Managing Multinational

8/18/2019 Managing Multinational

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CHAPTER 2

THEORIES OF INTERNATIONAL TRADE

Trade theories facilitate in understanding the basic reasons behind the evolution of a country as a supply base or market for specific products. They also offer an insight, both

descriptive and prescriptive, into the potential product portfolio and trade patterns.

1. Theory of Mercantilism.

● Attributes and measures the wealth of a nation by the size of its accumulated

treasures.

● Aims at creating trade surplus which in turn contributes to the accumulation of

a nation’s wealth.

● Restriction on imports through tariff and quotas and promotion of export by

subsidising production.

● Greatly assisted and benefited the colonial powers in accumulating wealth.

● This is the raison d’etre behind the import substitution strategy adopted by

many before the economic liberalisation

● Now in neo - mercantilism, aim is creating favorable trade balance. Eg Japan.

● Is the theory valid still ? A qualified yes. Equate political power with economic

power with a trade surplus as in case of Japan.

Limitations: ● Trade is win - lose game and hence no contribution to the global wealth. Thus

International trade remains a zero - sum game.

● Acc to David Hume’s Price - Specie - Flow doctrine, a favorable balance of

trade is possible only in short run and would automatically be eliminated in the

long run.

● If all follow this, would result in highly restrictive environment of international

trade.

● Focuses on gold and overlooks other factors in nation’s wealth such as

natural resources, manpower and its skill levels, capital etc.

● Used by colonial powers for exploitation. Colonies remained poor.

2. Theory of Absolute Advantage :

● An absolute advantage refers to the ability of a country to produce a good

more efficiently and cost effectively than any other country.

Chetan Prakash Jain. S 017, Comprehensive notes on Managing Multinational Enterprises, FMS (Exe) 4th


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● Adam Smith emphasised productivity and advocated free trade as a means

of increasing global efficiency in his treatise : An Inquiry into the Nature and

Causes of the Wealth of Nations, 1776.Based on theory of laissez faire and

advocated that the Governments should not interfere.

● Instead of producing all products, each country should specialise in producing those goods that it can produce more efficiently.

● It could be Natural : Cheap labour in India and China; or Acquired : Software

in India.

● Trading is not a Zero - sum game. Both countries mutually benefit as a result

of efficient allocation of their resources

3. Theory of Comparative Advantage:

● Promulgated by David Ricardo in Principles of Political Economy and

Taxation. This model examines differences in the productivity of labor (due

to differences in technology) between countries.

● In this, a country benefits from international trade even if it is less efficient

than other nations in the production of two commodities,

● Comparative Advantage is defined as the inability of a nation to produce one

good more efficiently than other country but ability to produce that good more

efficiently than any other good.

● Thus a country should specialise in production and export of a commodity in

which the absolute disadvantage is less than that of another commodity. eg. US has a comparative advantage in computer production, Colombia has in

rose production.

● When countries specialise in production in which they have a comparative

advantage, more goods and services can be produced and consumed as a

result of which total world output increases.

● Balassa index is used to measure revealed comparative advantage.

● The main implications of the model are well supported by empirical evidence :

○ productivity differences play an important role in international trade.

○ comparative advantage (not absolute advantage) matters for trade.

Limitation of theories of specialisation :

● These lay emphasis on specialisation with an assumption that countries are

driven only by the impulse of maximisation of production and consumption.

Middle east countries pursue developing agricultural sector to attain self

reliance.



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● Specialisation in one commodity may result in efficiency gain. At times it's due

to synergies.

● It assumes full employment condition which is not valid.

● The other partner may forgo absolute gains to prevent relative losses.

● Overlooks : logistics costs, size of economy and production runs.● Little insight into type of products in which one can have an advantage.

● The model predicts that countries should completely specialise in production

which rarely happens as :

○ More than one factor of production reduces the tendency of

specialisation;

○ Protectionism

○ Transportation costs reduce or prevent trade.

4. Theory of Factor Endowment (HECKSCHER - OHLIN):

● It explains the reasons for differences in the commodity prices and

competitive advantage between two nations. In other words, this model

examines differences in labor, labor skills, physical capital, land, or other

factors of production between countries

● A nation will export the commodity whose production requires intensive use of

the nation’s relatively abundant and cheap factors and import the commodity

whose production requires use of the nation’s scarce and expensive factors.

● Thus, the pattern of trade are

determined by factor endowment rather than productivity.

● The Leontief paradox : US exported more labour intensive commodities and

imported more capital intensive products contrary to what H - O model

predicted.

● The model predicts that relative output prices and factor prices will equalise,

neither of which occurs in the real world. The model has less empirical

support.

5. Country Similarity theory:

● Staffan B Linder found that while Factor endowment theory explained trade

in natural resource based industries, in case of manufactured goods, costs

were determined by the similarity in product demands across countries rather

than by the relative production costs or factor endowments.

● Majority of trade occurs between nations that have similar characteristics.



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● Principles :

○ preference similarity

○ Similar demand pattern

○ proximity of geographical locations

6. International Product Life Cycle Theory (IPLC)

● It explains shifting of markets as well as the location of production.

● The level of innovation and technology, resources, size of market and

competitive structure influence trade patterns.

● Gap in technology, preference and the ability of customers in international

market also determine the stage of IPLC.

● Developed by Robert Vernon.

Four distinct identifiable phases :

● Introduction :

● Growth

● Maturity

● Decline.



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Eg : UK and bicycle

7. The NEW Trade Theory

● Trade not only to benefit from their differences but also to increase returns

which in turn enable them to benefit from specialisation

● It brings in the concept of economies of scale and the first mover advantage

to explicate the Leontief paradox.

● Higher economies of scale lead to increase in returns, enabling countries to

specialise in the production of such goods and trade with countries with

similar consumption patterns.

● It explains both intra-industry and intra-firm trade.

8. Theory of Competitive Advantage :

● Propounded by Michael Porter in ‘The Competitive Advantage of Nations ‘

● It concentrates on a firm’s home country environment as the main source of

competencies and innovations.

● As 4 determinants interact with each other, it is also known as Diamond

model. the Four determinants are :

Factor (input) conditions:● How well endowed a nation is as far as resources are concerned.

● HR, Capital, Natural

● Infrastructure : Administrative, information, technological

Demand Conditions:

● Sophisticated and demanding customers.

● Local customer needs that anticipate those elsewhere.

● Unusual local demand in specialised segment that can be served nationally

and globally.

Related and supporting industries:

● Access to capable, locally based suppliers and firms in related fields

● Presence of clusters instead of isolated industries.

Firm strategy, structure and rivalry:

● A local context and rules that encourage productivity,

● Incentive systems based on merit,

● Open and vigorous local competition esp among locally based rivals



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Determinants of Competitive Advantage

Implications of trade theories :

● Conceptual base for international trade and shifts in trade patterns and determinants

of competitiveness.

● Location implications : makes sense to disperse production activities to countries where they can be performed most efficiently.

● First mover implications: It pays to invest substantial financial resources in building a

first mover. or early mover advantage.

● Policy implications : promoting free trade is generally in the best interests of the

home- country, although not always in the best interests of the firm. Even though,

many firms promote open markets.



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CHAPTER 5 : WTO

WTO is the only international organisation that deals with global rules of trade between

nations. It provides a framework for conduct of international trade in goods and services. It

lays down rights and obligations of governments in the set of multilateral agreements and also covers IPR, dispute settlement etc. It came into existence on 1.1.95 as successor to

GATT. It is a member driven, consensus- based organisation.

WTO v/s GATT:

S.No

GATT WTO

1 Remained a provisionalagreement

The Commitments are permanent

2 Mainly to trade in goods Covers other areas such as services,IPR etc also

3 Had contracting parties Has members

4 No institutional foundation Has a Permanent institution with itsown secretariat

5 Could continue with domesticlegislation even if that violated aprovision of GATT

Not allowed under WTO

6 A number of provisions wereplurilateral and therefore selective

All the agreements are multilateral innature involving commitment of entiremembership.

7 Did not cover certain grey areassuch as agriculture, textiles and

clothing.

Such areas covered under WTO

8 Highly susceptible to blockages Has a Dispute SettlementMechanism



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Reasons for a country to join WTO

1. Need to individual bilateral trade agreements obviated if a country joins this

multilateral framework.

2. More likely to get better deal in multilateral agreements than in bilateral agreements.3. Can learn from other’s experiences and also influence decision making process in

WTO.

4. Dispute settlement system works as an inbuilt mechanism for enforcement of rights

and obligations of member countries.

5. WTO covers more than 98% countries. Would be odd to remain out of that.

Organisational Structure of WTO:

1. First level : The Ministerial Conference

2. Second level : General Council, Dispute Settlement body, Trade Policy

Review body

3. Third level: Councils for each broad area of trade. (Trade, Services,

TRIPS

4. Fourth level : Subsidiary bodies

Principles of the Multilateral Trading System under the WTO:1. Trade without discrimination : A country cannot discriminate between its trading

partners and products and services of it's own and foreign origin.

a. MFN treatment: In case a country grants someone a special favour (such as

lower rate of custom/import duty etc), then it has to do the same for all other

WTO member.

b. National treatment: It means giving others the same treatment as one’s own

nationals, i.e. imported and locally produced goods should be treated equally

at lease after the foreign goods have entered the market.

2. Gradual move towards freer market through negotiations

3. Increased predictability of international business environment

4. Promoting fair trade competition.

Doha Ministerial Conference : November 2001

The main commitments of Doha Declaration are :



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1. To continue the commitment for establishing a fair and market oriented trading

system through fundamental reform of support and protection of agricultural

markets, specifically through

a. Substantial improvement in market access.

b. Reduction of all forms of export subsidies with a view of phasing them out.c. Substantial reductions in trade distorting domestic support.

2. To give developing nations Special and Differential Treatment in negotiations to

enable them effectively to take into account their development needs

3. To ensure negotiations on trade in services aimed at promoting the economic

growth of all trading partners and the development of developing and least

developed countries.

4. To reduce or eliminate tariffs and non-tariffs barriers in non-agricultural markets, in

particular on products of export interest to developing countries.

5. Doha Development Agenda (DDA) is a ‘single undertaking’ that means nothing is

agreed until everything is agreed.

The WTO talks, named the Doha Round because they were launched in Doha, Qatar, are

stalemated over agricultural trade. Most other countries lay the main blame for the

impasse on the United States. U.S. negotiators have tabled a proposal that is widely seen

as requiring little or no actual policy change by the United States, particularly with respect to trade distorting subsidies paid to certain U.S. farm sectors, while asking for wide and

deep market opening by its trading partners. The majority of countries, including most of

the developing world and the European Union, have been unwilling to agree to what they

see as maximum concessions by themselves in return for minimal concessions by the

United States. More significantly, other countries have refused to make offers to open their

markets for services and manufactured goods until they know the outlines of an

agricultural deal.

The claim that developing country agricultural markets are closed to U.S. exports and must

be pried open during the Doha Round is simply not supported by the facts.

The European Union has signaled that it is prepared to improve its offer to open its

agricultural markets from a current proposal of tiered tariff reductions that would produce

an overall average cut of 39 percent to a more ambitious formula that would yield an

average cut of about 50 percent. This level of cuts by the EU would be unprecedented in



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world trade negotiations and would put pressure on other wealthy countries to agree to do

the same. Developing countries have offered to cut their own tariffs, on average, by about

55 percent of the reductions offered by the developed world. If their legitimate concerns on

special products are met, it is quite possible that they would agree to an overall formula of

tariff cuts that is somewhat more ambitious. An agricultural trade package along these lines

The trend in the current world economy is that of improvement in bilateral and

regional/interregional agreements between countries and regional organizations. These

agreements have shaped global trade as a whole. More precisely, these agreements

provide a rational way for countries and regional organizations to break out of the

stagnancy in the Doha round negotiations.

There are two implications which need to be overcome by the WTO and regional

organizations, they are as follows: first, regional organizations need to develop a flexible

framework in order to manage and monitor economic agreements within their regions.

Second, these regional/inter-regional agreements need to be harmonized by regional

organizations and related countries in order to complement the WTO multilateral trading

system. There is a possibility that these regional/inter-regional agreements will create a

synergy with the WTO multilateral trading system.

Nairobi :

10th WTO Ministerial Conference adopted Nairobi Package

The five-day long 10th World Trade Organisation (WTO) Ministerial Conference concluded

on 19 December 2015 in Nairobi, Kenya. The conference concluded with the adoption of

the Nairobi Package that is aimed at benefitting organization’s poorest members.

The conference was attended by trade ministers of 162 member countries of the WTO.

India was represented by Minister of State (Independent Charge) for Commerce & Industry

Nirmala Sitharaman. It is for the first such meeting hosted by an African nation.

The Nairobi Package contains a series of six Ministerial Decisions on agriculture, cotton

and issues related to least-developed countries. These include

1. Agriculture



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Developing country members will have the right to have recourse to a special safeguard

mechanism (SSM) for agricultural products.

Members shall engage constructively to negotiate and make all concerted efforts to agree

and adopt a permanent solution on the issue of

public stockholding for food security purposes.

In relation to agricultural products, developed members shall immediately eliminate their

remaining scheduled export subsidy entitlements, while developing country members

shall eliminate their export subsidy entitlements by the end of 2018.

2. Cotton

The decision related to cotton includes three agriculture elements viz., market access,

domestic support and export competition.

On market access, the decision calls for cotton from LDCs to be given duty-free and

quota-free access to the markets of developed countries — and to those of developing

countries declaring that they are able to do so — from 1 January 2016.

The domestic support part of the cotton decision acknowledges members' reforms in their

domestic cotton policies and stresses that more efforts remain to be made.

On export competition for cotton, the decision mandates that developed countries prohibit

cotton export subsidies immediately and developing countries do so at a later date.

3. LDC Issues

The Ministerial Conference adopted a decision that will facilitate opportunities for

least-developed countries' export of goods to both developed and developing countries

under unilateral preferential trade arrangements in favour of LDCs.

On the services front, the conference decided on implementation of preferential treatment

in favour of services and service suppliers of Least Developed Countries and increasing

LDC Participation in services trade.

4. Expanded Information Technology Agreement (ITA)



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Along with the above decisions, the conference agreed on the timetable for implementing

a landmark deal to eliminate tariffs on 201 information technology products valued at over

1.3 trillion US dollars per year.

Negotiations on the expanded ITA were conducted by 53 WTO members, including both

developed and developing countries, which account for approximately 90 per cent of world

trade in these products.



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CHAPTER 11

MODES OF INTERNATIONAL BUSINESS EXPANSION

Five stages of Internationalisation: follow a gradual pattern.UPPSALA MODEL:

1. Domestic operation and marketing activities,

2. Infrequent exports

3. Exports through independent representatives or agents

4. Establishment of Sales subsidiaries

5. Foreign production and manufacturing..

Three types of Expansion modes :

1. Trade related

2. Conractual

3. Investment

Factors :

1. Ability and willingness to Commit resources in the target country

2. Magnitude of Risk the firm is willing to take,

3. Types of Return anticipated,

4. Extent of Control to be exerted,

5. Level of Externalisaiton of the firm’s resources,6. Desired Flexibility of expansion mode.

Strategic trade offs in selecting international business expansion modes :



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TRADE RELATED MODES:

A. Exports :

1. Exports :

a. Manufacturing goods in the home country or a third country and shipping

them for sales to a country other than the country of production.

b. Most common initial mode of entry, involving lower risks and is a low cost and

simple mode of entry.

c. Strategic option to dispose off surplus productions.

d. Suitable for

i. assessing potential for new markets.

ii. markets with small potential or infrequent demand pattern

iii. markets with uncertainities.

2. Indirect Exports:a. Through an export intermediary based in its home country

b. not required to deal with hassles of export operations, needs little international

experience and much less resource commitment.

c. low cost opportunity to test products in the international markets.

d. Limitations:

i. Feedback from customers limited



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ii. Part with relatively higher share of its profit margins

iii. Little insight into the markets

iv. Does not develop its own contacts with buyers.

e. through Agents in the home country- Importers buying agents, buying

offices, Merchant intermediaries (Merchant exporter, International trading companies, Trading/ export houses)

3. Direct Exports :

a. Without any market intermediary in the home country

b. Advantages:

i. Higher share of profit

ii. collects marketing intelligence

iii. develops skills for export operations

iv. established rapport and brand image because of direct contact.

c. Agents (in host country): Merchant importers, Distributors etc.

B. Piggybacking :

● Expanding business in foreign country by using the distribution network of another

company, termed as piggybacking or complementary exporting.

● Exporting firm ‘rides’ at the back of the ‘carrier’.

● gets immediate access with little investment.

● used for related but non-competitive products of unrelated companies.● Eg : Fiat and Tata Motors, Wrigley with Parry’s confectionary.

C. Countertrade:

● Various forms of trade arrangements wherein the payment is in the form of

reciprocal commitments for other goods or services rather than an exclusive

cash transaction.

● trade financing and price setting are tied together in a single transaction

Advantages :

1. Opportunity to access the market that do not have the capability to pay in hard

currency.

2. Trade opportunity with restrictive market

3. Facilitates higher capacity utilisation

4. established long term relationship with international buyers.



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5. Effective instrument for industrial growth in countries with foreign exchange

constraints

6. Increase profit and market share

7. For importer :effective source of finance

8. conservation of foreign exchange, coping with statutory requirements related to foreign currency

9. Reduces debt liability.

Major forms of Countertrade :

No use of money:

1. Simple Barter :

2. Clearing Arrangements: transaction of goods and services extends over a long

time.

3. Switch Trading: A third party known as the switch trader is involved in the

transaction which facilitates buying of unwanted goods from the importer and

making payment either by cash or barter to the exporter.

Involves use of money:1. Counter purchase : involves two separate transactions payable in hard currency

each with its own cash value. (Brazil exports vehicles, steel to Oil countries for Oil)

2. Buyback (compensation): Output of equipment and plant sold is taken back.

3. Offset : Importer makes partial payment in hard currency, besides promising to

source inputs from the importing country and also makes investment to facilitate

production of such goods.

Eg. India and Iraq : Oil for wheat and rice barter deal.

Air India and Boeing .

Criticism of Countertrade:

1. Distorting effect on free market operations.

2. Importers have restricted choice,

3. Seldom improved BOP/foreign exchange problems of importing countries,

4. Often obsolete technology is dumped.



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D. E-modes of business expansion

CONTRACTUAL MODE OF EXPANSION

● Make use of strategic strengths ( Superior Technology, strong brand equity,

manufacturing facilities, established distribution networks )and resources of a

foreign based partner company for international business expansion

● Often complementary in nature and have mutually beneficial effect on a firm’s

overseas operations.

● Preferred under following circumstances:

○ Reluctance to invest considerable resource

○ High level of perceived / actual risk.

○ local partner can add considerable value to firm’s operations.

○ High tariffs on imported goods

○ Socio cultural differences

○ Policy restrictions prohibiting use of other business expansion modes such as investment.

MAJOR FORMS OF CONTRACTUAL MODE OF EXPANSION

1. International strategic alliance: When a firm agrees withe one or more than one

firm overseas, to carry out a business activity wherein each one contributes its

different capabilities and strengths to the alliance, this is termed as International

strategic alliance. Relationship is reciprocal, along horizontal lines and firms retain

their national and ideological identities while competing in markets excluded from

the partnership. Eg PHILIPS.

Advantages :

● Investment cost is shared

● Access to tangible and intangible resources of each other

● Reduction in individual risk

● Firms cooperate and even forces cooperation on competing firms.



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Limitations:

● Share internal resources and information

● Goal compatibility may lead to confilict

● Sharing resources may nurture future competitors

Eg Star Alliance in Airline industry, Ranbaxy with Nippon Chemiphar Ltd in Japan

2. International Contract Manufacturing:

● Strategic tool for economic development in a no of countries.

● Eg China produces for many companies and their products. Nike gets entire

manufacturing through this. Ranbaxy and Lupin got such contracts from foreign

companies.

3. International Management Contract:

● By providing its managerial and technical expertise on contractual basis

● Eg. Global Hyatt, Taj Hotels, Engineer India Ltd.

4. Turnkey Projects :

● By making use of its core competencies in designing and executing

infrastructure, plants or manufacturing facilities overseas.

● Eg Bechtel has completed more than 22000 such projects in more than 140

countries.



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5. International leasing:

● By leasing out new and used equipment to a manufacturing firm in such

countries which do not possess enough financial resources or necessary

foreign currency to pay for equipment and machinery

● International Lease Finance Corporation (ILFC) at Los Angles is the largest Aircraft lessor.

6. International licensing:

● A firm makes its intangible assets, such as patents, trademarks and

copyrights, technical knowhow and skills available to a foreign company for a

fee termed as royalty.

● Powerful tool for international expansion with little financial committment

● Eg Arrow , the shirt maker uses this strategy. Dr Reddy.

● It could be Process licensing or Trade-mark licensing.

● Cross licensing: In this companies swap their intellectual property for mutual

benefit.

● LIMITATION :

○ Maintaining product quality : could adversely affect brand image

○ Could restrict licensor’s future activities in the country.

○ may nurture a future competitor

7. International franchising:● Low risk, low cost business expansion mode enabling a firm to simultaneously

expand in many countries with little financial commitments.

● Four Characteristics :

○ Contractual relationship in which the franchisor licenses the franchisee

to carry out business under a name owned by or associated with the

franchisor and in accordance with a business format established by the

franchisor.

○ Control by the franchisor over the way the business is carried.

○ Provision of assistance throughout the period of contract.

○ Franchisee owns , provides capital and assumes risk

Advantages

● Facilitates rapid, low cost entry.

● Low investments and overheads

● Avoids day to day hassles of operation



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● Makes use of local entrepreneurs as business partners

● speedy transfer of tech and business skills

● access to well estd. products and brand names

● benefits from shared responisibility

● International market promotion helps the franchisee● legal independance

Widely used in fast food chains and hotel industry.

Limitations:

● Host country regulations,

● Identification of right partner,

● only fees and not profits

● lack of direct control over opertions.

● adverse effect on brand if quality is compromised

● Uncertainties and conflicts in receiving franchising fees.



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INVESTMENT MODES:

If a country is found to be attractive enough to justify a firm’s long-term commitment,

investment modes of expansion are often adopted. Its like shifting manufacturing

operations to foreign countries mainly for the reasons:● Effective response to market conditions.

● take advantage of host country’s incentives,

● gain acess to host country’s resources to be used as inputs,

● cost effective location

● manufacturing in close proximity to market,

● to circumvent trade restrictions and prohibitive import duties,

● to minimise logistics costs.

Major forms :

1. Overseas assembly or Mixing:

Manufacturer exports components, parts or machinery in Completely Knocked Down

(CKD) condition and asssembles these parts at a site in a foreign country. Also termed as

‘Screwdriver Operations’.

2. Joint ventures :

A firm shares equity and other resources with other partner firms to form a new

company in the target countryEg. Maruti Suzuki and GOI.

Benefits :

● Provide access where complete ownership is restricted,

● Access to complementary strengths,

● less investment as compared to complete ownership

● Higher returns than trade or contractual mode,

● Reduced risks,

● effectively overcome tariff and non tariff barriers

Limitations:

● Shared control,

● Future competitor,

● Management problems if culture differences are not taken care of,

● Trade secrets, know-how shared,

● Lack of flexibility as investment are long term.

Eg: Sony and Ericsson, very common in oil and gas industry.



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3. Wholly owned subsidiaries:

Besides ownership and control, wholly owned subsidiaries help the internationalising

firm protect its technology and skill from external sharing.Limitations :

● Commitment of large financial and other operational resources,

● High investment and therefore high risk,

● Requires considerable international experience and exposure to establish

one.

● Generally not allowed in vital and sensitive industrial sectors,

● Stricter scrutiny and operational norms,

● High vulnerability to criticism by various interest groups

MAJOR FORMS:

1. Greenfield operations:

● Creating production and marketing facilities on a firm’s own from

scratch. (Exapansion or re-investment in existing foreign affiliates or

sites is referred as BROWNFIELD INVESTMENT). Greenfield

investment is preferred in following situations:

● Right targets for M & A not avaiable,

● Financial constraints to Acquisition,● Incentives of the host country,

● Where international acquisitions are prohibited,

2. Mergers and Acquisitiins:

Transfer of existing assets of a domestic firm to a foreign firm lead to MnA.

Preferred over Greenfield for the following reasons:

● imp where speed of expansion is important,

● ready access to tangible and intangible assets,

● adds to operational efficiency overseas.

Could be 3 types :

1. Minority

2. Majority

3. Full outright stake

Eg, Lucent and Alcatel, P&G and Gillette.

Reasons for international acquisitions by Indian firms:

● Increase productivity levels to international standards,



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● profitability by economies of scale and scope,

● improve competitiveness in global market

● better access to foreign markets.

Eg. Tata Corus deal

STRATEGY

BASIC DECISION RULES FOR SELECTING MODE

1. Naive Rule

The firm uses same expansion mode for all markets ignoring heterogeneity of

different markets and conditions.

2. Pragmatic Rule

The firm enters a new market initially with a low risk entry mode. It looks for a

workable entry mode only if the initial entry mode is not feasible or profitable.

3. Strategy Rule

All alternative expansion modes are systematically compared and evaluated before

a decision is made.This rule helps maximize the profit contribution over the strategic

planning period subject to availability of resources, risks, and non- profit objectives.

MARKETING STRATEGY AND EXPANSION MODES

If in select few countries : Market Penetration

If simultaneously or in quick succession in many countries: Market skimming

Depending on : 1. Complexity of Business environment

2. Marketing Strategy,

the strategic options are indicated as under:



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SEQUENTIAL ADOPTION OF BUSINESS EXPANSION MODES



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Why should the firms go foreign ?

There are both organisational and environmental factors.

Organizational reasons are :

1. Exploiting world wide market imperfections : The essence of competitive advantage is a firm’s ability to create and sustain economic profits in an imperfect marketplace

for products (by producing differentiated products) and factors (looking for cheaper

inputs in foreign locations.)

2. Exploiting the opportunities that arise along the life cycle of a firm’s product.

Environmental or external reasons are :

1. Responding to the macro-economic imperatives for globalization :

a. Globalization of capital markets ;

b. Decline in costs of transport and communications;

c. Growth of regional and international trading arrangement.

2. Exploiting the competitive advantage of nations; as explained in Michael Porter’s

theory.

What are the two sets of idea that provide guidelines for firms in making their

foreign entry decisions ?

1. The theory of internalization based on the economics of transaction costs of

activities undertaken by the firm.

a. This theory of transaction cost economy (TCE)argues that transactions in

markets settings may be prone to friction and failure resulting in transaction

costs for firms undertaking them. Such transactions are more likely to entail

such costs are characterised by three attributes :

i. They have asset specificity : The assets involved in the transaction can

not be redeployed to alternative uses or users without loss in value;

ii. There is likelihood of a greater frequency of interactions between the

parties to the transaction and

iii. There is uncertainty surrounding the outcome of an arms - length

transaction.

The logic behind TCE is that the MNE will internalise (through FDI) when the

basis of its competitive advantage is derived from non-transferable sources

(tech, brand equity, R&D, innovation, IPR etc). In such instances it is likely



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that the exporting or licensing may not be effective in transferring the

competitive advantage.

2. The impact of the two environmental variables that are unique to the MNE, i.e.

Multiple Sources of External Authority (MA) and Multiple Denominations of Value

(MV).a. The sovereignty of a nation-state is embodied in its authority to influence

events within its legal territory and its choice to be relatively immune to

outside influences. This authority generally manifests itself in terms of laws

and regulatory institutions, political institutions, official language(s), norms of

behavior, culture. The MNE has exposure to multiple (often conflicting)

sources of external authority.There are three aspects of MA that merits

consideration:

i. The number of geographic locations that the firm operates in;

ii. The variance in country environments resulting from operating in

different geographic locations and

iii. The lack of a superstructure to mediate threats or opportunities that

arise at the intersections of the variances in country environments.

Therefore, when MA is high, the MNE should choose export of

contractual modes of entry and when MA is low, the MNE should choose the

DFI mode of entry.

b. Similarly, under MV (Multiple Denominations of Value) :which means the

firm’s cash flows are denominated in different exchange rates. This in turn,

results in three effects on the MNE: (1). “translation exposure”, which is the

problem of ex-post settling up and valuations already undertaken across

multiple currencies; (2) “transaction exposure” , which is the problem of

hedging known or anticipated cash flows against future exchange rate shifts;

and (3) “economic exposure”, which is the problem of the impact of

unanticipated changes in real exchange rates on the firm’s competitive

position.

MV, thus , has the opposite set of implications. When the degree of MV is

high, MNE would favor the DFI mode of entry , in order to take advantage of the

benefits from asset diversification. However, if MV is low, there is little value to asset

diversification and therefore, MNE would prefer export and contractual mode of

entry in order to avoid the costs of carrying excess capacity worldwide.



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CHAPTER 12

FOREIGN DIRECT INVESTMENT

FDI means acquiring ownership in an overseas business entity. Its management

dimensions distinguishes itself from portfolio investment. It is defined as an investment

involving a long - term relationship and reflecting a lasting interest and control by a

resident enterprise in one economy in an enterprise resident in an economy other than that

of the foreign direct investor.

It is less sensitive to fluctuations in forex. Returns from FDI are generally inform of profit

i.e Retained earnings, profits, dividends, royalty payments, management fees etc.

Importance :

● Largest source of external finance for developing countries.

● Role in development process of host economies,

● Role in enhancing exports of the host country,

● Helps enhance the competitiveness of domestic economy through tech transfer,

strengthening infrastructure, raising productivity and generating employment

opportunities.

● Can influence eco and political affairs

● modern form of economic colonialism and exploitation.● Preferred because : non- debt creating, non - volatile, and the returns depend on

the performance of the project financed by the investors.

● Superior as :

○ Longer term perspective, non volatile,

○ more likely to be used for improving productivity and not to finance

consumption,

○ more than just capital (tech, know - how and other skills) and thus have a

greater impact on economic growth.

Raison d’etre for FDI

● Cost of transportation,

● Liability of foreignness, eg Kelloggs in India and Disneyland in France,

Benefits of FDI:



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● Access to superior technology,

● Increased competition,

● Increase in domestic investment,

● Bridging host countries foreign exchange gaps.

Negative impact● Market monopoly

● Crowding out and unemployment effects,

● Technology dependence,

● Profit outflow,

● corruption,

● National security

Selection of FDI destination

● Cost of capital input,

● Wage rate,

● Taxation regime,

● Costs of inputs,

● Cost of logistics,

● Market Demand.

Types of FDI

1. On the basis of Direction of investment

a. Inward FDIb. Outward FDI (Direct Investment Abroad - DIA)

2. On the basis of type of Activity

a. Horizontal FDI : similar production activity

b. Vertical FDI : to provide inputs or to sell outputs

i. Backward Vertical FDI : extractive industries, BP and SHELL

ii. Forward Vertical FDI

c. Conglomerate FDI : manufacturing products not manufactured by the firm in

the home country

3. On the basis of Investment objective

a. Resource - seeking FDI

b. Market - seeking FDI

c. Efficiency - seeking FDI

4. On the basis of Entry Modes

a. Greenfield investments,

b. Mergers and Acquisitions



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5. On the basis of Sector

a. Industrial FDI : in manufacturing

b. Non industrial FDI : in services.

6. On the basis of Strategic Modesa. Export replacement

b. Export platforms

c. Domestic Substitution

THEORIES OF INTERNATIONAL INVESTMENT

1. Capital Arbitrage Theory

One of the earlier theories based on the belief that FDI takes place due to

differences in the rates of return on capital across countries. Based on the assumption that

the markets were perfectly competitive and the firms invest overseas as a form of factor

movement to benefit from differential profits.

Its more suitable for FPI where the returns on capital are crucial in the short term.

2. Market Imperfection Theory :

Various factors lead to imperfections in market. FDI is often employed as a strategic

tool to access restrictive markets with market imperfections and thus help in international

business expansion, by effectively bypassing the trade restrictions such as prohibitive

import tariffs and quotas. Eg, Japanese automobiles major establishing manufacturing facilities in US and Europe.

3. Internalization Theory :

A firm expands internationally in order to exploit its specific advantage or core

competencies in foreign markets. The firms try to protect such core competencies within

the organisation by way of investing in a foreign country in order to have control over its

overseas operations.

4. Monopolistic Advantage Theory:

It is the monopolistic advantages (also known as Firm Specific Advantage (‘FSA)

such as ‘superior knowledge’ and ‘economies of scale’ not possessed by competing firms

that justify investment in physical capital overseas. Two requirements :

● The advantage should outweigh the cost of operating in foreign country and

exposing itself to an alien business environment;



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● The firm should be able to enjoy such advantage only through control of

foreign operations by ownership rather than other low risk modes of business

expansion.

5. International Product Life Cycle Theory:

● Valid for both trade and investment pattern.● However doesn’t explain why investment is preferred than exporting or

licensing.

● Mainly applies to industrial FDI in manufacturing sector.

● Ignores revenue as it is cost-centered.

● Does not discuss opportunities when FDI is more profitable.

6. Eclectic Theory:

● By Prof Dunning.

● This (O, L, I) is a blend of macroeconomic theory of international trade (L) and

micro economic theories of the firm (O & I). It provides most comprehensive

explanation of FDI, integrating firm specific (O - Ownership factor), location

specific (L) and internationalization (I) advantages.

The ownership factor (O).

● Some core competencies or FSA such as intangible assets, tangible assets,

size, monopolistic advantages are specific to the firm.

● Though it incurs costs such as , Cost of foreignness (psychic distance,

unfamiliarity with market conditions, Differences in environment, increased expenses.

● The FSA lower its operational costs or earn higher revenues.

The location factor (L)

● Key determinant to its relative attractiveness as an investment destination.

● Advantages could be Economic, Socio- cultural, low psychic distance,

Political.

The internalisation factor (I)

● The firm attempts to internalise its operations to

○ protect its propriety knowledge from competitors

○ create and maintain monopolistic or oligopolistic power in the market,

○ protect itself against market uncertainties

MNEs also indulge in arbitraging government imposed market regulations.



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Chapter 13

Multinational Enterprise.

A business entity that operates in multiple (more than one) countries with effective control

over its operations by way of FDI.Critreri:

● Should own or control operations in multiple countries, typically across world.

● Should generate a substantial portion of its revenues by its operations from foreign

countries.

● Should employ workforce from multiple countries i.e. global employement.

● It should have a strategic management perspective and a vision of multinational

operations.

● A global company is characterised by a strong global positioning in terms of global

assets, capabilities, brands and its relative resilience to shocks and even to the

business cycle

TYPES OF MNE:

1. On the basis of investment :

a. Associates : An enterprise in which a non resident investor owns between 10

and 50%.

b. Subsidiaries: more than 50 %

c. Branches: Unincorporated wholly or jointly owned by a non resident investor.

2. On the basis of Operations:

a. Horizontally integrated MNE: manufacturing operations in differenent

countries producing same or similar products

b. Vertically integrated MNE: products of one operations serve as input for

other production,

c. Diversified MNEs: Either Horizontally or Vertically integrated.

3. On the basis of Management Orientation:

a. Ethnocentric firms:

i. HQs dominate the decision making which is centralised.

ii. Complex organisational structure at HQ and simple at subsidiaries.

iii. Home country expatriates dominate senior management.

iv. predominantly concerned with viability worldwide and legitimacy only in

its home country.



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b. Polycentric Firms :

i. High level of market orientation where subsidiaries have autonomy in

decision making

ii. Foreign affiliates are highly adapted to the market requirements and

cultures of countries of their operations,iii. Core decision making may be centrally integrated

iv. Concerned with legitimacy in all countries where it operates in, even if

that means some loss of profits..

c. Regiocentric Firms:

i. Foreign affiliates consolidate their decision making and organisatin on

regional basis.

ii. Regional offices have considerable autonomies with accountability to

the parent firm.

iii. the level of integration is high within the regions but NOT across the

region- offers operational advantage.

iv. Tries to balance viability and legitimacy at the regional level

d. Geocentric Firms:

i. Organisation more complex than any other.

ii. follows a collaborative approach in decision making between HQs and

subsidiaries.

iii. Universal standards for evaluation and control.

iv. Best workforce is employed for key positions from across the world.v. Tries to balance viability and legitimacy through a global networking of

its business

vi. Enclave: deals with high priority problems of host countries in a

marginal fashion.

Integrative: recognises that the MNE’s key decisions must b e

separately assessed for their impact on each country.

IMPACT OF MNEs ON HOST ECONOMIES:

Positive effects :

1. Bring in FDI : leading to industrial and economic development

2. Transfer of technology, managerial skills and marketing strategises which have a

favorable impact on overall industrial growth.

3. Promote Competition :



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4. Promote R & D

5. Benefit Customers

6. Promote exports in the Host economies : along with import substitution.

Negative effects :

1. Influencing host country’s Govt. decisions.

2. Transfer of inappropriate technology.

3. Dumping of obsolete technology

4. Cultural Imperialism

Eg: McDonaldisation of eating habits in many countries.

Walt Disney’s failure in French EuroDisney is a classic case of French resistance to

‘American cultural Imperialism’ .

5. Exploitation of host country’s resources

6. Perceived as agents of neo colonialism

7. Promotes unhealthy market competition

8. Promotes hostile M & A.

9. Crowding out domestic enterpreneurship

10. Limited benefits to Host country mainly on BOP position, supporting

industries and supplieres may not benefit if the MNE is vertically integrated

11. Circumventing host country’s regulatory framework : use of transfer pricing

to avoid tax payments.



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CHAPTER 14

INTERNATIONAL MARKETING

It has assumed importance not only for operating in international market, but also as a pre-condition for success in operating domestically because the home market has now

become export market as a result of liberalization. Focus has shifted from selling to

customer needs. Procuring a new customer costs 5X than retaining one. Costs 16 X more

to bring a new customer to the same level of profitability as the lost customer.

Thus IM can be defined as ‘the performance of business activities, designed to plan, price

promote and direct the flow of a company’s goods and services to customer or users in

more than one nation for a profit’.

IM would involve :

● Identifying needs and wants of customers in International Markets,

● Taking marketing mix decisions related to product, pricing, distribution and

communication, keeping in view the diverse consumer and market behaviour across

different countries on one hand and firms’ goals towards globalisation on the other,

● Penetrating into International Markets using various modes of entry and

● Taking decisions in view of dynamic IM environment.

FRAMEWORK OF IM :

● Setting Marketing objectives :● Market Identification Segmentation and Targeting:

○ Use a reactive or a pro-active approach

○ Use of direction and composition of trade statistics to see cross country

comparison of market size and its growth rate

○ Market Size = GDP (production) + Value of imports of G&S -Value of exports

of G&S

○ Segmentation should be measurable, sustainable, accessible, differentiable

and actionable. On the basis of geography, demographic factors such as

income, age, gender etc, psychographic profiles, marketing opportunity,

marketing attractiveness

● Entry Mode Decisions

○ Trade :Exports : low investment, less risky, for small and mid-sized companies

with resource constraints;

○ Contractual

○ Investment mode.



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● IM Marketing Mix Decisions:

○

○ 4Ps - Controllable factors

○ Uncontrollable factors : Environmental - Social, cultural, political, legal and

cultural

1. Product Decisions:

○ Components of product : Core Component, Packaging component, and Augmented component.

Product Standardisation

○ refers to marketing a product in the overseas market with little change except

for some cosmetic changes such as modifying packaging and labelling. eg

heavy Plants and Machinery, products with global appeal (Big Mac etc).

○ Benefits :

■ Global Product image,

■ Catering to global customers,■ Cost savings on ac of economies of scale,

■ Economy in design and monitoring.

■ Facilitates in designing the product as a global brand.

○ Factors favouring

■ High level of technology- intensity : maintains international standards

and reduce confusion,

■ Formidable adaptation costs,

■ Convergence of customer needs worldwide (MTV, MacD, Levi’s jeans,

■ Country - of - origin impact, (electronics from Japan, fragrance from France, Software from India etc)

Product Adaptation

○ Refers to making changes in the product in response to the needs of the

target market is termed as Product Adaptation or Customisation.

○ May vary from major modification to minor alterations in its packaging, logo or

brand name.



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○ Benefits:

■ tap markets which were not accessible due to mandatory requirements,

■ competitively fulfills customer needs and expectations in varied cultural

environment,

■ facilitates gaining market share,■ increased sale leads to scale economies.

○ Mandatory factors favouring Product Adaptation:

■ Government regulations, (ban on use of azo dyes in Europe requires

use of natural dyes in all products, Made in China idols of Ganesha,

Durga …)

■ Standards of electric current,

■ Operating systems,

■ Measurement systems,

■ Packaging and labelling regulations

○ Voluntary factors favouring Product Adaptation:

■ Customer Demographies : (Size in garments; Own attributes in Barbie

Doll)

■ Culture (Food items and clothing; Mac Burger; Camers sales boomed

with polaroid instant photography)

■ Conditions of use: (Nokia 1100 - anti slip grip, torchlight, dust

resistance cover, recently Motorola with shatter proof screen)

■ Price○ Trade- off strategy between Product Standardisation and Product Adaptation.

Product Launch: Depending upon market and the product attributes:

○ Waterfall approach :

The product trickle down in the international markets in a cascade manner

and

are launched sequentially.

Longer duration is available for a product to customise in a foreign market

before its is launched in another market.

More suitable for firms that have limited resources and who find it difficult to

manage multiple market simultaneously,

Can be carried out in a phased manner.

22 years for McD, 20 years to Coca Cola before they marketed overseas

○ Sprinkler approach:

Product is launched simultaneously in various countries. Preferred over

Waterfall approach in the following conditions:



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Highly competitive market,

Short life-cycle of the product.

High potential (size, growth, less entry cost) of the market

Resource and capability of the firm to manage multiple market

simultaneously.eg luxury fashion goods, IT software.

Branding Decisions: Quelch identifies 6 traits for a global brand:

○ Dominates the domestic market, which generates cash flow to enter new

markets.

○ Meets a universal consumer need,

○ Demonstrates universal consumer need,

○ Reflects consistent positioning worldwide,

○ Benefits from positive country-of-origin effect,

○ Focus is on the product category

2. Pricing Decisions :

● Only component of the Mix which is often adopted in international market with the

least commitment of the firm’s resources.

● Extremely significant for developing and least developed countries

● Approaches :

○ Cost based pricing

○ Full cost pricing

○ Marginal cost pricing:■ provides an alternate marketing outlet

■ as a tool to penetrate into International Markets

■ gets some contribution which the firm could have otherwise forgone

■ -ves: recovery of fixed cost required, anti dumping, trigger price wars,

and unrealistic low price quotations

○ Market based pricing

● Factors influencing Pricing Decisions:

○ Cost, Competition, Purchasing Power, Buyers Behaviour, Foreign exchange

fluctuations.

3. International Distribution Channels:

● May be defined as ‘a set of interdependent organisations networked together to

make the product or services available to the end consumer in international

markets’.

● More complex than domestic because of :



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○ Significant differences in the markets distribution systems

○ Selection in overseas market in more complex due to non familiarity.

○ Collecting information regarding same requires more resources both

managerial and financial.

○ Difficult to assess long term commitment of channel members● Types: Direct and Indirect (does not come in contact with overseas based market

intermediary).

4. Communication Decisions:

● Attempting to convey a set of messages to the target customers through some

channel in order to create a favourable response for their market offerings and

regularly receive market feedback.

● Involves advertising, direct marketing, personal selling, sales promotion, public

relations an trade fairs & exhibitions.

● Factor affecting selection of the communication mix are :

○ Market Size and Characteristics,

○ Cost and Resource availability,

○ Media availability,

○ Type of product and its price sensitivity,

○ Mode of entry in the International Market.

● Advertising:

○ Standardisation v/s adaptation○ Ad with no change: UCB

○ Ad with changes in illustration : in market segmented on the basis of

psychographic profile of the customers., cultural proximity of customers,

tech-insensitive or industrial product, similarity in marketing environment.

○ Advertising Adaptation : (AXE, Pepsi)

● Direct Marketing : Direct mailing, Door-to-door marketing, Multi-level marketing.

● Personal Selling:

● Sales promotion: use of short-term incentives to induce a purchase decisions.

● Public relations,

● International Trade fairs and exhibitions.

Factors influencing International Communication Decisions

● Culture : (Revital : daily health supplement in India, multivitamin supplement in

Nigeria).

● Language: (Honda -Fitta car renamed as Jazz, Tata Zica changed now)

● Education



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● Media infrastructure

● Government regulations.

Framework for International Product Promotion Strategies :

Keegan’s framework help us determine the appropriate Product Promotion Strategies

depending upon the Product function or need satisfied; the condition of product use; and

customer’s ability to buy.

Strategy Productfunction orneedsatisfied

Conditions ofproductuse

Abilityto buyproduct

Recommendedproductstrategy

Recommendedcommunicationsstrategy

Rankorderfromleasttomostexpensive

Productexamples

Straightadaptation

Same Same Yes Extension Extension

1 SoftDrinks

Product

extension-promotionadaptation

Differen

t

Same Yes Extension Adaptati

on

2 Bicycles,

Chewinggum,Reid &Taylor

Productadaptation-

promotionextension

Same Different Yes Adaptation Extension

3 Detergents,Electrical

appliances

Dualadaptation

Different

Different Yes Adaptation Adaptation

4 Clothing



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Developing newproduct

Same Different No Invention Developnewcommunications

5 WashingMachines



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CHAPTER 15

INTERNATIONAL FINANCE

1. INTERNATIONAL MONETARY SYSTEMS

a. Gold Standards :

Specie, Bullion and Exchange : Abandoned after Great Depressin of 1930.

b. Fixed Exchange Rates :

Bretton Woods Conference in July 1944. Gold exchange standard. This era

went

on till 1971, 15th August when US abandoned its commitment to conver the

US

dollar at fixed price of $35 per ounce. Followed by Smithsonian agreement in

Dec 1971. Finally abandoned in 1973

c. Floating Exchange Rate System:

Countries are reasonably insulated from the problems faced by other

countries.

2. CONTEMPORARY EXCHANGE RATE ARRANGEMENTS:

a. Floating Exchange Rate System : independently (clean) floating or

managed (dirty) floating.

b. Pegged Exchange Rate System: Pegging value of home currency to a

foreign currency or a basket of currencies.Soft pegs : Conventional fixed peg (fluctuates for at least 3 months with in a

band of less than 2 % or 1 % against another currency); Intermediate pegs (crawling

pegs and bands where peg is periodically adjusted)

Hard pegs : Currency board arrangements refer to a monetary regime based

on an explicit legislative commitment to exchange domestic currency for a specified

foreign currency at a fixed exchange rate. In some, there may not be any separate

legal tender and they use currency of a foreign country.

3. PREVAILING CURRENCIES AND MARKETS

a. US $ most important.

b. Eurocurrency: A currency deposited in a bank outside the country of its origin

is known as eurocurrency. The market for this has grown considerably over

the years.

4. DETERMINATION OF EXCHANGE RATES:



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a. Purchasing Power Parity Theory: Assuming non-existence of tariffs and

other trade barriers and zero cost of transport, the law of one price, the

simplest concept of PPP, states that identical goods should cost the same in

all nations. The equilibrium price rate b/w two currencies would be equal to

the ratio of price levels in two countries. Cross country comparison of the exchange rates of currencies may be carried out using the Big Mac Index and

CommSec iPod index.

b. Interest Rate Theories: Unlike the Price levels used in PPP theory, here

inflation rates are used in determining the exchange rates.

i. Fisher Effect Theory : (Nominal interest rate = Real interest rate +

Expected inflation rate).

ii. International Fisher Effect Theory : It’s a combination of PPP and FE

stating that the exchange rate movements are caused by interest rate

differentials which is an unbiased predictor of the future changes in the

spot rate of exchange.

5. FOREIGN EXCHANGE MARKET: Refers to the organised setting within which

individuals, businesses, governments and banks buy and sell foreign currencies

and other debt instruments

a. Types : Inter-bank or wholesale market and Retail market

b. Participants in the foreign exchange model: Traders, Hedgers and

Arbitragers.c. Exchange rate quotations : The value of one currency in the units of another

is known as Exchange Rate.

● Spot vs forward quote: The amount agreed for foreign exchange transaction

may be delivered either immediately (spot) or at a later date (forward)

● Direct vs indirect: Under direct, units of home currency per unit of a foreign

currency are quoted (Rs 68 per US $ 1.). Under indirect, units of foreign

currency per unit of home currency i.e. inverse of direct quote.

● Cross exchange rate : quoting exchange rates of two currencies without using

the US dollar as the reference point.

● Bid vs Ask.: The price at which a bank is willing to pay is called Bid, whereas

the price at which the bank is willing to sell the currency is known as Ask.

6. FOREIGN EXCHANGE RISKS AND EXPOSURE:

a. Foreign exchange risks refer to the variance of domestic currency value of

assets, liabilities, or operating income attributable to unanticipated changes in



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exchange rates (and not to unpredictability of foreign exchange rates).This

risk becomes dependent on foreign exchange exposure.

b. Foreign exchange exposure: Refers to the sensitivity of the real value of

assets, liabilities and operating income to unanticipated changes in exchange

rates expressed in its functional currencyThus forex risk is a function of variance both in unanticipated changes in

exchange rates and forex exposures. Three types of exposure :

● Transactional exposure : Effect of exchange rate fluctuations on the value of

anticipated cash-flows denominated in home or functional currency terms,

relating to transactions already entered into in foreign currency terms.

● Economic exposure: Effect on a firm’s future operating cash flows.

(operating exposure). Strategies to manage such exposure are leads, lags,

netting and matching.

● Translation exposure : or Accounting exposure arising due to conversion or

translation of the financial statements of foreign subsidiaries and affiliates

denominated in foreign currencies into consolidated financial statements of an

MNE in its functional or home currency.

c. Managing foreign exchange risk : Hedging is a common methodology in

foreign exchange management and refers to the avoidance of foreign

exchange risk and covering an open position.

● Forward contract : It is a commitment to buy or sell a specific amount of

foreign currency at a later date or within a specific time period and at an exchange rate stipulated when the transaction is struck.

● Future contract : It is a standardized contract that trades on organized future

markets for a specific delivery date only. Differences with forward contract are

as follows:

○ Has standardized round lots.

○ Date of delivery not negotiable,

○ International money markets or foreign exchanges issue future

contracts while forward contracts are issued by commercial banks.

● Options : It is an agreement between a holder (buyer) and a writer (seller)

that gives the holder the right, but not the obligation, to buy or sell the foreign

currency at the pre- determined price, unlike in a forward contract, if is is not

profitable. The price at which the option is exercised is known as the ‘Strike

price’. Call option (right to buy) - used to hedge future payable; Put option

(right to sell) - used to hedge future receivables.



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● Swap : Agreement to exchange one currency for another at a specified

exchange rate and date is termed as currency swap.

● Currency arbitrage : Buying a currency at a lower rate in one market for

immediate resale at a higher rate in another with an objective to make profit

from divergence exchange rates in different money markets is known as currency arbitrage.

d. Business Strategy to Manage foreign exchange fluctuations :

On appreciation of currency, goods become more expensive in foreign

markets whereas imported goods become cheaper. An increase in the domestic

price of foreign currency is referred to as depreciation, whereas the decline in the

domestic price of the foreign currency is termed as appreciation.

Different strategies to be adopted by the firm :

S.No

If domestic currency is weak If domestic currency is strong

1 Stress price benefits Engage in non-price competition byimproving quality, delivery, and after -sales service

2 Expand product lines and add

more costly features

Improve productivity and engage invigorous cost reduction

3 Shift sourcing and manufacturing

to the domestic market

Shift such to overseas

4 Exploit export opportunity in all

markets

Give priority to exports to relativelystrong - currency countries.

5 Conduct conventional cash-for-

goods trade

Deal with counter - trade with weakcurrency country

6 Use full costing approach, but use marginal-cost pricing to

penetrate new or competitive

markets

Cut profit margin and use marginal -cost pricing.

7 Speed repatriation of foreign-

earned income and collections

Keep the foreign earned income inhost country, slow collection.



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8 Minimise expenditures in local,

host country currency

Maximize expenditures in local, host-country currency.

9 Buy needed services in domestic

market

Buy needed services abroad and pay

for them in local currencies.

10 Minimise local borrowings Borrow money needed for expansionin local market.

11 Bill foreign customers in domestic

currency.

Bill foreign customers in their own

currency.

12

7. GLOBAL CASH MANAGEMENT :

Use a centralized system, a cash management centre (CMC)

8. MODE OF PAYMENT IN INTERNATIONAL TRADE:

The mode of payment differs widely, depending upon the nature of market

competition, type of products dealt in, creditworthiness of buyers and exporters’

relationship and experience with the importer. Various factors affecting the terms

include the risks associated, speed, security, cost, and the market competition.

Different modes are :

a. Advance payment:

b. Documentary credit: The payment collection mechanism that allows

exporters to retain ownership of the goods or reasonable ensures their

receiving payments is known as documentary collection. The bank acts as

the exporter’s agents. It has two principal documents :



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Bills of lading : issued by the shipping company to the shipper for accepting

the merchandise for the carriage and only its legitimate holder is entitled to claim

ownership of the goods covered therein on its surrender in original to the shipping

company at the destination.

Bill of exchange : It is an unconditional order in writing, signed by the seller (Drawn by the exporter) also known as the drawer, addressed to the buyer

(importer) or importer's agent (also known as drawee) ordering the importer to pay

on demand or at a fixed or determinable future date, the amount specified on its

face.It is used as an instrument to effect payment in international comeerce. It is

negotiable. Using a draft enables the exporter (beneficiary) to employ his bank as a

collecting agent.

This advising bank gets in touch with the importer through an issuing bank

which gives a letter of credit on behalf of the importer. Bills of lading and the bill of

exchange are given to the advising bank which sends them to the issuing bank

which after scrutiny releases payments to the advising bank / exporter. (It could be a

sight L/C or a usance L/C - time draft). Letter of Credit (L/C) may be irrevocable,

revocable or confirmed (confirmed by a bank in the exporter’s country which

commits itself to irrevocable make payments on presentation of documents under a

irrevocable L/C), unconfirmed, sight .

c. Term credit : A financial instrument used by the importer and during the

deferred time period, he can often sell the goods and pay the due amount with the sales proceeds.

d. Revolving : The amount involved is reinstated when utilized without issuing

another L/C.

e. Documentary credit without letter of credit:

f. Consignment Sales: The shipment of goods is made to the overseas

consignee and the title of goods is retained with the exporter until is finally

sold.

g. Open Account : Both the parties agree upon the sales terms without

documents calling for payments.

9. INTERNATIONAL TRADE FINANCE:

a. Banker’s Acceptance : It is the time draft or bill of exchange (a short term

debt instrument) drawn on and accepted by a bank. The bank buys

(discounts) the BA and pays the drawer (exporter) a sim less than the face

value of the draft followed by selling to an investor in the money market.



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b. Discounting: Exporters can convert their credit sales into cash by way of

discounting the draft even it is not accepted by the bank.

c. Accounts Receivables Financing : In an open account shipment or time

draft, goods are often shipped to the importer without assurance of payment

from a bank. Banks often provide loans to the exporter based on its creditworthiness secured by an assignment of the accounts receivable.

d. Factoring : It involves purchase of export receivables by the factor at a

discounted price. The factoring service could be undertaken with recourse or

without recourser to the seller. The factors assume the credit risks.

e. Forfeiting : It refers to the exporter relinquishing his / her rights to a

receivable due at a future date in exchange for immediate cash payment at an

agreed discount, passing all risks and the responsibility for collecting the debt

to the forfeiter. Generally, forfeiting is applicable in cases where export of

goods is on credit terms and the export receivables are guaranteed by the

importer’s bank. Its like converting a credit sale into a cash sale. For the

exporters, it improves liquidity, frees the balance sheet of debt, frees from

risks, and does not impact his borrowing limit, hedges against interest &

exchange rate risks,saves on insurance cost, etc

f. Letters of Credit

g. Counter- Trade : Combines trade financing and price setting in one

transaction.

10. EXPORT FINANCE :

a. Export Credit : pre and post shipment

b. Financing to overseas importers : Buyer’s credit, Line of Credit (exporter

country’s bank to an overseas bank / govt / institution to facilitate the import of

a variety of listed goods from the exporting country.

c. Credit risk insurance :

Additional

Forward and Future Contract

Fundamentally, forward and futures contracts have the same function: both types of

contracts allow people to buy or sell a specific type of asset at a specific time at a given

price.

However, it is in the specific details that these contracts differ. First of all, futures contracts



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are exchange-traded and, therefore, are standardized contracts. Forward contracts, on the

other hand, are private agreements between two parties and are not as rigid in their stated

terms and conditions. Because forward contracts are private agreements, there is always

a chance that a party may default on its side of the agreement. Futures contracts have

clearing houses that guarantee the transactions, which drastically lowers the probability of default to almost never.

Secondly, the specific details concerning settlement and delivery are quite distinct. For

forward contracts, settlement of the contract occurs at the end of the contract. Futures

contracts are marked-to-market daily, which means that daily changes are settled day by

day until the end of the contract. Furthermore, settlement for futures contracts can occur

over a range of dates. Forward contracts, on the other hand, only possess one settlement

date.

Lastly, because futures contracts are quite frequently employed by speculators, who bet

on the direction in which an asset's price will move, they are usually closed out prior to

maturity and delivery usually never happens. On the other hand, forward contracts are

mostly used by hedgers that want to eliminate the volatility of an asset's price, and delivery

of the asset or cash settlement will usually take place.



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CHAPTER 16

GLOBAL OPERATIONS AND SUPPLY CHAIN MANAGEMENT

Globalisation of operations:The force of globalisation, such as reduction in trade barriers, cheaper and easier means

of international transportation and communication, wage differential, and market saturation

in the home market on one hand and rapidly growing marketing opportunities overseas,

especially in emerging economies on the other, have led to expansion of operation on a

global scale. Globalisation of operations include :

● Global sourcing of inputs,

● Global production of goods and services,

● Global transportation of products,

● Global management of entire supply chain.

Offshoring :

Relocation of business processes to a low-cost location by shifting the task overseas is

termed as Offshoring. Particularly suitable for the following activities:

● Products at the maturity stage where technology becomes standardised and

widespread, requiring long production runs m

Managing Multinational

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