Chapter 10 - International Business - I

Introduction

 

• International business has entered into a new era of reforms. India too did not remain cut-off from these developments. India was under a severe debt trap and was facing crippling balance of payment crisis.

 

• In 1991, it approached the International Monetary Fund (IMF) for raising funds to tide over its balance of payment deficits. IMF agreed to lend money to India subject to the condition that India would undergo structural changes to be able to ensure repayment of borrowed funds.

 

• India had no alternative but to agree to the proposal. It was the very conditions imposed by IMF which more or less forced India to liberalize its economic policies. Since then a fairly large amount of liberalization at the economic front has taken place.

 

• Though the process of reforms has somewhat slowed down, India is very much on the path to globalization and integrating with the world economy. While, on the one hand, many multinational corporations (MNCs) have ventured into Indian market for selling their products and services; many Indian companies too have stepped out of the country to market their products and services to consumers in foreign countries.

 

 

 

Meaning of International Business

• Business transaction taking place within the geographical boundaries of a nation is known as domestic or national business. It is also referred to as internal business or home trade.

 

• Manufacturing and trade beyond the boundaries of one’s own country is known as international business. International or external business can, therefore, be defined as those business activities that take place across the national frontiers.

 

• It involves not only the international movements of goods and services, but also of capital, personnel, technology and intellectual property like patents, trademarks, know-how and copyrights.

 

• The other equally important developments are increased foreign investments and overseas production of goods and services. Companies have started increasingly making investments into foreign countries and undertaking production of goods and services in foreign countries to come closer to foreign customers and serve them more effectively at lower costs. All these activities form part of international business.

 

 

 

 

 

 

 

Reason for International Business

 

• The fundamental reason behind international business is that the countries cannot produce equally well or cheaply all that they need. This is because of the unequal distribution of natural resources among them or differences in their productivity levels. Availability of various factors of production such as labour, capital and raw materials that are required for producing different goods and services differ among nations. Moreover, labour productivity and production costs differ among nations due to various socio-economic, geographical and political reasons.

 

• The international business as it exists today is to a great extent the result of geographical specialization as pointed out above. Fundamentally, it is for the same reason that domestic trade between two states or regions within a country takes place. Most states or regions within a country tend to specialize in the production of goods and services for which they are best suited.

 

• Most developing countries which are laboured abundant, for instance, specialize in producing and exporting garments. Since they lack capital and technology, they import textile machinery from the developed nations which the latter are in a position to produce more efficiently.

 

 

 

 

 

 

International Business vs. Domestic Business

Key aspects in respect of which domestic and international businesses differ from each other are discussed below.

 

(I) Nationality of buyers and sellers: 

Nationality of the key participants to the business deals differs between domestic and international businesses.

In the case of domestic business, both the buyers and sellers are from the same country. This makes it easier for both the parties to understand each other and enter into business deals.

But this is not the case with international business where buyers and sellers come from different countries. Because of differences in their languages, attitudes, social customs and business goals and practices, it becomes relatively more difficult for them to interact with one another and finalize business transactions.

 

(ii) Nationality of other stakeholders:

Domestic and international businesses also differ in respect of the nationalities of the other stakeholders such as employees, suppliers, shareholders/partners and general public who interact with business firms.

While in the case of domestic business all such factors belong to one country, and therefore relatively speaking depict more consistency in their value systems and behaviors

Decision making in international business becomes much more complex as the concerned business firms have to take into account a wider set of values and aspirations of the stakeholders belonging to different nations.

 

 

 (iii) Mobility of factors of production:

 The degree of mobility of factors like labour and capital is generally less between countries than within a country. While these factors of movement can move freely within the country, there exist various restrictions to their movement across nations.

Apart from legal restrictions, even the variations in socio-cultural environments, geographic influences and economic conditions come in a big way in their movement across countries.

This is especially true of the labour which finds it difficult to adjust to the climatic, economic and socio-cultural conditions that differ from country to country.

 

(iv) Customer heterogeneity across markets:

Since buyers in international markets hail from different countries, they differ in their socio-cultural background.

Differences in their tastes, fashions, languages, beliefs and customs, attitudes and product preferences cause variations in not only their demand for different products and services, but also in variations in their communication patterns and purchase behaviors.

Such variations greatly complicate the task of designing products and evolving strategies appropriate for customers in different countries.

Though to some extent customers within a country too differ in their tastes and preferences. These differences become more striking when we compare customers across nations.

 

 

 

 

(v) Differences in business systems and practices:

The differences in business systems and practices are considerably much more among countries than within a country.

Countries differ from one another in terms of their socio-economic development, availability, cost and efficiency of economic infrastructure and market support services, and business customs and practices due to their socio-economic milieu and historical coincidences.

All such differences make it necessary for firms interested in entering into international markets to adapt their production, finance, human resource and marketing plans as per the conditions prevailing in the international markets.

 

(vi) Political system and risks: 

Political factors such as the type of government, political party system, political ideology, political risks, etc., have a profound impact on business operations.

 Since a business person is familiar with the political environment of his/her country, he/she can well understand it and predict its impact on business operations.

But this is not the case with international business. Political environment differs from one country to another. One needs to make special efforts to understand the differing political environments and their business implications.

Since political environment keeps on changing, one needs to monitor political changes on an ongoing basis in the concerned countries and devise strategies to deal with diverse political risks.

A major problem with a foreign country’s political environment is a tendency among nations to favor products and services originating in their own countries to those coming from other countries.

While this is not a problem for business firms operating domestically, it quite often becomes a severe problem for the firms interested in exporting their goods and services to other nations or setting up their plants in the overseas markets.

 

(vii) Business regulations and policies:

Coupled with its socio-economic environment and political philosophy, each country evolves its own set of business laws and regulations.

Though these laws, regulations and economic policies are more or less uniformly applicable within a country, they differ widely among nations.

Tariff and taxation policies, import quota system, subsidies and other controls adopted by a nation are not the same as in other countries and often discriminate against foreign products, services and capital.

 

(viii) Currency used in business transactions:

Another important difference between domestic and international business is that the latter involves the use of different currencies.

Since the exchange rate keeps on fluctuating, it adds to the problems of international business firms in fixing prices of their products and hedging against foreign exchange risks.

 

 

 

 

 

 

Scope of International Business

Major forms of business operations that constitute international business are as follows.

(I) Merchandise exports and imports: 

Merchandise means goods that are tangible, i.e., those that can be seen and touched. When viewed from this perceptive, it is clear that while merchandise exports means sending tangible goods abroad, merchandise imports means bringing tangible goods from a foreign country to one’s own country.

 Merchandise exports and imports, also known as trade in goods, include only tangible goods and exclude trade in services. 

 

 (ii) Service exports and imports: 

Service exports and imports involve trade in intangibles. It is because of the intangible aspect of services that trade in services is also known as invisible trade.

A wide variety of services are traded internationally.

 

(iii) Licensing and franchising: 

Permitting another party in a foreign country to produce and sell goods under your trademarks, patents or copy rights in lieu of some fee is another way of entering into international business.

Franchising is similar to licensing, but it is a term used in connection with the provision of services.

 

 

 

(iv) Foreign investments: 

Foreign investment is another important form of international business. Foreign investment involves investments of funds abroad in exchange for financial return. Foreign investment can be of two types: direct and portfolio investments.

            

 

Benefits of International Business

Benefits to Nations

(I) Earning of foreign exchange: 

International business helps a country to earn foreign exchange which it can later use for meeting its imports of capital goods, technology, petroleum products and fertilizers, pharmaceutical products and a host of other consumer products which otherwise might not be available domestically.

 

(ii) More efficient use of resources: 

International business operates on a simple principle —produces what your country can produce more efficiently, and trade the surplus production so generated with other countries to procure what they can produce more efficiently.

When countries trade on this principle, they end up producing much more than what they can when each of them attempts to produce all the goods and services on its own.

If such an enhanced pool of goods and services is distributed equitably amongst nations, it benefits all the trading nations.

 

 

(iii) Improving growth prospects and employment potentials: 

Producing solely for the purposes of domestic consumption severely restricts a country’s prospects for growth and employment.

Many countries, especially the developing ones, could not execute their plans to produce on a larger scale, and thus create employment for people because their domestic market was not large enough to absorb all that extra production.

 

(iv) Increased standard of living: 

In the absence of international trade of goods and services, it would not have been possible for the world community to consume goods and services produced in other countries that the people in these countries are able to consume and enjoy a higher standard of living.

 

Benefits to Firms

 

(I) Prospects for higher profits: 

International business can be more profitable than the domestic business. When the domestic prices are lower, business firms can earn more profits by selling their products in countries where prices are high.

 

(ii) Increased capacity utilization: 

Many firms setup production capacities for their products which
are in excess of demand in the domestic market.

Production on a larger scale often leads to economies of scale, which in turn lowers production cost and improves per unit profit margin.

 

(iii) Prospects for growth: 

Business firms find it quite frustrating when demand for their products starts getting saturated in the domestic market. Such firms can considerably improve prospects of their growth by plunging into overseas markets.

This is precisely what has prompted many of the multinationals from the developed countries to enter into markets of developing countries. While demand in their home countries has got almost saturated, they realized their products were in demand in the developing countries and demand was picking up quite fast.

 

(iv) Way out to intense competition in domestic market: 

When competition in the domestic market is very intense, internationalization seems to be the only way to achieve significant growth.

Highly competitive domestic market drives many companies to go international in search of markets for their products.

International business thus acts as a catalyst of growth for firms facing tough market conditions on the domestic turf.

 

(v) Improved business vision: 

The growth of international business of many companies is essentially a part of their business policies or strategic management.

The vision to become international comes from the urge to grow, the need to become more competitive, the need to diversify and to gain strategic advantages of internationalization.

 

Modes of Entry into International Business

 

1. Exporting and Importing

Exporting refers to sending of goods and services from the home country to a foreign country.

In a similar vein, importing is purchase of foreign products and bringing them into one’s home country.

There are two important ways in which a firm can export or import products: direct and indirect exporting/importing.

In the case of direct exporting/importing, a firm itself approaches the overseas buyers/suppliers and looks after all the formalities related to exporting/importing activities including those related to shipment and financing of goods and services. Indirect exporting/importing,

On the other hand, is one where the firm’s participation in the export/import operations is minimum and most of the tasks relating to export/import of the goods are carried out by some middle men such as export houses or buying offices of overseas customers located in the home country or wholesale importers in the case of import operations. Such firms do not directly deal with overseas customers in the case of exports and suppliers in the case of imports.

• Advantages
• As compared to other modes of entry, exporting/importing is the easiest way of gaining entry into international markets. It is less complex an activity than setting up and managing joint-ventures or wholly owned subsidiaries abroad.
• Exporting/importing is less involving in the sense that business firms are not required investing that much time and money as is needed when they desire to enter into joint ventures or set up manufacturing plants and facilities in host countries.
• Since exporting/importing does not require much of investment in foreign countries, exposure to foreign investment risks is nil or much lower than that is present when firms opt for other modes of entry into international business.
  

 

• Limitations

Major limitations of exporting/importing as an entry mode of international business are as follows:

• Since the goods physically move from one country to another, exporting/importing involves additional packaging, transportation and insurance costs. Especially in the case of heavy items, transportation costs alone become an inhibiting factor to their exports and imports. On reaching the shores of foreign countries, such products are subject to custom duty and a variety of other levies and charges. Taken together, all these expenses and payments substantially increase product costs and make them less competitive.
• Exporting is not a feasible option when import restrictions exist in a foreign country. In such a situation, firms have no alternative but to opt for other entry modes such as licensing/franchising or joint venture which makes it feasible to make the product available by way of producing and marketing it locally in foreign countries.
• Export firms basically operate from their home country. They produce in the home country and then ship the goods to foreign countries. Except a few visits made by the executives of export firms to foreign countries to promote their products, the export firms in general do not have much contact with the foreign markets. This puts the export firms in a disadvantageous position vis-à-vis the local firms which are very near the customers and are able to better understand and serve them.

 

 

 

Contract Manufacturing

Contract manufacturing refers to a type of international business where a firm enters into a contract with one or a few local manufacturers in foreign countries to get certain components or goods produced as per its specifications.

Contract manufacturing, also known as outsourcing, can take three major forms:

• Production of certain components
• Assembly of components into final products
• Complete manufacture of the products.

 

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Advantages

• Contract manufacturing permits the international firms to get the goods produced on a large scale without requiring investment in setting up production facilities. These firms make use of the production facilities already existing in the foreign countries.
• Since there is no or little investment in the foreign countries, there is hardly any investment risk involved in the foreign countries.
• Contract manufacturing also gives an advantage to the international company of getting products manufactured or assembled at lower costs especially if the local producers happen to be situated in countries which have lower material and labour costs.
• Local producers in foreign countries also gain from contract manufacturing. If they have any idle production capacities, manufacturing jobs obtained on contract basis in a way provide a ready market for their products and ensure greater utilization of their production capacities

 

• The local manufacturer also gets the opportunity to get involved with international business and avail incentives, if any, available to the export firms in case the international firm desires goods so produced be delivered to its home country or to some other foreign countries.

 

Limitations

The major disadvantages of contract manufacturing to international firm and local producer in foreign countries are as follows:

• Local firms might not adhere to production design and quality standards, thus causing serious product quality problems to the international firm.
• Local manufacturer in the foreign country loses his control over the manufacturing process because goods are produced strictly as per the terms and specifications of the contract.
• The local firm producing under contract manufacturing is not free to sell the contracted output as per its will. It has to sell the goods to the international company at predetermined prices. These results in lower profits for the local firm if the open market prices for such goods happen to be higher than the prices agreed upon under the contract.

 

 

Licensing and Franchising

• Licensing is a contractual arrangement in which one firm grants access to its patents, trade secrets or technology to another firm in a foreign country for a fee called royalty.

 

• The firm that grants such permission to the other firm is known as licensor and the other firm in the foreign country that acquires such rights to use technology or patents is called the licensee.

 

• It may be mentioned here that it is not only technology that is licensed. In the fashion industry, a number of designers license the use of their names. In some cases, there is exchange of technology between the two firms. Sometimes there is mutual exchange of knowledge, technology and/or patents between the firms which is known as cross-licensing.

 

• Franchising is a term very similar to licensing.

 

• One major distinction between the two is that while the former is used in connection with production and marketing of goods, the term franchising applies to service business.

 

• The other point of difference between the two is that franchising is relatively more stringent than licensing. Franchisers usually set strict rules and regulations as to how the franchisees should operate while running their business.

 

• Barring these two differences, franchising is pretty much the same as licensing. Like in the case of licensing, a franchising agreement too involves grant of rights by one party to another for use of technology, trademark and patents in return of the agreed payment for a certain period of time. The parent company is called the franchiser and the other party to the agreement is called franchisee.

 

• Advantages
• Under the licensing/franchising system, it is the licensor/franchiser who sets up the business unit and invests his/her own money in the business. As such, the licensor/franchiser has to virtually make no investments abroad. Licensing/franchising is, therefore, considered a less expensive mode of entering into international business.
• Since no or very little foreign investment is involved, licensor/franchiser is not a party to the losses, if any, that occur to foreign business. Licensor/franchiser is paid by the licensee/franchisee by way of fees fixed in advance as a percentage of production or sales turnover. This royalty or fee keeps accruing to the licensor/franchiser so long as the production and sales keep on taking place in the licensee’s/franchisee’s business unit.
• Since the business in the foreign country is managed by the licensee/franchisee who is a local person, there are lower risks of business takeovers or government interventions.
• Licensee/franchisee being a local person has greater market knowledge and contacts which can prove quite helpful to the licensor/franchiser in successfully conducting its marketing operations.
• As per the terms of the licensing/franchising agreement, only the parties to the licensing/franchising agreement are legally entitled to make use of the licensor’s/franchiser’s copyrights, patents and brand names in foreign countries. As a result, other firms in the foreign market cannot make use of such trademarks and patents.

 

• Limitations
• When a licensee/franchisee becomes skilled in the manufacture and marketing of the licensed/franchised products, there is a danger that the licensee can start marketing an identical product under a slightly different brand name. This can cause severe competition to the licenser/franchiser.
• If not maintained properly, trade secrets can get divulged to others in the foreign markets. Such lapses on the part of the licensee/franchisee can cause severe losses to the licensor/franchiser.
• Over time, conflicts often develop between the licensor/franchiser and licensee/franchisee over issues such as maintenance of accounts, payment of royalty and non-adherence to norms relating to production of quality products. These differences often result in costly litigations, causing harm to both the parties.
  

 

 

Joint Ventures

• Joint venture is a very common strategy for entering into foreign markets.

 

• A joint venture means establishing a firm that is jointly owned by two or more otherwise independent firms. In the widest sense of the term, it can also be described as any form of association which implies collaboration for more than a transitory period. A joint ownership venture may be brought about in three major ways:

       (I) foreign investor buying an interest in a local company

       (ii) Local firm acquiring an interest in an existing foreign firm

       (iii) Both the foreign and local entrepreneurs jointly forming a new enterprise.

 

 

 

• Advantages
• Since the local partner also contributes to the equity capital of such a venture, the international firm finds it financially less burdensome to expand globally.
• Joint ventures make it possible to execute large projects requiring huge capital outlays and manpower.
• The foreign business firm benefits from a local partner’s knowledge of the host countries regarding the competitive conditions, culture, language, political systems and business systems.
• In many cases entering into a foreign market is very costly and risky. This can be avoided by sharing costs and/or risks with a local partner under joint venture agreements.

 

 

• Limitations
• Foreign firms entering into joint ventures share the technology and trade secrets with local firms in foreign countries, thus always running the risks of such a technology and secrets being disclosed to others.
• The dual ownership arrangement may lead to conflicts, resulting in battle for control between the investing firms.

 

 

Wholly Owned Subsidiaries

• This entry mode of international business is preferred by companies which want to exercise full control over their overseas operations.

 

• The parent company acquires full control over the foreign company by making 100 per cent investment in its equity capital.

 

• A wholly owned subsidiary in a foreign market can be established in either of the two ways:

(I) Setting up a new firm altogether to start operations in a foreign country — also referred to as a green field venture, or

(ii) Acquiring an established firm in the foreign country and using that firm to manufacture and/or promote its products in the host nation.

 

• Advantages
• The parent firm is able to exercise full control over its operations in foreign countries.
• Since the parent company on its own looks after the entire operations of foreign subsidiary, it is not required to disclose its technology or trade secrets to others.

 

• Limitations
• The parent company has to make 100 per cent equity investments in the foreign subsidiaries. This form of international business is, therefore, not suitable for small and medium size firms which do not have enough funds with them to invest abroad.
• Since the parent company owns 100 per cent equity in the foreign company, it alone has to bear the entire losses resulting from failure of its foreign operations.
• Some countries are averse to setting up of 100 per cent wholly owned subsidiaries by foreigners in their countries. This form of international business operations, therefore, becomes subject to higher political risks.

 

 

India’s Involvement in World Business

• India is now the 10th largest economy in the world and the fastest growing economy, next only to China.
• As per the Goldman Sach Report 2004, India is poised to be the second largest economy by 2050. Despite these features, India’s involvement with international business is not very impressive.
• India’s share in world trade in 2003 was abysmally low i.e., just 0.8 per cent as compared to those of other developing countries such as China (5.9 per cent), Hong Kong (3.0 per cent), South Korea (2.6 per cent), Malaysia (1.3 per cent), Singapore (1.9 per cent), and Thailand (1.1 per cent).
• Even in respect of foreign investments, India has been considerably lagging behind other countries. The following sections provide an overview of the major trends and developments in India’s foreign trade and investments.

India’s Foreign Trade in Goods

• India accounts for a small share in world trade, its exports and imports constitute major economic activities for the country.
• Due to faster growth achieved at the external front, share of foreign trade in the country’s Gross Domestic Product (GDP) has considerably increased from 14.6 per cent in 1990-91 to 24.1 per cent in 2003-04.