate according to the foreign exchange market. The exchange rate system of floating currencies may more technically be known as a managed float - allowing a currency price to float freely between an upper and lower bound, a price "ceiling" and "floor. (USA)
Bonds are debt instruments that allow the borrower to raise capital by promising to repay the principal with interests on a specified date
Hedging is the use of financial instruments to manage exposure to currency risk
World's currency: only 8 percent of the world's currency exists as physical cash.
Direct quote: number of units of the domestic currency needed to acquire one unit of foreign currency, known as the normal or American quote. The teller might say, “It will cost you $1.30 to buy €1."
Indirect quote: the number of units of the foreign currency obtained for one unit of the domestic currency, known as the reciprocal or European term. The teller might say, “For $1.00, you can buy €0.74.”
Currency Traders:
Hedgers, who seek to minimize the risk of exchange-rate fluctuations by buying forward contracts or similar financial instruments.
Speculators, who seek profits by investing in currencies, and expect them to rise in value in the future.
Arbitragers, who buy and sell the same currency in two or more foreign exchange markets to take advantage of differences in the currencies exchange rate.
Regulating Exchange Rates:
Since dollar exchange rates are set on the open market, the Government can only indirectly impact exchange rates. (In countries, like China, where the rate is fixed, the government can directly change the rate.) The most direct way is by raising the Fed Funds Rate, which increases interest rates throughout the banking system, reduces the supply of money, and makes the dollar stronger relative to other currencies. If the Fed lowers the Funds rate, then of course the opposite occurs, and the dollar becomes weaker.
The Treasury Department can also print more money, which increases the supply, weakening the dollar. It can also borrow more money from other countries, known as selling Treasury notes. This not only increases the supply of money, but it also increases the debt, both of which weaken the dollar.
Euro appreciation: If the euro/dollar exchange rate goes from one euro equals $1.25 to a new rate of one euro equals $1.50 → due to increased demand for Euros or decreased supply of Euros, the euro becomes expensive to U.S. customers, and fewer BMWs will be sold.
Euro depreciation: If the euro/dollar exchange rate goes from one euro equals $1.25 to a new rate of one euro equals $1.00 → the euro then becomes cheap to the U.S. consumer, and more BMWs will be sold.
Factors that influence the supply and demand for a currency: (1) economic growth, (2) interest rates and inflation, (3) market psychology, and (4) government action.
How exchange rates are determined:
In a free market, the “price” of any currency (rate of exchange) is determined by supply and demand.
o The greater the supply of a currency, the lower its price
o The lower the supply of a currency, the higher its price
o The greater the demand for a currency, the higher its price
o The lower the demand for a currency, the lower its price
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