IB Text Notes

Chapter 1
International Business: An Overview
Objectives
! Define international business and describe how it differs from domestic business.
! Explain why companies engage in international business and why its growth has
accelerated.
! Introduce different modes a company can use to accomplish its global objectives.
! Illustrate the role social science disciplines play in understanding the environment of
international business.
! Provide an overview of the primary patterns for companies’ international expansion.
! Describe the major countervailing forces that affect international business.
Chapter Overview
More and more foreign countries are becoming a source of both production and sales for many
firms. Chapter 1 examines the reasons for this, as well as the various modes used by firms to
engage in international business. The chapter describes the evolution of firm strategy as part of
the internationalization process, plus the countervailing forces that firms are likely to encounter
during that process. In addition, the elements of the external international business environment
are briefly introduced, prior to their being considered in detail in the following three chapters.
Chapter Outline
OPENING CASE: Star Wars: Episode II —Attack of the Clones
This case sets forth the global mindset of Lucasfilm with respect to the production and
distribution of Star Wars: Episode II—Attack of the Clones. It describes the advantages gained
by using multi-country production locations and an international cast and crew. In addition, it
explains the reasons behind the simultaneous release of the film in nine countries on the first day,
plus another large group of countries the following day. The case also describes the strategic
adjustments that Lucasfilm made to accommodate national technical and cultural differences, as
well as the additional revenue sources associated with the sales of rights to produce and sell
products associated with characters and scenes from the movie.
Teaching Tip: Carefully review the PowerPoint slides for Chapter 1. For additional
visual summaries of key chapter points, also review text Figures:
 1.2—International Business: Operations and Influences
 1.4—Means of Carrying Out International Operations
 1.5—Physical and Societal Influences on International Business
 1.6—The Competitive Environment and International Business
 1.7—The Usual Pattern of Internationalization.
Finally, note the atlas that follows the chapter (pages 30-41).
I. INTRODUCTION TO THE FIELD OF INTERNATIONAL BUSINESS

International business involves all commercial transactions—private and governmental
(public)—between two or more countries. Global events and competition affect almost all
firms, large or small. However, the international environment is more complex and
diverse than a firm’s domestic environment.
A. Why Companies Engage in International Business
1. Expand Sales. Companies may increase the potential market for their
sales by pursuing international consumer and industrial markets.
2. Acquire Resources. Foreign-sourced goods, services, components,
capital, technology and information can make a firm more competitive
both at home and abroad.
3. Minimize Risk. Firms may pursue foreign markets in order to minimize
cyclical effects on sales and profits; they may also wish to counter the
potential advantages that competitors might gain by participating in
foreign market opportunities.
B. Reasons for Recent International Growth—From Carrier Pigeons to the
Internet
1. Expansion of Technology. Vast improvements in transportation and
communication technology have significantly increased the efficiency of
international business operations.
2. Liberalization of Cross-Border Movements. The reduction of trade
barriers via the General Agreement of Tariffs and Trade and other such
mechanisms has provided increased access to many foreign markets.
3. Development of Supporting Services. Services provided by
governments, banks and other businesses greatly facilitate the conduct and
reduce the risks of doing business internationally.
4. Consumer Pressures. Because of innovations in transportation and
communications technology, consumers are better informed and thus
demand higher-quality, more cost-competitive products.
5. Increase in Global Competition. Companies may choose to operate
internationally in order to gain access to foreign opportunities and improve
their overall operational flexibility and competitiveness.
II. MODES OF INTERNATIONAL BUSINESS
A firm can engage in international business through various operating modes, including
exporting and importing merchandise and services (see Chapters 5 and 6 regarding
international trade), licensing and management contracts (see Chapter 14 regarding
collaborative arrangements), foreign direct and portfolio investments (see Chapters 8 and
11 regarding foreign direct investment) and strategic alliances with other companies (see
Chapter 14 regarding collaborative arrangements).
A. Merchandise Exports and Imports
Merchandise exports consist of tangible (visible) products, i.e., goods, which are
sent to a foreign country for use or resale. Merchandise imports consist of
tangible (visible) products, i.e., goods, brought into a country for use or resale.
B. Service Exports and Imports
Service exports and imports represent intangible (invisible), i.e., non-
merchandise, products. The firm or individual “exporting” a service will receive
international earnings; the firm or individual “importing” a service will make an
international payment.
1. Tourism and Transportation. When an American flies to Germany on
Lufthansa (a German airline) and stays in a German-owned hotel,
payments made to Lufthansa and the hotel represent service export
earnings for Germany and service import payments for the United States.
2. Performance of Services. Some services, such as turnkey
operations (construction of facilities, performed under contract, that are
transferred to the owner when they are ready for operation)
and management contracts (arrangements in which one firm provides
personnel to perform management functions for another), yield export
earnings to service providers in the form of fees paid by foreign clients.
3. Use of Assets. Firms may receive export earnings, i.e., royalties, by
allowing foreign clients to use their assets (trademarks, patents, copyrights
and other expertise). Licensing represents a transaction in which a licensor
(exporter) sells the rights to the use of its intellectual property to a licensee
(importer) in exchange for a fee. Franchising is a special form of
licensing in which the licensor is granted more control over the licensee in
exchange for the provision of additional support and services.
C. Investments
Foreign investment consists of the direct and portfolio ownership of assets in a
foreign country.
1. Direct Investment. Foreign direct investment (FDI) occurs when an
investor gains a controlling interest in a foreign operation. Sole ownership
represents 100% ownership of an operation; however, effective control
can be realized with just a minority stake if the remaining ownership is
widely dispersed. A joint venture represents a direct investment in which
two or more partners share ownership. A mixed venture represents a
commercial operation in which ownership is shared by a government and
a business.
2. Portfolio Investment. Portfolio investment is a non-controlling interest in
a venture made in the form of either debt or equity.
D. International Companies and Terms Used to Describe Them
1. There are numerous forms of collaborative arrangements through which
companies work together internationally, such as licensing, management
contracts, or long-term contractual arrangements. A strategic alliance is
more narrowly defined to indicate that the agreement is of critical
importance to the competitive viability of one or more partners.
2. A multinational enterprise (MNE) is a firm that takes a global approach
to foreign markets and production, i.e., it takes a corporate perspective in
its worldwide selection of markets and production sites. The
terms multinational corporation (MNC) and transnational company
(TNC) may also be used in this context.
3. A global company (also known as a globally integrated
company) integrates its operations on a worldwide basis. A multidomestic
company (also known as a locally responsive company) tailors its
strategies to national and/or regional preferences by granting decision-
making authority to local managers.
III. EXTERNAL INFLUENCES ON INTERNATIONAL BUSINESS

A. Understanding a Company’s Physical and Societal Environments
To effectively operate in the external environment, a firm’s managers must
understand not only business operations, but they also must have a working
knowledge of the basic social sciences, such as law, political science,
anthropology, sociology, psychology, economics and geography.
B. The Competitive Environment
The competitive environment varies by industry and country. Likewise, a
company’s competitive situation may differ in terms of its relative strength and in
terms of which competitors it faces from one country to another. Thus, a firm’s
competitive strategy directly influences how and where it can best operate.
IV. EVOLUTION OF STRATEGY IN THE INTERNATIONALIZATION PROCESS

Typically, a firm’s commitment to international operations evolves as part of its overall
growth and operating strategies over time. Nonetheless, more start-up companies are
becoming international very early in their lives because of advancements in
communications and managerial knowledge about foreign locations.
A. Patterns of Expansion
1. Passive to Active Expansion. Most companies think only of domestic
opportunities until a foreign opportunity presents itself.
2. External to Internal Handling of Operations. After initially relying on
intermediaries, a firm will learn enough about foreign operations to
consider them less risky than at the onset. It then may choose to handle at
least some of those operations internally.
3. Deepening Mode of Commitment. Usually firms begin their
international operations via importing or exporting. Once they have
successfully built export markets, however, they often move into some
type of foreign production to meet foreign demand.
4. Geographic Diversification. Initially companies tend to expand to those
foreign locations that are geographically close and culturally similar. Later
they move to more distant countries perceived to have less similar
environments to their home countries in order to expand on the one hand,
but minimize risk on the other.
B. Leapfrogging of Expansion
Many start-up firms are now beginning with a global focus because of the
international education and experience of their founders. Technological advances
in the Internet and other forms of communication give these companies access to
both worldwide markets and resources.
V. COUNTERVAILING FORCES
Countervailing forces influence the conditions in which companies operate and their
options for operating internationally. Rivalries among countries, cross-national treaties
and agreements and ethical dilemmas can inhibit a firm’s quest for maximum global
profits.
A. Globally Standardized versus Nationally Responsive Practices
Trends that influence the worldwide growth in international business often favor
the use of a global strategy, i.e., standardization, thus capturing gains
from economies of scale. On the other hand, a firm may choose to use
a multidomestic strategy, i.e., to be nationally responsive, thus increasing its
effectiveness by adjusting to the different conditions it encounters in the various
countries in which it operates.
B. Country versus Company Competitiveness
At one time the performance of a country and that of its domestic companies were
considered to be mutually dependent and beneficial. However, many companies
now choose to compete by seeking maximum production efficiency on a global
scale, even if it means moving production activities abroad. If as a result high-
value activities increase sufficiently in the home country, it will realize an
economic gain; if not, the country’s economic position will deteriorate. Countries
continue to entice both domestic and foreign firms to locate activities within their
borders through regulations, on the one hand, and incentives on the other.
C. Sovereign versus Cross-National Relationships
Although governments act in their own self-interest, they may choose to
cooperate with one another and even cede limited sovereignty through treaties and
other agreements.
1. Countries enter into a variety of bilateral and multilateral treaties and
agreements with other countries regarding commercial activities in order
to gain reciprocal advantages for themselves and their domestic firms.
2. Countries enact treaties and agreements to coordinate activities along their
shared borders and deal with problems that a single country acting alone
cannot solve.
3. Countries enact treaties and agreements to deal with areas of concern that
lie outside the territory of all countries, i.e., the non-coastal areas of the
oceans, outer space and Antarctica.
ETHICAL DILEMMAS AND SOCIAL RESPONSIBILITY:

Sorting through the World of Right and Wrong in International Business
Firms take many actions that elicit almost universal agreement about what is right or wrong. In
the international arena, however, religious beliefs, social attitudes, laws, regulations and policies
may vary significantly. No set of workable corporate guidelines is universally accepted and
observed. An MNE may find it has either more or less latitude in making decisions in the foreign
countries in which it operates. Cultural relativism holds that ethical truths depend upon the
groups holding them; thus intervention in local traditions is seen as unethical. On the other
hand, normativism holds that there are universal standards of behavior everyone should follow,
thus making non-intervention unethical. From a business standpoint, two possible objectives are
to (a) proactively create competitive advantages though socially responsible behavior that leads
to trust and commitment and (b) avoid being perceived as irresponsible.
LOOKING TO THE FUTURE:

Seizing That Window of International Business Opportunity
At this time there is much confusion about the future growth of international business.
Nonetheless, a firm that wants to capitalize on international opportunities must not wait too long.
By envisioning different ways in which the future may evolve, a company can be better prepared
to develop the facilities and people needed to succeed in an uncertain environment.
WEB CONNECTION
Teaching Tip: Visit www.prenhall.com/daniels for additional information and links

relating to the topics presented in Chapter 1. Refer your students to the on-line study
guide, as well as the Internet exercise for Chapter 1.
_________________________
CLOSING CASE: Disney Theme Parks [See Map 1.1]
1. What do you think motivated Disney to set up parks abroad, and what might be the pros
and cons from the standpoint of the Walt Disney Company?
Surely Disney was motivated to expand internationally in order to increase sales and
profits. Initially, Tokyo Disneyland was established in response to a proposal
from Japan’s Oriental Land Company, i.e., Disney was pulled into the international
arena. The pros associated with Disney’s international expansion include a larger market
for all Disney-related products: theme park visitors, Disney merchandise and licensing
royalties. In addition, much of the expansion has been done in collaboration with joint
venture partners, thus reducing the risk to Disney. The cons reflect the costs and risks
associated with foreign direct investment activities, including cultural differences such as
those encountered in France as well as trade and investment barriers.
2. Why do you suppose Disney made no financial investment in Japan, one of $140 million
in France and then one of over $300 million in Hong Kong?
The Oriental Land Company initially proposed the Tokyo park to Disney; because
Disney did not want to provide any financing, the land company owns the park and pays
Disney royalties from the operation. Given the success of that operation, Disney actively
sought to enter the European market, although it collaborated with numerous partners in
the development of that operation. In Hong Kong, Disney sees a gateway toChina, as
well as the fact that Hong Kong is Asia’s largest tourist destination. The Hong
Kong government holds a 57 percent interest in the joint venture, while Disney owns 43
percent.
3. What factors in the external environment have contributed to Disney’s success, failure
and adjustment in foreign theme park operations?
Market demand for theme park entertainment, as evidenced first by foreign visitors to
Disney’s US parks and then by visitors to its foreign operations, is substantial.
Nonetheless, both the level of demand and Disney’s ultimate profitability are sensitive to
upturns and downturns in the economic environment. Likewise, cultural differences have
proven both beneficial (in Japan) and problematic (in France), and winter weather proved
troublesome in France. Disney has adjusted to these factors by limiting its financial
exposure via licensing and joint venture operations, adjusting prices in response to local
conditions, adding features that are particularly desirable to host country visitors and
adjusting its policies to be culturally compatible with host country traditions. In addition,
Disney’s collaboration with the governments of France and Hong Kong has been crucial
to the successful development of those respective operations.
4. Should Disney set up a park in Shanghai? If so, what types of operating adjustment might
it make there?
This is an excellent question for a class debate. Shanghai would provide additional access
to the Chinese market; however, the possibility that Shanghai would siphon off potential
visitors to the Hong Kong park is very real. If, as Disney says, the two parks would
attract different types of visitors, Disney would likely have to adjust part of its product
offering and perhaps its pricing policies as well in order to maximize its earnings at each
park.
Additional Exercises: The Internationalization Process
Exercise 1.1. Ask students to name companies, both domestic and foreign, that operate
internationally. Take time to explore the extent and nature of those firms’ operations.
Also discuss a logical pattern of expansion for each type of operation. Conclude the
discussion by examining the list and asking if there are any particular types of firms that
seem to lend themselves to global operations and strategies more easily than others. Have
the students explain why this might be so.
Exercise 1.2. Explore the impact of standardization, containerization and

computerization upon the foreign trade process. Then ask students to discuss the role
technology has played in other areas of the foreign trade, licensing and foreign direct
investment processes.
Exercise 1.3. Ask students to develop a list of products (both goods and services) with
global potential, i.e., those that require little or no adjustment in foreign markets. If
adjustments are required, what would they be? Conclude the discussion by having the
students develop a second list of products that would either require substantial
adjustments or would have little if any potential in a global setting. Explore the reasons
for this.
Chapter 2
The Cultural Environments Facing Business
Objectives
! Discuss the problems and methods of learning about cultural environments.
! Explain the major causes of cultural difference and change.
! Examine behavioral factors influencing countries’ business practices.
! Examine cultural guidelines for companies that operate internationally.
Chapter Overview
When companies source, produce, and/or market products in foreign countries, they encounter
fascinating and often challenging cultural environments. Chapter 2 explores the basic concept of
culture and its effect on international business operations and strategy. It explores cultural
awareness as well as the causes of cultural differences, rigidities and changes. In so doing it
focuses on the impact of cultural traditions on business activities, as well as the mutually
satisfactory reconciliation of cultural differences. The chapter concludes with a discussion of the
ways in which firms can maximize their effectiveness while operating in a world of complex,
dynamic, cultural diversities.
Chapter Outline
OPENING CASE: Adjusting to Saudi Arabian Culture [See Map 2.1]
This case provides a striking example of the challenges presented to foreign firms by a pervasive
national culture. It shows why companies have had mixed success in Saudi Arabia, a modern yet
ancient society grounded in Islamic law, religious convictions and behavioral traditions. The case
describes various ways in which firms have adjusted their products, facilities and operating
strategies in order to meet government requirements and yet satisfy the Saudi consumer. It also
discusses numerous paradoxes encountered regarding legal sanctions, purchasing patterns and
attitudes toward work. It concludes by noting some of the opportunities that exist in Saudi
Arabia, either because of or in spite of the contrasts and paradoxes found there.
 2.1—Cultural Influences on International Business
 2.4—The Hierarchy of Needs and Need-Hierarchy Comparisons.
I. INTRODUCTION
Culture represents the specific learned norms of a society, based on attitudes, values and
beliefs. Major problems of cultural collision may occur because a firm implements
practices that do not reflect local customs and values and/or its employees are unable to
accept or adjust to foreign behaviors.
II. CULTURAL AWARENESS

Although people agree that cross-cultural differences do exist, they often disagree on
their impact. Are they widespread or exceptional? Are they deep-seated or superficial?
Are they easily discerned or difficult to perceive? Nonetheless, firms must develop
awareness about those cultures in which they operate. However, the amount of effort
needed to do this depends on the similarities between or among countries and the types of
business operations undertaken.
III. IDENTIFICATION AND DYNAMICS OF CULTURES

Cultures consist of people who share attitudes, values and beliefs. Cultures are dynamic;
they evolve over time.
A. The Nation as a Point of Reference
Similarity among people is both a cause and an effect of national boundaries; in
addition, laws apply primarily along national lines. National identity is
perpetuated through the rites and symbols of a country and a common perception
of history. At the same time, various subcultures and ethnic groups may transcend
national boundaries. In some instances, similarities may link groups across
different nations more closely than certain groups within a nation.
B. Cultural Formation and Dynamics
Culture is transmitted in a variety of ways, but by age 10 most children have their
basic value systems firmly in place. Nonetheless, individual and societal values
and customs often evolve in response to changing economic and social realities.
Change brought about by imposition is known as cultural imperialism. The
introduction of certain elements of an outside culture may be referred to
as creolization, indigenization, or cultural diffusion.
C. Language as a Cultural Stabilizer
While a common language within a country serves as a unifying force, language
diversity may undermine a firm’s ability to conduct business on a national level.
Isolation from other groups, especially because of language, tends to stabilize
cultures. Some countries see language as such an integral part of their cultures
that they attempt to regulate the use or inclusion of foreign words.
D. Religion as a Cultural Stabilizer
Religion can be a strong shaper of values and beliefs and is a major source of both
cultural imperatives and taboos. Still in all, not all nations that practice the same
basic religion place identical constraints on business. Historically, violence
among religious groups has disrupted local and international business activities in
both home and host country firms.
IV. BEHAVIORAL PRACTICES AFFECTING BUSINESS

Attitudes and values affect all dimensions of business activities, from what products to
sell to how to organize, finance, manage and control operations.
A. Social Stratification Systems
People fall into social stratification systems according to group memberships that
in turn determine a person’s degree of access to economic resources, prestige,
social relations and power. Ascribed group memberships are defined at birth and
are based on characteristics such as gender, family, age, caste and ethnic, racial,
or national origin. Acquired group memberships are based on one’s choice of
affiliations, such as political party, religion and professional organizations. Social
stratification affects both business strategy and operational practices.
1. Role of Competence. Some nations base a person’s eligibility for jobs
and promotions primarily on competence, but in others, competence is of
secondary importance. In more egalitarian societies, group membership is
less important, but in more closed societies, group membership may
dictate one’s access to education, employment, etc.
2. Gender-based Groups. There are strong country-specific differences in
attitudes toward males and females, as well as vast differences in the types
of jobs regarded as male or female. Nonetheless, barriers to employment
based on gender are easing in many parts of the world.
3. Age-based Groups. Many cultures assume age and wisdom are
correlated; thus, they usually have a seniority-based system of
advancement. In others, there is an emphasis on youth, particularly in the
realm of marketing. All in all, age represents a complex, dynamic issue.
4. Family-based Groups. In societies where there is low trust outside the
family (e.g., China and southern Italy), small family-run companies are
generally more successful than large firms. However, this may impede the
economic development of the country if large-scale operations are
necessary to compete globally.
5. Occupation. In every society certain occupations are perceived as having
greater economic and social prestige than others. Although some
perceptions are universal, there are significant national and cultural
attitudes about the desirability of specific occupations as well as the desire
to work as an entrepreneur rather than as an organizational employee.
B. Motivation
Employees who are motivated to work long and hard are generally more
productive than those who are not. On an aggregate basis, this will have a positive
effect on economic development and national competitiveness.
1. Materialism and Leisure. People are motivated to work for various

reasons, including the desire for achievement. In some societies, people
desire less leisure time than others. In 1904 sociologist Max Weber
claimed that predominantly Protestant Western economies were the most
economically developed because of the emphasis on hard work and
investment. Weber identified this view of work as a path to salvation as
the Protestant ethic. In rural India, however, where minimal material
achievement is a desirable end, added productivity will likely be taken in
the form of leisure, rather than income.
2. Expectation of Success and Reward. Although the same tasks
performed in different countries will have different probabilities of
success as well as different rewards for success and different
consequences for failure, people will usually work harder at any task when
the reward for success is greater than the consequence of failure. The
greatest enthusiasm for work exists when high uncertainty of success is
combined with the likelihood of a very positive reward for success and
little or none for failure.
3. Masculinity Index. Hofstede’s study of employees from 50 countries
defined a high masculinity index as describing someone who holds the
belief that it is better to live to work than to work to live. However, such
attitudes, as well as a preference for promotion and profitability over
quality of life and environment, are not shared by all. Those differences of
opinion present major challenges for international managers.
4. Need Hierarchy. Maslow’s hierarchy of needs states that people will try
to fulfill lower-order physiological needs before satisfying (in order) their
security, social, esteem and self-actualization needs. People from different
countries attach different degrees of importance to needs and may even
rank some of the higher-order needs differently.
C. Relationship Preferences
In social stratification systems, not everyone within a given reference group is
necessarily an equal. In addition, there may be strong or weak pressures for
conformity within one’s group. Both of these differences influence management
style and marketing behavior.
1. Power Distance. Power distance describes the relationship between
superiors and subordinates. When power distance is high, the management
style is generally distant, i.e., autocratic or paternalistic; when it is low,
managers tend to interact with and consult subordinates as part of the
decision-making process. [For example, Malaysians typically exhibit high
power distance, while Austrians typically exhibit low power distance.]
2. Individualism vs. Collectivism. Nationalities differ as to whether they
prefer an autocratic or a consultative working relationship, whether they
want set rules and how much they compete or cooperate with fellow
workers. Individualism is the trait that indicates a person’s desire for
personal freedom, time and challenge and one’s low dependence on the
organization; self-actualization is a prime motivator. On the other
hand, collectivism indicates a person’s desire for training, collaboration
and shared rewards, i.e., one’s high dependence on and allegiance to the
organization. [For example, Americans tend to be individualistic, while
the Japanese tend to be collectivist.]
D. Risk-taking Behavior
Nationalities differ in their attitudes toward risk-taking. Uncertainty avoidance,
trust and fatalism are examined here.
1. Uncertainty Avoidance. Uncertainty avoidance describes one’s
acceptance of risk. When the score is high, people need precise directions
and long-term assurances; when the score is low, people are willing to
accept the risk of trying new products or moving to new jobs. [For
example, Greeks tend to exhibit high uncertainty avoidance, while Swedes
tend to be low on the scale.]
2. Trust. Trust represents one’s belief in the reliability and honesty of
another. Where trust is high, there tends to be a lower cost of doing
business. [For example, Norwegians tend to exhibit a high degree of trust,
whereas Brazilians tend to be skeptical.]
3. Fatalism. Fatalism represents the belief that events are predestined. Such
a belief may discourage people from working hard to achieve an outcome
or accepting responsibility. [Muslim societies, for example, tend to be
fatalistic.]
E. Information and Task Processing
People from different cultures obtain, perceive, and process information in
different ways; thus, they may also reach different conclusions.
1. Perception of Cues. People identify things by means of their senses in
various ways with each sense. The particular cues used vary both for
physiological and cultural reasons. [For example, the richer and more
precise a language, the better one’s ability to express subtleties.]
2. Obtaining Information. Language represents a culture’s means of
communication. In a low-context culture, people rely on first-hand
information that bears directly on a decision or situation; people say what
they mean and mean what they say. In a high-context culture, people also
rely on peripheral information and infer meaning from things
communicated indirectly; relationships are very important. [For example,
while Germany is considered to be a low-context culture, Saudi Arabia is
considered to be a high-context culture.]
3. Information Processing. All cultures categorize, plan and quantify, but
the ordering and classification systems they use often vary.
In monochronic cultures (e.g., northern Europeans) people prefer to work
sequentially, but in polychronic cultures (e.g., southern European) people
are more comfortable working on multiple tasks at one time. Likewise, in
some cultures people focus first on the whole and then on the parts;
similarly, in idealistic cultures people will determine principles before
they attempt to resolve issues, but in pragmatic cultures they will focus
more on details than principles.
V. STRATEGIES FOR DEALING WITH CULTURAL DIFFERENCES

Once a company identifies cultural differences in the foreign countries in which it
operates, must it alter its customary practices?
A. Making Little or No Adjustment
Some countries are relatively similar to one another because they share the same
language, religion, geographical location, ethnicity and/or level of economic
development. If products and operations do not run counter to deep-seated
attitudes, or if the host country is willing to accept foreign customs as a trade-off
for other advantages, significant adjustments may not be required. Generally, a
company should expect to have to consider fewer adjustments when moving
within a culturally similar cluster than when it moves from one distinct cultural
cluster to another.
B. Communications
Problems in communications may arise when moving from one country to
another, even though both countries share the same official language, as well as
when moving from one language to another.
1. Spoken and Written Language. Translating one language into another
can be very difficult because (a) some words do translate directly, (b) the
common meaning of words is constantly evolving, (c) words may mean
different things in different contexts and (d) a slight misuse of vocabulary
or word placement may change meanings substantially. Poor translations
may have tragic consequences.
2. Silent Language. Silent language incorporates the wide variety of
nonverbal cues through which messages are sent—intentionally or
unintentionally. Color associations, the distance between people during
conversations, the perception of time and punctuality, a person’s perceived
status and kinesics (body language) are all significant. Misunderstandings
in any of these areas can have a very negative impact.
C. Culture Shock
Culture shock represents the trauma one experiences in a new and different
culture because of having to learn to cope with a vast array of new cues and
expectations. Reverse culture shock occurs when people return home, having
accepted the culture encountered abroad and discovering that things at home have
changed during their absence.
D. Company and Management Orientations
Whether and to what extent a firm and its managers adapt to foreign cultures
depends not only on the conditions within those cultures but also on the policies
of the company and the attitudes of its managers.
1. Polycentrism. Polycentrism represents a managerial approach in which
foreign operations are granted a significant degree of autonomy in order to
be responsive to the uniqueness of local cultures and other conditions.
2. Ethnocentrism. Ethnocentrism represents a belief that one’s own
culture is superior to others, and that what works at home should work
abroad. Excessive ethnocentrism may lead to costly business failures.
3. Geocentrism. Geocentrism represents a managerial approach in which
foreign operations are based on an informed knowledge of both home and
host country needs, capabilities and constraints.
E. Strategies for Instituting Change
Companies may need to transfer new products and/or operating methods from one
country to another in order to gain or maintain a competitive advantage. To
maximize the potential benefits of their foreign presence, firms need to treat
learning as a two-way process and transfer knowledge from host countries back
home as well as from home to host countries.
1. Value System. The more change upsets important values, the more
resistance it will encounter. Accommodation is much more likely when
changes do not interfere with deep-seated customs.
2. Cost Benefit of Change. Some adjustments to foreign cultures are costly
to undertake, but their benefits are only marginal. The expected cost-
benefit of any change must be carefully considered.
3. Resistance to Too Much Change. Resistance to change may be reduced
if only a few demands are made at one time; additional changes may be
phased in incrementally.
4. Participation. A proposed change should be discussed with stakeholders
in advance in order to ease their fears of adverse consequences—and
hopefully gain their support.
5. Reward Sharing. A company may choose to provide benefits for all the
stakeholders affected by a proposed change in order to gain support for it.
6. Opinion Leaders. Characteristics of opinion leaders often vary by
country. By discovering the local channels of influence, an international
firm may seek the support of opinion leaders to help speed the acceptance
of change.
7. Timing. Many good business changes fail because they are ill-timed.
Attitudes and needs change slowly, but a crisis may stimulate the
acceptance of change.
8. Learning Abroad. The essence for undertaking transnational practices is
to capitalize on diverse capabilities by transferring learning among all the
countries in which a firm operates.
To Intervene or Not to Intervene
Neither international firms nor their employees are always expected to adhere to a host
government’s behavioral norms. Some firms choose not to operate in locales where
objectionable social and political practices are the norm; others may operate in such places while
pressuring the host country to change; still others may rationalize or simply tolerate the status
quo. A difficult question concerns international business practices that may undermine a host
country’s long-term cultural identity. The Society for Applied Anthropology advises
governments and agencies on instituting change in different cultures; its code of ethics considers
whether a project or planned change will actually benefit the target population. However, the
trade-off between economic gains and the loss of cultural identity and traditions is often very
difficult to measure.

The Globalization of Culture
Although some tangibles have become more universal, the ways in which people cooperate,
solve problems and are motivated tend to remain much the same. Language differences continue
to bolster ethnic identities, and religious differences are as strong as ever. Such disparities
fragment the globe into regions and countries into clusters of subcultures that may in fact
transcend national boundaries.
WEB CONNECTION

guide, as well as the Internet exercises for Chapter 2.
_________________________
CLOSING CASE: John Higgins [See Map 2.5]
1. How would you describe Higgins’ and Prescott’s attitudes toward implementing U.S.
personnel policies in the Japanese operations?
While Higgins’ attitude appears to be polycentric, Prescott’s attitude seems to be
more geocentric. By invariably raising objections to changes that were contrary to the
Japanese norm, and even going so far as to intercede on behalf of a fired employee in
order to assure his continued employment, Higgins placed himself in an adversarial
position with Prescott. In fact, Japanese subordinates were more willing than Higgins to
try out new ideas. Believing in the fundamentals of the home point of view and as well as
the importance of understanding foreign attitudes, Prescott felt that the company’s real
contribution to Japanese society was in introducing innovation; he was opposed to blindly
copying local customs.
2. What are the major reasons for the differences in attitude?

Whereas Higgins’ interest (and business experience) lay almost solely in Japan,
Prescott’s experience was much broader, as indicated by his previous overseas
assignments in India, the Philippines and Mexico, as well as his several years in the home
office. Higgins became enchanted with Japan while stationed there with the U.S. Army.
Upon his return as an employee of Weaver, Higgins attempted to disassociate himself
with the “ugly American” image. He became completely immersed in Japanese culture
and society. He married a Japanese woman, spent his home-leave time in Japan and
requested and received the company’s permission to extend his stay in Japan indefinitely.
Prescott, on the other hand, sensed that changes were occurring in traditional Japanese
customs and culture. Having been given the responsibility of the expansion of the
Japanese operation, Prescott placed greater importance on productivity and competence
than on tradition and relationships.
3. If you were the Weaver corporate manager responsible for the Japanese operations and
the conflict between Higgins and Prescott came to your attention, what would you do? Be
sure to identify some alternatives first and then make your recommendations.
Clearly the successful joint venture between Weaver and Yamazaki represents a
relationship and operation that is highly valued by both partners. Further, Higgins’
affinity with his subordinates and relationship with both general managers serves to
complicate a naturally delicate situation. Initially a solution must be found to prevent the
further deterioration of the relationship between Higgins and Prescott. Prescott might be
encouraged to increase his understanding of the nuances of Japanese culture by
participating in expatriate managerial training programs with others executives from his
peer group either in Japan or at home. At the same time, Higgins’s position must be
clarified. Does he work for Prescott, the joint venture, or Weaver Pharmaceutical (the
U.S. parent)? In addition, to improve Higgins’ understanding of the role of Weaver’s
various international operations within the context of the whole corporation, he might be
temporarily or permanently reassigned to the home office (the latter alternative, however,
would surely lead to his resignation, given his standing offers from other firms in Japan).
In the long run, Weaver may wish to reconsider its decision to have two top-level
expatriate managers in Japan. The firm may also wish to reconsider its pre-departure and
on-going training policies for all its expatriate employees.
Additional Exercises: Cultural Challenges
Exercise 2.1. Refer students to the end-of-chapter case: John Higgins. Ask them to
compare the apparent relationship preferences of Higgins and Prescott from the
perspectives of (a) power distance and (b)individualism vs. collectivism.
Exercise 2.2. Pop culture can influence the development of global preferences in a
number of ways. Lead students in a discussion of the ways in which movies can affect the
cultural dimensions of a society (select particular movies, examine various values
embedded in them and discuss the nature of their impact upon the lifestyles of people
around the world).
Exercise 2.3. In some countries, religion has a dramatic effect on people’s attitudes,
customs and behavior. Lead students in a discussion of the relationship between
particular religious beliefs and peoples’ attitudes towards work. Then ask them to discuss
the influence of religion in the workplace in a number of selected countries.
Exercise 2.4. The distinction between cultural relativism and cultural normativism is
very important because it embraces the policies of multinational firms and the behavior
of their employees with respect to their home and host cultures. Ask students to debate
the extent to which firms should impose their own corporate (cultural) values upon (a)
their foreign operations and (b) the communities and countries in which they operate.
The Political and Legal Environments Facing Business
Objectives
! Discuss the different functions that political systems perform.
! Compare democratic and totalitarian political regimes and discuss how they can
influence managerial decisions.
! Describe how management can formulate and implement strategies to deal with foreign
political environments.
! Study the different types of legal systems and the legal relationships that exist between
countries.
! Examine the major legal issues in international business.
Chapter Overview
When companies source, produce and/or market products in foreign countries, they may
encounter challenging political and legal environments. Chapter 3 provides a conceptual
foundation for the examination of the political and legal dimensions of international business
operations. It compares major political regimes and discusses their potential influence upon the
development and implementation of appropriate political and legal strategies. It also explores the
major types of legal systems that exist today, as well as the legal relationships among countries.
The chapter concludes with an examination of major legal issues in international business.
Chapter Outline
OPENING CASE: The Hong Kong Dilemma [See Map 3.1]
Swire Pacific Ltd., a major hong prominent in Hong Kong business circles, is a subsidiary of
British-based John Swire & Sons, which has nearly 90% of its assets in China. Swire Pacific Ltd.
must learn to cope with an unstable regional and global economic environment and also succeed
in the new political environment developing in Hong Kong. The case discusses Swire’s approach
to dealing with the transition in Hong Kong by establishing a close working relationship with the
Chinese. It also raises Swire’s concerns about the firm’s future in both Hong Kong and China.
What will be the effect on Hong Kong as China continues to position Shanghaias a major center
of international business? Is Swire correct in pegging its future to that of China?
 3.1—Political and Legal Influences on International Business
 3.2—The Political Spectrum.
I. INTRODUCTION
For a multinational enterprise to succeed in countries with different political and legal
environments, its management must carefully analyze the fit between its corporate
policies and the political and legal conditions of each particular nation in which it
operates.
II. THE POLITICAL ENVIRONMENT

A country’s political system integrates the various parts of its society into a viable,
functioning whole. It also influences the extent to which government intervenes in
business, and thus the way in which business is conducted both domestically and
internationally.
III. BASIC POLITICAL IDEOLOGIES

A political ideology is the body of constructs, theories and aims that constitute a
sociopolitical program (e.g., liberalism or conservatism). Pluralism indicates the
coexistence of a variety of ideologies within a particular society. The ultimate test of any
political system is its ability to hold a society together. While shared ideologies create
bonds within and among countries, differing ideologies tend to split societies apart.
A. The Impact of Ideological Differences on National Boundaries
History, culture, politics and geography all contribute to the definition of national
boundaries. When a political system collapses, those under the system often
fragment into smaller sociopolitical groups. When operating in a foreign country,
it is very important for managers to understand feelings that could cause political
tension and instability.
B. The Political Spectrum
MNEs may be able to operate effectively in both democratic and totalitarian
regimes, but democracies usually offer greater economic freedom and enact more
legal statutes designed to safeguard individual and corporate rights.
1. Democracy. A democracy represents a political system in which citizens
participate in the decision-making and governance process, either directly
or through elected representatives. Contemporary democracies share the
following characteristics: freedom of opinion, expression and the press;
freedom to organize; free elections; an independent and fair court system;
a nonpolitical bureaucracy and defense infrastructure; and access to the
decision-making process. Nonetheless, in decentralized democracies
(e.g., Canada and the USA) companies may still face different and
sometimes even conflicting laws from one state or province to another.
a. Political Rights and Civil Liberties. Political rights include fair
and competitive elections, the empowerment of elected
representatives, the right to organize and the protection of
minorities. Civil liberties include freedom of the press, equality
under the law and personal freedoms.
b. Stability in Democracies. Many democracies that have emerged
since the early 1970s are fragile and unstable. At the same time,
confidence in politicians and government has generally declined in
many of the more mature democracies.
2. Totalitarianism. Totalitarianism represents a political system in which
citizens seldom if ever participate in the decision-making and governance
process; power is monopolized and opposition is neither recognized nor
tolerated. In theocratic totalitarianism, religious leaders are also the
political leaders. In secular totalitarianism, the government usually
imposes order through military power. Variants of totalitarianism include
fascism, authoritarianism and communism.
IV. THE IMPACT OF THE POLITICAL SYSTEM ON MANAGEMENT

DECISIONS
A. Political Risk
Political risk reflects the expectation that the political climate in a foreign country
will change in such a way that a firm’s operating position will deteriorate.
1. Types and Causes of Political Risk. Political actions that may adversely
affect a firm’s operations would include government takeovers of
property, operational restrictions and damage to property or personnel. In
addition, civil unrest and disorder and antagonistic external relations
(including boycotts and other forms of protest) may also negatively impact
a firm’s operations.
2. Micro and Macro Political Risks. Micro political risks are those aimed
only at specific foreign investments (e.g., a particular MNE),
whereas macro political risks affect a broad spectrum of foreign investors.
B. Government Intervention in the Economy
When companies move abroad, management must deal with governments that
may have different attitudes about their roles in their respective economies—
attitudes which may be inconsistent over time. Under an individualistic
paradigm the government believes in minimal interference in the economy; it
may intervene to deal with market defects but generally promotes marketplace
competition. Under acommunitarian paradigm, however, whether democratic
(Japanese) or authoritarian (Chinese) in nature, the government defines economic
needs and priorities and partners with business in major ways.
V. FORMULATING AND IMPLEMENTING POLITICAL STRATEGIES

Formulating political strategies may be more complicated than formulating competitive
marketplace strategies. Logical steps include: identifying the issues, defining the nature
of the issues, assessing the potential actions of others, identifying key players,
formulating alternative strategies, assessing the potential impact of particular activities
and selecting and implementing the most appropriate strategy.
VI. THE LEGAL ENVIRONMENT
Managers must be aware of the legal systems in the countries in which their firms
operate, the basic nature of the legal profession (both domestic and international) and the
legal relationships that exist between and among countries. Legal systems differ both in
terms of the nature of the system and the degree of independence of the judiciary from
the political process.
A. Kinds of Legal Systems
1. Common Law. Common law originated in the United Kingdom and is
based upon tradition, precedent, custom and usage; therefore, courts play
an important role in interpreting the law.
2. Civil Law. Civil law, also known as codified law, originated with the
Romans and is based upon a detailed set of laws that make up a detailed
code that includes rules for conducting business; courts play an important
role in applying the law.
3. Theocratic Law. Theocratic law is based upon religious precepts. The
best example is Islamic law, or Shair’a. The key for businesses is to
adhere to the constraints of ancient Islamic laws while maintaining
sufficient flexibility to operate in a modern global economy.
B. Consumer Safeguards
Different legal systems provide varying safeguards with respect to product
liability and other legal issues. For example, access to and assistance from the
legal community, legal fees and the ability to use foreign lawyers all differ across
countries.
C. The Legal Profession
Although lawyers and law firms vary in terms of how they practice law and
service clients, MNEs must use lawyers for a variety of services, such as
negotiating contracts, formalizing agent-distributor relationships and protecting
intellectual property. Just as MNEs have expanded abroad to take advantage of
international business opportunities, law firms have expanded abroad to service
their clients. The key for managers doing business overseas is to choose a law
firm with the needed expertise and overseas connections, whether through the
company’s own offices, a merger, or correspondent relationships.
D. Legal Issues in International Business
National laws may affect the business climate both within and beyond a country’s
borders and pertain to both domestic and foreign firms. Areas addressed include
health and safety standards, employment practices, antitrust prohibitions,
contractual relationships, environmental practices, intellectual property, cross-
border investment flows, tariffs and non-tariff barriers, to name but a few. In
addition, international treaties among nations may also affect the nature and
extent of business operations.
Is “When in Rome, Do as the Romans Do” the Best Approach for Global Ethics?
Cultural relativism implies that there is no method for deciding whether particular behavior is
really appropriate. However, it is possible to do so by seeking justification for that behavior;
such justification is a function of cultural values (many of which are universal), legal principles
and economic practices. Some people argue the legal justification for ethical behavior is the only
truly important justification. However, that argument is insufficient because not everything that
is unethical is illegal. Moral as well as legal concepts must be considered. Further, the law tends
to be slow to develop in emerging areas of business concern. In addition, both laws and legal
systems vary among countries. Civil law countries tend to have a large body of laws that specify
legal behaviors, while common law countries tend to rely more on precedent than statutory
regulations.

Will Democracy Survive?
There is a clear link between political and economic freedom and economic growth. However,
democracy does not necessarily mean stability; in fact, in a transition economy political risk is
often quite high. Some people argue if a country is to flourish as a democracy, certain
preconditions such as economic development must be present. Others feel, however, that
democracy is the result of having political leaders who exhibit both the determination and the
skills required to assure democratization occurs.
WEB CONNECTION

guide, as well as the Internet exercises for Chapter 3.
_________________________
CLOSING CASE: Newmont Mining in Indonesia
1. What were the key political problems facing Mr. Lahti and Newmont Mining
in Indonesia?
When Newmont first began Indonesian operations in 1996, it worked directly with the
central government. However, the unwillingness of current leaders to use Suharto’s tough
tactics on local governments led to a substantial loss of power by the central government.
Consequently businesses are now confused as to whether to follow the central or the
regional government’s laws and policies. Further, local groups have found it the perfect
time to demand greater social and environmental responsibility from companies operating
in their regions.
2. How has the legal situation in Indonesia contributed to Newmont Mining’s dilemma?
The turmoil in Indonesia’s legal system makes it very risky for foreign firms to operate
there. Newmont’s contract with the central government exempted the company from
paying any taxes on mining waste materials. However, Minahasa’s parliament passed a
law allowing the collection of levies from local operations, and the district demanded
$8.2 million in back-pay of taxes for waste material. After having to shut down a number
of times, Newmont finally settled with Minihasa’s local courts for $500,000 plus
$2,500,000 to be added to employee programs and community development projects. To
solve such conflicts, the central government recently passed local autonomy laws.
However, with no regulations to govern their implementation, many fear the confusion
and problems will simply escalate. In addition, former landowners have blockaded the
entrance to the mine, claiming they were not fairly compensated for the value of the land.
3. What are the environmental dimensions to gold mining in Indonesia, and whose
responsibility is it to protect the environment?
With mounting evidence of pollution problems, Newmont has been under environmental
scrutiny ever since the opening of the Minihasa mine. Local environmentalists claimed
the tailings Newmont dumps into the ocean contain toxic levels of mercury and arsenic.
Despite conducting an environmental risk assessment and detoxifying the tailings before
dumping them into the ocean as ordered by the government, local activists continue to
protest against Newmont’s operation. Others, however, believe the environmental
problems are primarily caused by illegal miners who use antiquated mining practices to
extract the gold; they also use mercury to separate the gold from the ore and then dump
the waste into local rivers. Although Newmont attempted to work with the government in
dealing with the illegal miners, the government failed to take action for fear of a
demonstration against it.
4. Evaluate Mr. Lahti’s approach to solving Newmont’s problems. Could he have done
anything differently?
At the time Newmont established its mining operations in Indonesia, the central
government was very much in control of the country, and the future seemed reasonably
predictable. However, the effects of political and economic turbulence are largely beyond
the control of firm managers, particularly in the short run, and certainly so in this case.
Although Mr. Lahti was both locally responsive and proactive in his attempts to solve
Newmont’s problems at the Minishasa Raya mine, it appears the relationship between
Newmont and the local activists was largely an adversarial one. If Mr. Lahti had been
able to find a way to work in collaboration with the firm’s employees and local
community leaders and activists to address perceived problems with its operation—and to
promote its benefits—perhaps he could have achieved greater progress. In addition,
Newmont may need to rethink its method of operating in countries with relatively high
economic and political risk. Entering into joint ventures with local firms may be a viable
alternative.
Additional Exercises: Political and Legal Factors
Exercise 3.1. Ask students to discuss the difficulties faced when a country changes from
a totalitarian to a democratic political system. Then have the students compare the
political transition of a large country such as Russia to the transition of a smaller country
such as Hungary. Ask whether political transition has been a smoother process in one of
the two countries and examine both the differences and the similarities in the two
processes.
Exercise 3.2. Ask students to identify companies, both domestic and foreign, that operate
internationally. Then ask the students to explore the possible sources of political risk for
each of those firms, given the countries in which they have a presence and the nature of
their products and operations. Be sure to consider both the micro and macro types of risk.
Exercise 3.3. Identify the various home countries of students in your class. Then lead the
class in a comparative analysis of some of the laws pertaining to (a) local business
activities and (b) cross-border business activities under the following types of legal
systems: common law, civil law, theocratic law and Asian law. Conclude by discussing
the challenges of dealing with particular types of international business issues in the
home countries of your students.
The Economic Environment
Objectives
! Learn the criteria for dividing countries into different economic categories.
! Learn the differences among the world’s major economic systems.
! Discuss key economic issues that influence international business.
! Assess the transition process certain countries are undertaking in changing to
market economies—and how this transition affects international firms and
managers.
Chapter Overview
When companies source, produce and/or market products in foreign countries, they
often encounter challenging economic environments. Chapter 4 first considers the
economic environments of countries in which an MNE might want to operate by
describing countries by income level and type of economic system. Then it examines
key macroeconomic indicators, such as economic growth, inflation and the surpluses
and deficits reflected in the balance of payments. Finally, the process and progress of
the transition to a market-based economy by many former centrally planned and other
countries is discussed.
Chapter Outline
OPENING CASE: McDonald’s Corporation in Emerging Markets

This case exemplifies the challenges of global expansion during times of economic
uncertainty as well as the risks of entering emerging markets. Despite enormous start-
up challenges, McDonald’s has done well in Russiaand China. On the other hand, it
was forced to closed 163 unproductive stores in Turkey, Malaysia and
the Philippines in 2001 at a cost of $91 million. In addition, the worldwide economic
downturn continued to pressure McDonald’s overall corporate profitability. To
counter this trend, McDonald’s refocused its expansion strategy by dedicating 60
percent of its efforts to the United States, Canada and Europe, where economies are
relatively stable and returns are strong. Expansion will also continue in China, where
growth potential is enormous. The case concludes by pondering the extent of
McDonald’s future worldwide operations.
Teaching Tip: Carefully review the PowerPoint slides for Chapter 4. For an
additional visual summary of key chapter points, also review text Figure 4.1—
Physical and Societal Influences on International Business. Finally, note the
U.S. Balance of Payments Appendix on text pages 136-137.
I. INTRODUCTION
Understanding the economic environments of foreign countries and markets is
vital to helping managers predict the ways in which trends and events will
likely affect their firms’ future performance there. Questions to be addressed
include both the size and the nature of the market. Answers are often complex.
II. AN ECONOMIC DESCRIPTION OF COUNTRIES

Companies do business abroad for a variety of reasons. Factor
conditions (production factors) include essential inputs to the production
process such as human resources, physical resources, knowledge resources,
capital resources and infrastructure; they are crucial for investments made for
production purposes. Demand conditions (market potential) include the
composition of local demand (quality of demand), the size and growth of local
demand (quantity of demand) and the internationalization of basic demand;
they are crucial for market-seeking investments. Location-specific
advantages incorporate the combination of factor and demand conditions, plus
other relevant qualities.
A. Countries Classified by Income
Size of national demand is indicated by Gross National
Income (GNI), previously referred to as Gross National Product
(GNP). The broadest measure of economic activity, GNI represents the
market value of final goods and services newly produced by
domestically owned factors of production. Gross Domestic Product
(GDP) represents that value of production that takes place within a
nation’s borders, without regard to whether the production is carried out
by domestic or foreign factors of production. Per capita GNI is
computed by dividing GNI by a country’s population. Because nominal
exchange rates (unadjusted market rates) do not always reflect
international differences in prices, purchasing power parity (PPP) is
used as an indicator of the number of units of a country’s currency
required to buy the same amounts of goods and services in its domestic
market. The World Bank refers to low- and middle-income nations
as developing countries, which are also known as emerging countries (a
term also used to describe the capital markets in such countries). While
developing countries in Asia and Latin America are generally moving
forward, those in Africa are not making much progress. High-income
nations are referred to as developed or industrialized countries.
B. Countries Classified by Region
MNEs tend of organize their operations along geographic lines. Major
geographic regions of the world include: East Asia and the Pacific,
Europe and Central Asia, Latin America and the Caribbean, the Middle
East and North Africa, and Sub-Saharan Africa.
C. Countries Classified by Economic System
Every government struggles with the right mix
of ownership and control of its economy. Ownership refers to the
ownership of resources engaged in economic activity—the public sector
(government), the private sector, or both. Control refers to the allocation
and control of resources engaged in economic activity. Just as there is a
relatively high correlation between economic freedom and political
freedom, there is also a relatively high correlation between economic
freedom and economic growth.
1. Market Economy. A market economy is one in which resources
are primarily owned and controlled by the private sector. Key
factors include consumer sovereignty (the right to choose what to
buy), the freedom of market entry and exit and the determination
of prices according to the laws of supply and demand.
2. Command Economy. A command economy (often referred to
as a centrally planned economy) is one in which all dimensions
of economy activity, including pricing and production decisions,
are determined by central government planning authorities.
3. Mixed Economy. A mixed economy describes an economic
system characterized by a mixture of market and command
economies, including a combination of public and private
ownership.Market socialism is characterized by the state
ownership of significant resources, but the allocation of those
resources comes from the market price mechanism, and prices are
determined by the laws of supply and demand.
III. KEY MACROECONOMIC ISSUES AFFECTING BUSINESS

STRATEGY
Macroeconomic factors can have a major impact on both the profitability and
the operating strategy of MNEs. Three key issues are economic growth,
inflation and surpluses and deficits.
A. Economic Growth
While history is often used to forecast future economic trends, it is
certainly not perfect. Further, there exists significant differences in
growth rates throughout the world. The direct impact of events such as
the Asian financial crisis, terrorist activities such as 9/11 and corporate
scandals such as Enron and WorldCom spreads quickly to international
markets, but the effects are uneven. Thus, future growth is bound to be
variable by region, even in the high-income countries.
B. Inflation
The inflation rate represents the percentage increase in the change in
prices from one period to the next, usually a year. A common indicator
of inflation is the consumer price index (CPI), which measures the cost
of a fixed basket of goods and services and compares the price from one
period to the next. Inflation occurs because aggregate demand is growing
faster than aggregate supply. Ultimately it affects interest rates,
exchange rates, the cost of living and the general confidence in a
country’s political and economic systems.
C. Surpluses and Deficits
Internal and external deficits are important indicators of a country’s
economic strength and stability. Surpluses are rarely a problem.
An internal deficit indicates that a government’s expenditures exceed its
revenues; an external deficit indicates that a country’s cash outflows
(payments) exceed its inflows (receipts).
1. The Balance of Payments. The balance of payments account
records commercial transactions and other financial flows
between the residents of a given country and the rest of the world.
a. The current account includes trade in goods and services
and income from assets abroad and payments on foreign-
owned assets in the country. The merchandise trade
balance reflects a country’s deficit or surplus with respect
to trade in goods. The service account reflects transactions
such as transportation and other international services and
royalties and fees on licensing agreements. (Unilateral
transfers include government and private relief grants and
income transferred abroad.)
b. The capital account records transactions in real or
financial assets between residents of a given country and
the rest of the world. An inflow of capital is a positive
transaction; an outflow is a negative transaction. Also
included in the capital account are changes in the official
reserve assets of a country, such as gold, special drawing
rights and foreign currencies.
2. External Debt. External debt consists of money borrowed from
foreign institutions. It can be measured in two ways: the total
amount of the debt and debt as a percentage of GDP. The larger
these two numbers, the more unstable an economy will become
and the more likely economic growth will slow.
3. Internal Debt and Privatization. Government budget deficits
result from an excess of government expenditures relative to
revenues and contribute to a country’s overall debt position. As
countries move to reduce their deficits, the privatization of state-
owned enterprises may occur, thus relieving the government of
the need to subsidize inefficient operations.
IV. TRANSITION TO A MARKET ECONOMY

Many countries are undergoing the transition from command economies to
market economies because of the failure of the central planning process to
generate satisfactory economic growth. In general, transitionimplies the
liberalization of economic activity, the reallocation of resources to their most
efficient use, macroeconomic stabilization, the privatization of state-owned
assets, budgetary constraints and the development of an institution and legal
framework to protect property and individual rights.
A. The Process of Transition
The transition process can provide significant opportunities for MNEs as
markets are opened and foreign direct investment opportunities expand.
For Russia, the transition to a market economy has been especially
difficult because the government has been trying to simultaneously
change the country’s economic and political systems. The Chinese
transition has been much more controlled—a change in that country’s
political system is not part of the process.
B. The Future of Transition
In the short-term, major challenges confronting the transition economies
will include continued macro stability, economic growth, improvement
in institutional and structural areas and the solution of social issues such
as poverty, child welfare and HIV/AIDS. In the long-term, however, the
challenges to the transition economies will virtually be the same as those
of other developing economies.

How Much Economic Assistance Is Too Much?
A major issue of economic social responsibility concerns the obligation of high-
income countries to assist developing nations. There are several areas of concern.
First, in order to participate in the trade process, emerging economies must have
access to high-income markets, i.e., discriminatory barriers should be abolished.
Second, foreign aid can be used as a tool for economic development, but not all
people share that view. Third, the forgiveness of loans to developing countries by
high-income governments could be part of the solution to the debt crisis. Such actions
are appropriate for governments, but it is unlikely that the private sector would
participate in these measures.
A Global Economy in the New Millennium
As the twenty-first century dawned, the global economy seemed to be strengthening,
but then a serious economic downturn in 2001-2002 threatened continued growth.
Because the U.S. accounts for nearly a third of the total global economic activity, the
rest of the world followed it into recession. Most people are looking for recovery to
occur in the U.S. and Europe in the not-too-distant future, but Asia’s progress is
expected to be slower because of Japan’s recession and banking crisis. Latin
American and African countries look to the IMF for assistance in lowering inflation,
reducing government spending, and reducing their dependence upon foreign capital.
WEB CONNECTION
Teaching Tip: Visit www.prenhall.com/daniels for additional information

and links relating to the topics presented in Chapter 4. Refer your students to
the on-line study guide, as well as the Internet exercises for Chapter 4.
_________________________
CLOSING CASE: The Daewoo Group and the Asian Financial Crisis
1. How would you describe Korea’s economic system? What are the key elements
in that system? How would you describe the interaction between politics and
economics in Korea?
Although falling into the category of “mostly free,” there is significant
government intervention in the South Korean economy. Modeled after the
Japanese system, South Korea has targeted export growth as the key to its
economic development. Historically, strong ties existed between the
government and the Korean chaebol (diversified business conglomerates that
include a trading company and are held together by cross ownership and family
ties). When negotiating with the IMF for loans to help deal with the effects of
the Asian financial crisis, the Korean government agreed to a number of
financial and other reforms, including the restructuring of the chaebol. The
previously close relationship between the government and the chaebol was
cause for frequent suspicion of corruption.
2. Does Korea look like a good place to invest? Why or why not?
The position one takes with respect to this question depends upon the particular
sector involved and the reason for the investment. Many view a time of
economic crisis and currency weakness as a good time to invest if appropriate
opportunities can be found. On the other hand, others will feel that economic
risk in Korea is still relatively high and that better opportunities can perhaps be
found elsewhere.
3. What are the key mistakes Kim Woo-Chung made in formulating and
implementing Daewoo’s strategy, and how did the economic crisis
in Korea and the rest of Asia affect that strategy?
Kim Woo-Chung’s major mistake in implementing Daewoo’s strategy was the
assumption of debt, which in 1998 equaled 13 percent of South Korea’s entire
GDP. Not only was the firm’s debt-to-equity ratio higher than the average of
other large chaebols, but a good share of the debt was owed to overseas
creditors. In spite of the warning signs that accompanied the Asian financial
crisis, President Kim continued to expand the firm’s operation at a time when
Samsung and LG were cutting back.
4. What risks does GM face in taking over Daewoo Motor?

GM faces major risks in the marketplace. By selling Daewoo cars in Europe
and the U.S., GM risks the cannibalization of its own brands. In addition, the
effect of the Asian financial crisis and the downfall of Daewoo upon Korean
demand for Daewoo products is as yet unclear.
Additional Exercises: Economic Realities
Exercise 4.1. Ask students to explain why per capita income is often an
inadequate indicator of national wealth. Be sure they cite examples of particular
countries to support their points. Then ask them to explain why a particular
government would select gross domestic product (GDP) as a measure of
domestic economic activity, rather than gross national income (formerly gross
national product).
Exercise 4.2. Ask students to consider the following statement: “As a country’s
political system changes from a more repressive to a more representative form
of government, its economic system will necessarily change as well.” Then ask
them to consider whether the complete privatization of all state-owned and
controlled assets is necessary for an economic transition to be successful.
Exercise 4.3. In a day of global recession, many wonder if it is necessary or

desirable to have national economies linked to closely together. Ask the
students to consider what, if anything, a country can do to protect itself from
the impact of negative global economic events. Then ask them to consider
whether the impact of global recession on MNEs is necessarily the same as the
impact on countries. If not, why not?
Chapter 5
International Trade Theory
Objectives
! Explain trade theories.
! Discuss how to increase global efficiency through free trade.
! Introduce prescriptions for altering trade patterns.
! Explore how business decisions influence international trade.
Chapter Overview
Foreign trade is an age-old phenomenon. Chapter 5 examines many of the descriptive and
prescriptive theories associated with this process. Beginning with Mercantilism, the chapter
presents the concepts of absolute and comparative advantage, factor proportions theory and
country size and country similarity theories. It also discusses the international product life cycle
and Porter’s determinants of national competitive advantage. The chapter concludes with a
discussion of the strategic reasons firms participate in the international trade process.
Chapter Outline
OPENING CASE: Sri Lankan Trade [See Map 5.1]
This case describes the pivotal role of international trade in the development of the Sri Lankan
economy. An island nation of nearly 20 million people, the country’s trade activities date back to
the middle of the third century. During the colonial period, the Portuguese sought Ceylonese
spices, and then the British developed tea, rubber and coconut plantations. Since receiving its
independence from the UK in 1948, Sri Lanka has looked to international trade to help solve
such interrelated problems as its shortage of foreign exchange, its overdependence on exports of
tea and on the British market and the insufficient growth of output and employment.
Specifically, Sri Lanka has been guided by four different trade policies: a liberal approach of
noninterference in trade from 1948-1960, a policy of import substitution from 1960-1977, the
combination of strategic trade policy guided by import substitution from 1977-1988 and the
implementation of strategic trade policy combined with an openness to imports from 1988 to the
present. The move to establish strategic export industries has accomplished many of Sri Lanka’s
objectives; manufacturing now accounts for 70 percent of its exports, and tea is increasingly
being exported in value-added forms.
visual summaries of key chapter points, also review:
 Table 5.2—International Changes during a Product’s Life Cycle
 Figure 5.5—Determinants of Global Competitive Advantage in the text.
I. INTRODUCTION
Foreign trade (importing and exporting activities) is one means by which countries are
linked economically. Two general types of trade theories pertain to international
business. Descriptive theories deal with the natural order of trade; they examine and
explain patterns of trade under laissez-faire conditions. Prescriptive theories deal with
the question of whether governments should seek to alter the amount, composition and/or
direction of trade.
II. MERCANTILISM
The concept of mercantilism (a zero-sum game) was popular from about 1500-1800; it
purports that a country’s wealth is measured by its holdings of treasure (usually gold). To
amass a surplus (a favorable balance of trade) a country must export more than it imports
and then collect gold (and other forms of wealth) from countries that run
a deficit (an unfavorable balance of trade). Neomercantilism represents the more recent
policy of countries that try to run a favorable balance of trade in order to achieve some
particular national objective via protectionism.
III. ABSOLUTE ADVANTAGE

In 1776 Adam Smith claimed the wealth of a nation consisted of the goods and services
available to its citizens. His theory of absolute advantage holds that a country can
maximize its own economic well being byspecializing in the production of those goods it
can produce more efficiently than any other nation and enhance global efficiency through
its participation in (unrestricted) free trade.
A. Natural Advantage
A country may have a natural advantage in the production of particular products
because of given climatic conditions, access to certain natural resources, the
availability of needed labor forces, etc.
B. Acquired Advantage
An acquired advantage represents a distinct advantage in skills, technology
and/or capital assets, thus yielding differentiated product offerings and/or cost-
competitive homogeneous products.
C. Resource Efficiency Example [See Figure 5.2]
Real income depends on the output of goods as compared to the resources used to
produce them. The production possibilities curve shows that by specializing and
trading, two countries can have more than they would without trade, thus
optimizing global efficiency.
IV. COMPARATIVE ADVANTAGE
In 1817 David Ricardo reasoned there would still be gains from trade if a country
specialized in the production of those things it can produce most efficiently, even if other
countries can produce those things even more efficiently. Put another way, Ricardo’s
theory of comparative advantage holds that a country can maximize its own economic
well-being by specializing in the production of those goods it can
producerelatively efficiently and enhance global efficiency through its participation in
(unrestricted) free trade.
A. An Analogous Explanation of Comparative Advantage
Would it make sense for the best physician in town, who also happens to be the
most talented medical secretary, to handle all of the administrative duties of an
office? No. The physician can maximize both output and income by working as a
physician and employing a secretary. In the same manner, a country will gain if it
concentrates its resources on the production of those products it can produce most
efficiently.
B. Production Possibility Example [See Figure 5.3]
A country can simultaneously have a comparative advantage and an absolute
disadvantage in the production of a given product. Assume that the United
States is more efficient than Sri Lanka in the production of both wheat and tea.
However, the United States has a comparative advantage in wheat production. By
concentrating on the product in which it has the greater advantage (wheat) and
letting Sri Lanka produce the product in which the U.S. is comparatively less
efficient (tea), global output can be increased, and specialization and trade can
benefit both countries.
V. SOME ASSUMPTIONS AND LIMITATIONS OF THE THEORIES OF

SPECIALIZATION
The theories of absolute and comparative advantage are based upon the economic gains
from specialization, i.e., concentration on the production of a limited number of products.
Each holds that specializationwill maximize output and that subsequent trade will
maximize consumer welfare. However, both theories make certain assumptions that may
not always be valid.
A. Full Employment
Both theories assume that resources are fully employed. When countries have
many un- or under-employed resources, they may seek to restrict imports in order
to employ their own available workers and other assets.
B. Economic Efficiency Objective
Countries often pursue objectives other than economic efficiency. For example,
they may intentionally avoid overspecialization because of the vulnerability
created by potential changes in technology and price fluctuations.
C. Division of Gains
Although specialization does maximize output, it is unclear how those gains will
be divided. If one country perceives a trading partner as receiving too large a
share of the benefits, it may choose to forego its relatively small gains in order to
prevent the other country from receiving large gains.
D. Two Countries, Two Commodities
The world is comprised of multiple countries and multiple commodities.

Nonetheless, the theories are still useful; economists have applied the same
reasoning and demonstrated the economic efficiency advantages in multi-product
and multi-country production and trade relationships.
E. Mobility
Neither the assumption that resources can move domestically from the production
of one good to another and at no cost, nor the assumption that resources cannot
move internationally, is entirely valid. Nonetheless, domestic mobility is greater
than the international mobility of resources. Clearly, the movement of resources
such as labor and capital is an alternative to trade.
F. Statics and Dynamics
Although the theories of absolute and comparative advantage consider gains at a
given time (a static view), the relative conditions that surround a country’s
advantage or disadvantage are dynamic (constantly changing). Thus one cannot
assume future advantages will remain constant.
E. Services
Although the theories of absolute and comparative advantage were developed
from the perspective of trade in commodities, much of the same reasoning can be
applied to trade in services.
VI. THE THEORY OF COUNTRY SIZE

The theory of country size holds that large countries are more apt to have varied climates
and natural resources, and therefore will generally be more nearly self-sufficient than
small countries. Research based on country size helps explain the country-by-country
differences regarding how much and what products will be traded through specialization
that are not dealt with by the theories of absolute and comparative advantage.
A. Variety of Resources
Large countries are more apt to have varied climates and a greater assortment of
natural resources than smaller countries, thus making the large countries more
self-sufficient.
B. Transport Costs
Given the same types of terrain and modes of transportation, the greater the
distance, the higher transport costs will be. Thus certain firms in large countries
may face higher transportation costs in terms of serving their distant national
markets than do their closer foreign competitors.
C. The Size of the Economy and Production Scales
Countries with large economies and high per capita incomes are more likely to
produce goods that use technologies requiring long production runs. These
countries develop industries to serve their large domestic markets, which in turn
tend to also be competitive in export markets. On the other hand, given its
capacity the technologically intensive company from a small nation may have a
compelling need to sell abroad. In turn, this need would pull resources from other
industries within the firm’s domestic market, thereby causing more national
specialization than in a larger nation.
VII. THE FACTOR-PROPORTIONS THEORY
The Heckscher-Ohlin theory of factor endowment is useful in extending the concept

of comparative advantage by bringing into consideration a nation’s endowment and cost
of factors of production. The theory holds that a country will tend to export products that
utilize factors of production relatively abundant in that nation.
A. Land-Labor Relationship
In countries with many people relative to the size of the available land, labor
would be relatively (comparatively) cheap; thus those countries should
concentrate on producing and exporting labor-intensive goods.
B. Labor-Capital Relationship
In countries where little capital is available for investment and where the amount
of investment per worker is low, then low labor rates would also be expected.
Again, those countries should concentrate on producing and exporting labor-
intensive goods. (The fact that labor skills tend to vary across countries has led to
international task specialization with respect to national production activities.)
C. Technological Complexities
Factor proportions analysis becomes complicated when the same product can be
produced by different methods, such as with different mixes of labor and capital.
Managers must consider the cost in each locale, based on the type of production
that will minimize costs there.
VIII. THE PRODUCT LIFE CYCLE THEORY OF TRADE

Vernon’s international product life cycle (PLC) describes how the location of
production and trade activities shifts as a product moves through its life cycle.
A. Changes through the Cycle
A great majority of the new technology that results in new products and
production methods originates in industrial countries.
1. Introduction. Innovation, production and sales occur in the domestic
(innovating) country. Because the product is not yet standardized, the
production process tends to be relatively labor intensive, and innovative
customers tend to accept relatively high introductory prices.
2. Growth. As demand grows, competitors enter the market. Foreign
demand, competition, exports and often direct investment activities also
begin to accelerate.
3. Maturity. Global demand begins to peak, production processes are
relatively standardized and global price competition forces production site
relocation to lower cost developing countries.
4. Decline. Market factors and cost pressures dictate that almost all
production occur in developing countries. The product is then imported by
the country where it was initially developed.
B. Verification and Limitations of the PLC Theory
Exceptions to the typical pattern of the international product life cycle would
include: products that have very short life cycles, luxury goods, products that
require specialized labor, products that can be differentiated and products for
which transportation costs are relatively high.
IX. COUNTRY SIMILARITY THEORY
Previously examined theories would lead one to conclude that the greater the
dissimilarity among countries, the greater the potential for trade. However, the country
similarity theory states that when a firm develops a new product in response to observed
conditions in the home market, it is likely to turn to those foreign markets that are most
similar to its domestic market when commencing its initial international expansion
activities.
A. The Economic Similarity of Industrial Countries
So much trade takes place among industrialized countries because of the growing
importance of acquired advantage (skills and technology). In addition, markets in
most industrialized countries are large enough to support new product
introductions and their subsequent variants across the life cycle.
B. The Similarity of Location
Countries that are near to each other enjoy relatively lower transportation costs
than those that are more distant. While the disadvantages of distance may be
overcome through innovative technology and marketing methods, such gains are
difficult to maintain in the long run.
C. Cultural Similarity
Cultural similarity as expressed through language and religion is a major
facilitator of the international trade and investment process.
D. The Similarity of Political and Economic Interests
Countries that agree politically and are economically similar are likely to
encourage trade among themselves. In some circumstances at least, they may also
discourage trade among countries with whom they disagree.
X. DEGREE OF DEPENDENCE
Theories of independence, interdependence and dependence help explain world trade
patterns and countries’ trade policies. Realistically, countries are located along a
continuum between the two extremes.
A. Independence
Under conditions of independence, a country would not rely on other countries
for any goods, services, or technologies.
B. Interdependence
One way a country can limit its vulnerability to foreign changes is
through interdependence, i.e., the development of trade relationships on the basis
of mutual need. Each country depends about equally on the other as a trading
partner, so neither is likely to cut off supplies or markets for fear of retaliation
from the partner nation.
C. Dependence
Many developing countries are dependent (rely on) on the sale of one primary
commodity, or on one country as a primary customer and/or supplier. In addition,
emerging economies largely depend on production processes that compete on the
basis of low-wage inputs.
XI. STRATEGIC TRADE POLICY
Governments have long debated their roles in affecting the acquired advantage of
production within their borders. From the standpoint of national competitiveness, the
issue revolves around the development of successful industries. The two basic approaches
to strategic trade policy are (a) alter conditions that will affect industry in general or (b)
alter conditions that will affect a targeted industry.
XII. WHY COMPANIES TRADE INTERNATIONALLY

Regardless of the advantages a country may gain by trading, international trade will not
ordinarily occur unless companies within that country have competitive advantages and
perceive that international opportunities are greater than domestic ones.
A. The Porter Diamond
In addition to the four determinants of national competitive advantage that are set
forth in the Porter diamond, the roles of chance and government are also critical.
Usually all four determinants need to be favorable if a given national industry is
going to attain global competitiveness.
1. Demand Conditions. The nature and size of demand in the home market
lead to the establishment of production facilities to meet that demand.
2. Factor Conditions. Resource availability (inputs, labor, capital and
technology) contributes to the competitiveness of both firms and nations
that compete in particular industries.
3. Related and Supporting Industries. The local presence of internationally
competitive suppliers and other related industries contributes to both the
cost effectiveness and strategic competitiveness of firms.
4. Firm Strategy, Structure and Rivalry. The creation and persistence of
national competitive advantage requires leading-edge product and process
technologies and business strategies.
B. Points and Limitations of the Porter Diamond
The existence of the four favorable conditions often represents a necessary but not
a sufficient condition for the development of a particular national industry. Even
when abundant, resources are ultimately limited, thus firms must make choices
regarding their pursuit of existing opportunities. Further, given the ability of firms
to gain market information and production inputs from abroad, the absence of any
of the four conditions within a country may be overcome by their existence
internationally.
XIII. COMPANIES’ ROLE IN TRADE

International trade occurs because of the completion of mutually satisfactory transactions
between or among importers and exporters.
A. Strategic Advantages of Exports
The strategic advantages of exports include the utilization of excess capacity (that
in turn leads to improved economies of scale and cost competitiveness), the
potential profitability due to the nature of demand and government policies found
in foreign markets, as well as overall business risk minimization.
B. Strategic Advantages of Imports
The strategic advantages of imports include lower-cost, higher-quality products,
product line differentiation and expansion opportunities and overall business risk
minimization.
ETHICAL DILEMMA:
Values, Free Global Trade and Production Standards—A Hard Trio to Mix
The debate over laissez-faire versus activist government trade policies is generally a heated one
because different country values underlie differing views and government policies. The argument
for free trade policy is based on the achievement of global economic efficiency, but the
associated social and environmental values may differ across countries and cultures. Ethical
questions center on whether (a) all countries should have similar production standards and (b)
firms should be permitted to locate production activities in countries whose lower standards
allow them to realize lower costs.

Companies Adjust to Changing Trade Policies and Conditions
Firms have greater opportunities to pursue global strategies and capture economies of scale by
serving markets in more than one country from a single base of production if those countries
have relatively few restrictions on foreign trade and investment activities. Current issues concern
the future of trade relationships between industrialized and developing countries, as well as the
concept of national sovereignty. At least four factors might cause merchandise trade to become
relatively less significant in the future:
 the growing tide of protectionist sentiment
 the possibility of more efficient country-by-country production
 increasingly flexible and efficient small-scale production methods
 the rapid growth of services as a portion of production and consumption within the
industrialized nations.
WEB CONNECTION

relating to the topics presented in Chapter 5. Be sure to refer your students to the on-line
study guide, as well as the Internet exercises for Chapter 5.
_________________________
CLOSING CASE: The Indian Cashew Processing Industry [See Map 5.2]
1. What trade theories help to explain where cashew tree products have been produced
historically?
The primary theory that explains where cashew trees have been found historically is that
of factor proportions. Originally found in Brazil, the cashew tree was introduced into
other tropical countries by Portuguese traders. Vulnerable to insects in the close quarters
of plantations, cashews propagate in the wild forests of India, East Africa, Indonesia,
Southeast Asia and Brazil, i.e., places where the soil and climatic conditions are
favorable. Because cashew fruit only keeps for 24 hours after being harvested, it is
essentially bound to the place where it is grown. Cashew nuts, on the other hand, can last
a year or longer if properly handled. However, processing requires manual dexterity even
though wage rates are low. If the nut breaks during processing, its value decreases
significantly. Because the processing methods do not require expensive machinery, nuts
can be processed wherever there is a trained workforce willing to work for low wages.
Given the cost dimensions of the process, both the concepts of absolute and comparative
advantage apply. Once mechanical equipment was developed to replace hand processing,
product variants were distinguishable on the bases of quality and flavor differences, and
new competitors were present in the marketplace; it is evident that the cashew is moving
across the stages of the international product life cycle.
2. What factors threaten India’s future competitive position in cashew nut production?
Many developing countries are able to produce and/or process nuts as cheaply as India
and may, in some instances, be geographically or culturally closer to certain markets than
India. In addition, India’s position in cashew nut production is threatened by continued
improvements in the mechanical equipment designed to replace hand processing. All of
these factors encourage new competitors to enter the market, particularly at the
processing level, thus cutting off India’s access to additional supplies and diminishing its
share of the market.
3. If you were an Indian cashew producer, what alternatives might you consider to
maintain future competitiveness?
A cashew producer who competes in the high-end of the market will have a continued
advantage in the sale of higher-grade nuts until such time as newer machinery solves the
breakage problem. In addition, Indian cashews can be differentiated because of their
distinct flavor differences, which are the result of the growing conditions and process.
Therefore, given India’s leadership position with respect to cashew production and
product quality, producers should work hard to establish a national brand identity and
capture the country-of-origin assets associated with Indian cashews. However, Indian
producers must at the same time develop a contingency plan for the eventual possibility
of having to replace workers with processing machines and shifting those workers to
other types of jobs. Producers should also be proactive in terms of finding new uses for
products from the cashew tree.
Additional Exercises: The International Trade Process
Exercise 5.1. The concepts of absolute and comparative advantage and the international
product life cycle all deal with the composition of trade, i.e., explanations as to what
products are traded by given nations. Ask students to discuss the likelihood that (a) an
innovating country, (b) another industrialized country and (c) a developing country would
enjoy an absolute advantage, a comparative advantage, or no particular advantage as a
product moves through each of the stages of the international product life cycle. Be sure
students explain their reasoning.
Exercise 5.2. The factor proportions theory and the theory of country similarity both deal
with patterns of trade, i.e., national trading partners. Ask students to compare and
contrast the two theories, i.e., in what ways are they complementary and in what ways do
they differ? Then select the home countries of various students in your class and ask the
students to identify their natural and acquired advantages and then compare the various
similarities of the selected countries.
Exercise 5.3. Porter’s diamond deals with the competitive advantages of nations. Select
the home countries of various students in your class. Then lead the class in a comparative
analysis of the four points of Porter’s diamond, plus the roles of chance and government,
in each of those nations. Conclude the discussion by exploring the associated competitive
advantages that may accrue to firms that operate in each of those countries.
Government Influence on Trade
Objectives
! Evaluate the rationale for government policies that enhance and restrict trade.
! Examine the effects of pressure groups on trade policies.
! Compare the protectionist rationales used in developed countries with those used in
developing economies.
! Study the potential and actual effects of government intervention on the free flow of
trade.
! Give an overview of the major means by which trade is restricted, regulated and
liberalized.
! Profile the GATT and the World Trade Organization.
! Show that government trade policies create business uncertainties and business
opportunities.
Chapter Overview
A government’s political objectives are often at odds with economic proposals to improve its
market efficiency and international competitiveness. Chapter 6 first discusses the ways in which
governments intervene in the international trade process, their reasons for doing so and the
economic and non-economic effects of those actions upon participants in the process. It then
examines the role of the General Agreement on Tariffs and Trade and the World Trade
Organization in the international trade arena. The chapter concludes with a discussion of some
ways in which firms can deal with adverse trading conditions.
Chapter Outline
OPENING CASE: European and U.S. Trade Relations
This case vividly describes government influence on trade among the European Union,
the United States and the banana-producing countries of Latin America. In 1993, the EU adopted
a trade policy that directly favored the small banana growers in various countries in Africa,
the Caribbean and the Pacific. Following a nine-year “banana war” between the U.S. and the EU
that finally played out before the World Trade Organization, a truce was declared and a new
spirit of trade cooperation decreed. At the same time, however, the U.S. and the EU continued to
disagree on other trade matters such as the importation of hormone-treated beef, the labeling and
licensing of genetically modified foods, data protection and privacy, aerospace subsidies,
standards for a new generation of cellular phones and agricultural subsidies. The situation
reached a new extreme when President Bush moved to protect the U.S. steel industry through the
imposition of tariff barriers. The European Union blasted the U.S. for violating basic free trade
principles and WTO directives and retaliated by imposing trade sanctions on an assortment of
politically-targeted U.S. products.
Teaching Tip: Carefully review the PowerPoint slides for Chapter 6. Also review in the
text Table 6.3—GATT Milestones.
I. INTRODUCTION
In principle, no country allows an unregulated flow of goods and services across its
borders. Likewise, governments may choose to enable the global competitiveness of their
own domestic firms. The rationale for such policies may be economic or non-economic in
nature. Protectionism refers to government measures designed to shield domestic
industries from foreign competition. Such measures often provide direct or indirect
subsidies intended to help domestic firms compete with foreign producers either at home
or abroad.
II. CONFLICTING RESULTS OF TRADE POLICIES

While governments intervene in trade to attain economic, social and/or political
objectives, they also pursue political rationality when they do so. However, aiding
struggling constituencies without penalizing those who are well off is often impossible.
In addition to conflicting goals, there also looms the ever-present threat of retaliation
against protectionist actions.
III. ECONOMIC RATIONALES FOR GOVERNMENT INTERVENTION
A. Unemployment
One of the most effective types of political pressure is organized labor’s efforts to
preserve domestic jobs. By limiting imports, local jobs are retained as firms and
consumers are forced to purchase domestically produced goods and services.
However, unless the protectionist country is relatively small, such measures are
usually ineffective with respect to limiting unemployment. Further, such measures
are likely to lead to retaliation. Thus governments must carefully balance the costs
of higher prices with the costs of unemployment and the displaced production that
would result from free trade.
B. Infant-Industry Argument
First presented by Alexander Hamilton in 1792, the infant industry
argument holds that a government should shield emerging industries in which the
country may ultimately possess a comparative advantage from international
competition until its firms are able to effectively compete in world markets.
Eventual competitiveness is the result of movement along the learning curve plus
the efficiency gains from achieving the economies of large-scale production.
Nonetheless, infant-industry protection requires some segment of the economy
(typically local consumers) to incur the initial higher cost of inefficient local
production.
C. Industrialization Argument
Emulating historical patterns, many of today’s emerging economies use trade
protection to spur local industrialization.
1. Use of Surplus Workers. Surplus workers can more easily be used to

increase manufacturing output than agricultural output. However, this shift
may also lead to decreasing agricultural output and increasing demand for
social services. In this instance, improved agriculture practices may be a
better means of achieving economic success.
2. Promoting Investment Inflows. Import restrictions may increase foreign
direct investment if foreign firms want to avoid the loss of a lucrative or
potential market. The fact that FDI inflows may lead to increased local
employment is attractive to policy makers.
3. Diversification. Price variations can wreak havoc on economies that rely
on just a few commodities for job creation and export earnings. Contrary
to expectations, however, unless a country’s industrial base is expanded, a
move into manufacturing may simply shift that dependence from a
reliance on the basic commodities to the downstream manufactured goods
produced from them.
4. Greater Growth for Manufactured Products. Terms of trade refers to
the quantity of imports a given quantity of a country’s exports can buy.
Many emerging nations have experienced declining terms of trade because
the prices of raw materials and agricultural commodities have not risen as
fast as the prices of finished goods. In addition, changes in technology
have reduced the need for many raw materials. Further, cost savings
realized from manufactured products go mainly to higher profits and
wages, thus fueling the industrialization process.
5. Import Substitution vs. Export Promotion. Import
substitution represents an economic development strategy that relies on
the stimulation of domestic manufacturing by erecting barriers to imported
goods. If the protected industries do not become globally competitive,
however, local customers will continually be penalized by high
prices. Export promotion, on the other hand, encourages economic
development by harnessing a country-specific advantage (e.g., low labor
costs) and building a vibrant manufacturing sector through the stimulation
of exports. In reality, when effectively crafted, import substitution policies
may eventually lead to the possibility of export promotion as well.
6. Nation Building. The industrialization process helps countries build
infrastructure, advance rural development, enhance the quality of peoples’
lives and boost the skills of the workforce.
D. Economic Relationships with Other Countries
Countries track their own performance as compared to other countries and then
decide if they should impose trade restrictions as a means of improving their
competitive positions.
1. Balance of Payments Adjustments. The trade account is a major part of
the balance of payments for most countries. If balance-of-payments
difficulties persist, a government may restrict imports and/or encourage
exports in order to balance its trade account.
2. Comparable Access, or “Fairness.” Economic theory supports the idea

that a given country’s firms are entitled to the same access to foreign
markets as foreign firms have to their market. However, restricting trade,
even on the grounds of “fairness,” may lead to higher prices for domestic
customers.
3. Price-Control Objectives. Countries may withhold products from
international markets in an effort to raise world prices and thus improve
export earnings and/or favor domestic customers. (OPEC is a good case in
point.) The practice of pricing exports below cost, or below their home-
country prices, is known as dumping. Most countries prohibit imports of
“dumped” products, but enforcement usually occurs only if the product
disrupts domestic production. The optimum-tariff theory claims a foreign
producer will lower its prices if the destination country places a tariff on
its products. So long as the foreign producer lowers its price by any
amount, some shift in revenue goes to the importing country and the tariff
is deemed an optimum one.
IV. NONECONOMIC RATIONALES FOR GOVERNMENT INTERVENTION

A. Maintaining Essential Industries
The essential industry argument states a government will apply trade restrictions
to protect essential domestic industries so the country is not dependent on foreign
sources of supply. Protecting an inefficient industry, however, will inevitably lead
to higher costs.
B. Dealing with “Unfriendly” Countries
Groups concerned about security use national defense arguments to prevent the
export, even to friendly countries, of strategic goods that might fall into the hands
of potential enemies. Trade controls on non-defense goods may also be used as a
foreign policy weapon to try to prevent another country from meetings its political
objectives.
C. Maintaining Spheres of Influence
To maintain their spheres of influence, governments may give aid and credits to
and encourage imports from countries that join a political alliance or vote a
preferred way within international bodies.
D. Preserving Cultures and National Identity
Countries are partially held together though a unifying sense of cultural and
national distinctiveness. To sustain this collective identity, governments may limit
the presence of foreign products in certain sectors.
V. INSTRUMENTS OF TRADE CONTROL [See Figure 6.3]

Governments use many rationales and seek a range of outcomes when they try to
influence the international trade process. The choice of the instrument(s) of trade control
is crucial because each type may incite different responses from both domestic and
foreign groups. While some instruments directly limit the amount that can be traded,
others indirectly affect the amount traded by directly influencing prices, i.e., while tariff
barriers directly affect prices and subsequently the quantity demanded, nontariff barriers
may directly affect price or quantity.
A. Tariffs
A tariff (also called a duty) is a tax levied on internationally traded

products. Exports tariffs are levied by the country of origin on exported
products; a transit tariff may be levied by a country through which goods pass en
route to their final destination; import tariffs are levied by the country of
destination on imported products. A tariff increases the delivered price of a
product; at the higher price the quantity demanded will be lower. A specific
duty is a tariff that is assessed on a per-unit basis; an ad valorem tariff is assessed
as a percentage of the value of an item. If both a specific duty and an ad
valorem tariff are assessed on the same product, it is known as a compound
duty. Tariffs generate revenues for the assessing government or body.
B. Nontariff Barriers: Direct Price Influences
Nontariff barriers (NTBs) represent administrative regulations, policies and
procedures, i.e., quantitative and qualitative barriers, which directly or indirectly
impede international trade.
1. Subsidies. Subsidies consist of direct or indirect financial assistance from
governments to their domestic firms to help them overcome market
imperfections and thus make them more competitive in the marketplace.
2. Aid and Loans. Governments may give aid and loans to other countries
but require the recipient to spend the funds in the donor country; this is
known as tied aid or tied loans. In this way some products that might
otherwise be noncompetitive may in fact find international markets.
3. Customs Valuation. Sometimes it is difficult to determine the true value
of traded products. First, customs officials should use the declared invoice
price. If there is none, or if the authenticity of the value is in doubt, then
customs agents may assess the shipment on the basis of the value of
identical (preferable) or similar (acceptable) goods arriving at about the
same time.
4. Other Direct Price Influences. Other means countries may use to affect
prices include establishing special fees for consular and customs clearance
and documentation, requirements that customs deposits be made in
advance of shipment and minimum price levels at which products can be
sold after they receive customs clearance.
C. Nontariff Barriers: Quantity Controls
Quantity controls limit the supply of a product; the resulting shift in the supply
curve means the equilibrium price will then be higher.
1. Quotas. A quota represents a numerical limit on the quantity of a product

that may be imported or exported in a given period of time. (Because of
the increase in the equilibrium price, quotas may increase per-unit
revenues for firms that participate in the market.) Voluntary export
restraints (VERs) represent a negotiated limitation of exports from one
country to another and, as in the case of a quota, may result in higher
prices to customers. An embargo represents an outright ban on imports
from or exports to a particular country, i.e., it’s an economic means for
achieving a political goal. (A commodity cartel seeks higher, more stable
prices for its goods by assigning production quotas to individual countries
and thus limiting overall output.)
2. “Buy Local” Legislation. Buy local legislation represents laws intended
to favor the purchase of domestically sourced products over imported
products, particularly with respect to government procurement. Local
content requirements, i.e., costs incurred within the local country (usually
measured as a percentage of total costs), fall within this category.
3. Standards. The professed purpose of standards is to protect the safety or
health of the domestic population. However, countries may also devise
classification, labeling and testing standards that facilitate the sale of
domestic products but obstruct the sale of foreign-sourced products.
4. Specific Permission Requirements. Import and export licenses require
that firms secure permission from government authorities before
conducting trade transactions. Such procedures directly restrict trade when
permission is denied and indirectly restrict trade because of the cost, time
and uncertainty involved in the process. A foreign exchange
control requires an importer of a given product to apply to a government
agency to secure the foreign currency to pay for the product.
5. Administrative Delays. Intentional administrative delays create
uncertainty and increase the cost of carrying inventory. However,
competitive pressures can motivate countries to improve inefficient
administrative systems.
6. Reciprocal Requirements. Governments may require foreign suppliers
to accept products in lieu of money. Barter, i.e., the direct exchange of
products between two parties, and offset, i.e., the agreement by a foreign
firm to purchase products with a specified percentage of the proceeds from
an original sale within the importing country, both represent forms
of countertrade (see Chapter 17).
7. Restrictions on Services. Countries restrict trade in services for reasons
of essentiality and the maintenance of standards.
a. Essentiality. Countries consider certain services industries to be
essential because they serve strategic purposes or provide social
assistance to citizens. Private companies of any sort may be
prohibited, and in other cases price controls may be imposed by the
government; government-owned operations are often subsidized.
Essential services can include the public transportation, banking,
utilities, security and communications sectors.
b. Professional Standards. Governments may limit foreign entry

into particular service professions in order to assure that
practitioners are qualified. Licensing standards vary by country
and extend to a wide variety of occupations. Prerequisites for
taking certification examinations may be lengthy.
c. Immigration. Government regulations often require an
organization, whether domestic or foreign, to demonstrate the
skills needed for a particular job are not available locally before
hiring a foreigner.
VI. THE WORLD TRADE ORGANIZATION (WTO)

Governments actively cooperate with each other to reduce or remove trade barriers
through the auspices of the GATT and the WTO.
A. The General Agreement on Tariffs and Trade (GATT)
The General Agreement on Tariffs and Trade (GATT) was established by 23
signator nations in 1947 as a multilateral agreement with the objective to
liberalize world trade. The fundamental principle of “trade without
discrimination” was embedded in the most-favored-nation clause, i.e., the
principle that each member nation must open its markets equally to every other
member nation. Eight major rounds of negotiations from 1947 to 1994 (see Table
6.3) led to a wide variety of multilateral reductions in both tariff and nontariff
barriers. At the conclusion of the Uruguay Round, the World Trade Organization
was created for the purpose of institutionalizing the GATT.
B. The World Trade Organization (WTO)
The World Trade Organization (WTO) was founded in 1995 as a permanent
world trade body for the purpose of facilitating the development of a free and
open international trading system according to the GATT and for the adjudication
of trade disputes between or amongst member nations. The WTO adopted the
principles and agreements reached under the auspices of the GATT but expanded
its mission to include trade in services, investment, intellectual property, sanitary
measures, plant health, agriculture, textile and technical barriers to trade.
Currently the 140 member countries of the WTO collectively account for more
than 90 percent of world trade.
1. Normal Trade Relations. The WTO replaced the most-favored-
nation clause with the concept of normal trade relations, which prohibits
any sort of trade discrimination. With the following exceptions, it restricts
this privilege to official members:
a. Under the Generalized System of Preferences (GSP), emerging
economies’ manufactured goods are given preferential treatment
(lower barriers) over those from industrial countries in member
markets.
b. Concessions granted to members of economic blocs, such as the
EU or NAFTA, are not extended to countries outside the blocs.
(See Chapter 7)
c. Exceptions can be made in times of war or international tension.
2. Settlement of Disputes. Under the WTO there exists a clearly defined
mechanism for the settlement of disputes. Countries may bring charges of
unfair trade practices to a WTO panel; accused countries may appeal;
WTO rulings are binding.
VII. DEALING WITH GOVERNMENT TRADE INFLUENCES

Although each option has associated risks and costs, firms can deal with trade restrictions
by (a) moving operations to a lower-cost country, (b) concentrating on market niches that
attract less international competition, (c) adopting internal innovations that lead to greater
efficiency or superior products, or (d) trying to get government protection. Whether a
firm benefits more from protectionism or more from some other means for countering
international competition depends upon its own international strategy. Chances of success
in securing protectionism will be enhanced if companies enlist pertinent stakeholders to
share in the necessary lobbying efforts.
ETHICAL DILEMMA:
Do Trade Sanctions Work?
Countries wrestle with the basic question of whether to use trade policy to try to change
objectionable policies in other nations. The principal dilemma is the issue
of relativism versus normativism. Overall, trade sanctions aimed at changing policies in foreign
countries seldom work as intended; in fact, they can even cause job and other economic losses in
the sanctioning country. Some argue, however, that the ultimate purpose of sanctions is to make
a meaningful social or moral declaration. Other arguments against sanctions include the costs to
innocent people, the inability of sanctions to induce a change in leadership, the unevenness with
which policies are applied across countries, and the lack of agreement about the cause(s) being
protested.

The Prospects for Freer Trade
Countries usually prefer to exercise their sovereignty. However, they may cede authority on
trade issues by agreeing to the binding provisions of the WTO or by becoming members of a
regional economic bloc in order to capture the general advantages associated with doing so.
Groups that feel they are adversely affected by imports and/or unfair trade practices will try to
slow foreign trade liberalization. At the same time, consumers (and therefore firms) want to buy
high-quality products at cost-competitive prices. Thus, stakeholders must reason together as the
world continues to move toward freer markets and countries strive for the growth and
development of their own economies.
WEB CONNECTION

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CLOSING CASE: U.S.-Cuban Trade [See Map 6.1, Figure 6.4]
1. Should the U.S. seek to tighten its economic grip on Cuba? If so, why?
From a practical standpoint, most would argue that without the cooperation of the rest of
the world, there is little left that the U.S. can do. However, given the consensus
that Cuba consistently violates human rights, the continuance of U.S. trade sanctions
against Cuba is consistent with U.S. policy. In addition, Cuba’s expropriation of
American property without compensation is internationally recognized as unacceptable
behavior; thus, retaliation can be seen as an appropriate response. Finally, there is the
argument that if the Cuban economy can be further weakened, Castro may be
overthrown.
2. Should the U.S. normalize business relations with Cuba? If so, should the U.S. stipulate
any conditions?
There are both political and economic reasons for normalizing relations with Cuba. Cuba
has long-since ceased to be a military threat, and there is hope that closer political
relations with the U.S. (and the rest of the free world) will lead to greater democracy in
Cuba. Further, Cuban trade sanctions are far tougher than those levied by the U.S. against
Iran, Iraq, Libya and North Korea. Economically, it is argued that because of the U.S.
government posture, U.S. firms are losing out on opportunities to sell their products in
Cuba to competitors from other countries. However, it is not likely that Cuba would trade
with the U.S. as aggressively as in the past, even if it were possible. While progress in the
area of human rights may be slow, experience in other countries suggests that imposing
some human rights conditions may be effective in the long run. In addition, the U.S.
government may wish to facilitate the return to Cuba of U.S. companies whose properties
were expropriated, even though any remaining assets are likely in a state of serious
disrepair.
3. Assume you are Fidel Castro. What kind of trade relationship with the U.S. would be in
your best interest? What type would you be willing to accept?
Castro would logically want a trade relationship that would permit him to save face
politically while contributing to the economic development of the economy. Initial
overtures from the U.S. government could help bolster his political position and thus
would possibly be welcome as a way to begin negotiations. Economic development
assistance could come in the form of direct aid and, possibly, foreign direct investment,
although there surely would be substantial controls on either form.
4. How do the structure and relationships of the American political system influence the
existence and specification of the trade embargo?
The structure and relationships of the American political system serve to reinforce the
existence and specification of the Cuban trade embargo. Pro-embargo supporters
relentlessly lobby the U.S. Congress and presidential administration to tighten the
embargo in order to spur the collapse of Cuban communism. While recently diminished,
the pro-embargo viewpoint is supported by key people in key positions throughout the
government.
Additional Exercises: Government Influence on Trade

Exercise 6.1. Ask students to debate the use of embargoes as a means to accomplish
political objectives. Can an embargo by a single nation against another be truly effective,
or must it be a multilateral, if not a unilateral, action? Should the use of an embargo ever
be subject to the scrutiny of the World Trade Organization? Why or why not?
Exercise 6.2. From a global perspective one can observe excess capacity in the steel,
automobile and airline industries in both industrialized and developing countries. Ask
students to discuss the logic of (rationale for) this from the standpoint of the Infant
Industry Argument. Then ask them to debate whether the argument should be applied
only in the case of developing countries or in the case of all countries.
Exercise 6.3. In 1998 the World Trade Organization issued a ruling in which it said the
U.S. was wrong to prohibit shrimp imports from countries that failed to protect sea turtles
from entrapment in the nets of shrimp boats. The basic position of the WTO was that
while environmental considerations are important, the primary aim of international trade
agreements is the promotion of economic development through unfettered free trade. Ask
students to debate the position of the WTO in decoupling trade and environmental policy.
Regional Economic Integration

and Cooperative Agreements
Objectives
! Define different forms of economic integration and describe how each form affects
international business.
! Describe the static and dynamic effects as well as the trade creation and diversion
dimensions of economic integration.
! Present different regional trading groups such as the European Union (EU), the North
American Free Trade Agreement (NAFTA) and Asia-Pacific Economic Cooperation
(APEC).
! Describe the rationale for and success of commodity agreements.
! Discuss the effects of economic integration on the environment.
Chapter Overview
Regional economic integration represents a relatively new phenomenon in the history of world
trade and investment. Chapter 7 introduces the basic types of economic integration and discusses
both its potential positive and negative effects. It examines in detail both the European Union (its
structure and its operations) and the North American Free Trade Agreement. It then briefly
examines a variety of other regional economic groups. The chapter concludes with a discussion
of various commodity agreements, producer alliances and cartels, including the Organization for
Petroleum Exporting Countries.
Chapter Outline
OPENING CASE: Ford Europe
This case describes the way in which Ford Europe recently dealt with the challenges of an
increasingly competitive and dynamic European marketplace. Ford began production operations
in Europe in 1911 and ran the various operations there as separate subsidiaries until 1967, when
it created the regional umbrella of Ford Europe and began designing and assembling similar
automobiles throughout Europe. In 1995, Ford merged its North American and European
operations, shifted its focus to one of product lines rather than regions, and
assigned Europe responsibility for the development of small and mid-size cars. Sensing this
centralized strategy was pushing Ford too far away from its local markets, in 2000 Ford’s
European management undertook a “transformation strategy.” Ford closed certain factories and
turned others into “flex factories” where they can produce multiple cars on one production line.
Following the Firestone tire recall and the global economic downturn, Ford suffered a worldwide
loss of $5.45 billion in 2001. In Europe, however, after incurring a $1.1 billion loss in 2000, Ford
Europe broke even in 2001. Given the continuing challenges of the global economic
environment, Ford may be hard pressed to continue such success in Europe in the years to come.
Teaching Tip: Carefully review the PowerPoint slides for Chapter 7 and select those you
find most useful for enhancing your lecture and class discussion. For additional visual
summaries of key chapter points, also review the maps and tables in the text.
I. INTRODUCTION
Regional trading groups are an important influence on the strategies of MNE’s because
economic blocs define the size of regional markets and the rules under which firms must
operate. While WTO members are required to grant the same favorable trade conditions
to all other WTO members, the organization allows a departure from this principle in the
case of regional trade agreements.
II. REGIONAL ECONOMIC INTEGRATION

Regional economic integration represents an agreement between or among countries
within a geographic region, i.e., an economic bloc, to reduce and ultimately remove
within the bloc tariff and nontariff barriers to the free flow of goods, services, capital and
labor. Neighboring countries tend to ally because of their proximity to one another,
somewhat similar regional tastes, the relative ease of establishing channels of distribution
and a willingness to cooperate with one another for the greater benefit of all allied parties.
A. Types of Regional Economic Integration
1. Free Trade Area (FTA). A free trade area represents an economic bloc
in which all barriers to trade are abolished among member countries, but
each member maintains its own independent external trade barriers
beyond the bloc.
2. Customs Union. A customs union represents an economic bloc in which
all barriers to trade are abolished among member countries, and common
external barriers are levied against non-members.
3. Common Market. A common market represents an economic bloc in
which all barriers to trade are abolished among member countries,
common external barriers are levied against non-members and restrictions
on the internal flows of capital and labor are abolished.
4. Economic Integration. Economic integration, i.e., an economic

union, represents an economic bloc in which members abolish all barriers
to trade and flows of capital and labor within the bloc; establish common
external trade and investment barriers; harmonize commercial, monetary
and fiscal policies; establish a common currency and establish a
supranational political structure to deal with economic issues. (The limited
degree of political integration represents a tradeoff between the loss of
sovereignty on the one hand, and economic gains on the other.)
B. The Effects of Economic Integration
Regional economic integration can affect member countries in social, cultural,
political and economic ways. (MNEs are particularly interested in the economic
effects.) Static effects represent the shifting of resources from inefficient to
efficient firms as trade barriers fall. Dynamic effects represent the impact of
overall growth in the market, the expanding of production, the realization of
greater economies of scope and scale and the increasingly competitive nature of
the market.
1. Trade Creation. Trade creation occurs when production shifts from less
efficient domestic producers to more efficient regional producers for
reasons of absolute or comparative advantage, thus giving customers
access to a wider variety of lower-cost, higher quality products.
2. Trade Diversion. Trade diversion occurs when, as a result of common
external barriers, trade shifts from more efficient external sources to less
efficient suppliers within the bloc.
C. Major Regional Trading Groups
Firms are interested in regional trading groups for their markets, sources of raw
materials and production factors and locations.
III. The European Union (EU)

The European Union represents the most advanced regional trade and investment bloc in
the world today. Key milestones for the European Union are summarized in Table 7.1.
Map 7.1 identifies the members of the EU. Detailed information on the history, structure
and function of the EU is available on its website.
A. The EU’s Organizational Structure
While the European Council is designed to lead the EU, the European
Commission functions as its draftsman and servant, the European Parliament is its
sounding board and the European Court of Justice is the supreme appeals court
for EU law. These governance bodies set the parameters under which MNEs must
operate within the bloc.
1. The European Commission. The European Commission provides the
EU’s political leadership and direction; it consists of 20 members
appointed by member countries for four-year renewable terms. The
Commission is responsible for proposing EU legislation, implementing it
and monitoring compliance with EU laws by member states.
2. The European Council. Also known as the Council of
Ministers, the European Council is composed of one representative from
the government of each member state, but the particular membership
varies according to the topic under consideration. The Council can adopt,
amend, or ignore Commission-proposed legislation. It sets priorities, gives
political direction and resolves issues the European Commission cannot.
3. The European Parliament. Composed of 626 members (allocated on the

basis of country population) elected every five years, the European
Parliament considers legislation presented by theEuropean
Commission; if the legislation is approved, it is then submitted to
the European Council for final adoption. The Parliament also has control
over the EU budget and supervises executive decisions.
4. The European Court of Justice. The European Court of Justice ensures
consistent interpretation and application of EU treaties. Dealing mostly
with economic matters, it serves as an appeals court for individuals, firms
and organizations fined by the Commission for infringing upon Treaty
Law.
IV. THE SINGLE EUROPEAN MARKET

The Single European Act of 1987 was designed to eliminate all remaining barriers to
trade within the European Union and to harmonize commercial policy; nonetheless,
numerous barriers still remain.
A. Common Trade and Foreign Policy
During the initial formation of the EU, the focus was primarily upon economic
integration. Over time, however, member countries began to recognize the
benefits that could be realized from a common foreign policy as well. In 1993 the
EU began to formalize common objectives on armed conflicts, human rights and
other international foreign policy issues, although national attitudes often remain
splintered.
B. The EURO
The EURO represents a common European currency established on Jan. 1, 1999
as part of the EU’s move toward monetary union. The EURO is administered by
the European Central Bank (ECB), which was established on July 1, 1998 to set
monetary policy and manage the EURO’s exchange rate system. Member
countries, i.e., those part of the European Monetary Union (EMU), include all
members of the EU except the UK, Sweden, and Denmark. New bank notes were
issued in 2002. In general, the transition from a series of national currencies to a
single European currency has been smoother than predicted.
C. EU Expansion
The next level of EU expansion, set for 2004, is to include Poland, Hungary,
the Czech Republic, Slovenia, Slovakia, Latvia, Estonia, Lithuania, Malta and Cy
prus. Bulgaria and Romania have been given a date of 2007; Turkey has been put
on hold for human rights violations. The integration of such disparate countries
will not be easy—several are far from meeting the requirements for participation
in the EU. Even so, the size of the market will expand considerably and the EU’s
economic power will grow as well.
D. Implications of the EU on Corporate Strategy
Although Europe is moving closer together, it is still not as homogeneous as is
the U.S. Thus, while foreign firms will need to develop a pan-European strategy,
they should retain essential national strategies as well.
E. Where Next for the EU?

The EU will move closer to a free-market, borderless economy as the European
Court of Justice continues to remove obstacles to takeovers and other forms of
market entry into previously protected sectors. However, the recent downturn in
the economy appears to be slowing the pace and altering requirements with
respect to further economic integration.
V. THE NORTH AMERICAN FREE TRADE AGREEMENT (NAFTA)
The North American Free Trade Agreement (NAFTA) went into effect in 1994
following its signing by Canada, Mexico and the U.S., thus creating a regional economic
bloc of countries of quite different sizes and sources of national wealth. It represents a
powerful free trade area with a combined population and total GNI greater than that of
the 15-member EU. In general, the NAFTA calls for the elimination of tariff and nontariff
barriers, harmonization of the rules of trade, liberalization of restrictions on services and
foreign investment, enforcement of intellectual property rights and a dispute settlement
process.
A. Rules of Origin and Regional Content
NAFTA’s rules of origin require that at least 50 percent of the net cost of most
products originate within the region if those products are to be eligible for the
more liberal tariff conditions available within the bloc.
B. Special Provisions of NAFTA
The NAFTA is a unique sort of trade agreement in that it also addresses two side
issues: (a) regional labor laws and standards and (b) strengthened environmental
standards.
C. Impact of NAFTA on Trade, Investment and Jobs
While trade within the NAFTA region has more than tripled since 1994, the
investment and employment pictures are less clear. While some FDI has been
flowing out of Mexico since the maquiladoraswere stripped of their duty-free
status in 2001, other FDI has been flowing into Mexico from countries
like Germany and Japan.
D. NAFTA Expansion
Representatives from 34 countries continue to meet to try to create the Free Trade
Area of the Americas (FTAA). In the meantime, Canada and Mexico have both
entered into free trade agreements withChile. In addition, Mexico entered into a
free trade agreement with the EU on July 1, 2001, which will end all tariffs on
their bilateral trade by 2007.
E. Implications of NAFTA on Corporate Strategy
NAFTA is causing firms from all three member countries to re-examine their trade
and investment strategies. A number of industries, such as automotive products
and electronics, already view the region as one large market and have rationalized
their production, products and financing accordingly. Although low-end
manufacturing tends to be moving south to Mexico, more sophisticated
manufacturing and services are increasing in the U.S. In addition, Canadian firms
are generating more competition for U.S. firms along the U.S.-Canadian border
than are Mexican companies along the U.S.-Mexican border. Finally, as Mexican
incomes continue to rise, Mexican demand for foreign products is also increasing.
VI. REGIONAL ECONOMIC GROUPS IN LATIN AMERICA, ASIA AND AFRICA

The major trade group in South America is MERCOSUR, a customs union established in
1991 by Brazil, Uruguay, Paraguay and Argentina. Unfortunately, Argentina’s economic
crisis is threatening the stability of the entire region. The Andean Group, first created in
1969, has recently changed its focus from one of isolationism to being open to trade and
investment. Other regional groups include the Latin American Integration Association
(ALADI) and the Caribbean Community and Common Market (CARICOM).
The Association of Southeast Asian Nations (ASEAN) was first organized in 1967. On
Jan. 1, 1993, it officially formed the ASEAN Free Trade Area for the purpose of cutting
tariffs on interregional trade to a maximum of 5% by 2008. The Asia-Pacific Economic
Cooperation (APEC) community comprises 21 countries that border the Pacific Rim on
both the east and the west. Formed in 1989 to promote multilateral economic cooperation
within the Pacific region, APEC leaders have committed themselves to achieving free and
open trade in the region by 2010 for the industrial nations and by 2020 for the remainder.
However, given its size as well as the diverse interests of its members, progress may be
problematic. Several regional trade groups also exist in Africa where, with the notable
exception of the Union of South Africa, markets are relatively small and undeveloped.
Often, however, such groups have been preoccupied with political rather than trade
issues. Further, many African nations rely more on trade links with former colonial
powers than with each other.
VII. COMMODITY AGREEMENTS

A commodity agreement is designed to stabilize the price and supply of a primary
commodity.
A. Producers’ Alliances and International Commodity Control Agreements
(ICCAs)
While producers’ alliances represent exclusive membership agreements between
or among producing countries (a cartel), international commodity control
agreements (ICCAs) represent agreements between or among producing and
consuming countries. Examples of the former are the Organization of Oil
Exporting Countries (OPEC) and the Union of Banana Exporting Countries;
examples of the latter are the International Cocoa Organization (ICO) and the
International Sugar Organization (ISO). Often a quota system is used to determine
how producing (and consuming) countries will divide total output in order to
stabilize the price.
B. The Organization of Petroleum Exporting Countries (OPEC)
The Organization of Petroleum Exporting Countries (OPEC) represents a
producer cartel, i.e., a group of commodity-producing countries with significant
control over supply and banded together in order to control output and price.
OPEC’s oil exports represent about 55 percent of the crude oil traded
internationally. It controls prices by establishing production quotas on member
countries, which include Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria,
Qatar, Saudi Arabia, the United Arab Emirates and Venezuela.
C. The Environment
Although many environmental problems are national in nature, they may have
cross-national ramifications that can only be solved through international treaties
and other agreements. Examples would be the concern over water quality along
the U.S.-Mexican border and the impact of acid rain along the U.S.-Canadian
border. Even when regional agreements do exist, they do not solve problems on a
global basis. One of the key economic issues dealt with by the United Nations is
environmental protection and socioeconomic development. Contrary to popular
belief, many MNEs rank among the world’s most environmentally responsible
firms. Often MNEs welcome environmental agreements because they put all
companies on the same level, so that one firm is not disadvantaged as compared
to others.
ETHICAL DILEMMA:
The Seattle WTO Protest Spotlights Free Trade’s Effect on the Environment
Individual countries and regional trade groups have made environmental issues much more of a
priority since the protests associated with the meeting of the World Trade Organization in Seattle
in 1999. While some groups take the position that increased trade should help the environment,
others admit that it can in fact be harmful. The WTO advocates dealing with specific
environmental issues while increasing trade at the same time, but developing countries are
concerned environmental issues could be used as an excuse to impose trade sanctions against
them.

How Much Territory Will Regional Integration Cover?
Regional economic integration deals with the specific problems facing member countries,
whereas the WTO is concerned about trade issues facing the world as a whole. As a result,
regional integration may help the WTO achieve its objectives as the process leads to the
liberalization of issues not covered by the WTO. Regional economic integration can also serve to
lock in trade liberalization across developing countries.
WEB CONNECTION

_________________________
CLOSING CASE: Wal-Mart de Mexico
1. How has the implementation of NAFTA affected Wal-Mart’s success in Mexico?
The NAFTA has facilitated Wal-Mart’s success in Mexico in various ways. First, it
reduced tariffs on American-sourced goods from 10% to 3%. Second, it encourages
Mexico to improve its transportation system and infrastructure, thus helping solve Wal-
Mart’s logistical problems. Third, it eases restrictions on foreign direct investment; as a
result, many of Wal-Mart’s foreign suppliers have built plants in Mexico, where they can
better serve the whole of the NAFTA region.
2. How much of Wal-Mart’s success is due to NAFTA, and how much is due to Wal-Mart’s
inherent competitive strategy? In other words, could any other U.S. retailer have the
same success in Mexico post-NAFTA, or is Wal-Mart a special case?
The same benefits that have accrued to Wal-Mart following the implementation of the
NAFTA are also available to other competitors. However, Wal-Mart uses its sheer size
and volume of purchases to negotiate prices to rock-bottom levels that are not available to
smaller competitors. It also works closely with suppliers on inventory levels, using an
advanced information system that informs suppliers when additional merchandise will be
needed, thus allowing them to plan production runs more accurately and pass along the
captured cost reductions. Then, rather than pocketing the accrued cost savings, Wal-Mart
reduces its prices. Retailers that wish to compete with Wal-Mart will either have to meet
Wal-Mart’s prices or position themselves in a different segment of the market.
3. What do you think Commercial Mexicana S.A. should do, given the competitive position
of Wal-Mart?
Commercial Mexicana is considering three basic options as it tries to survive in the new
competitive environment driven by the presence of Wal-Mart in Mexico: remaining
independent, merging with a local retail chain, or merging with a foreign retail chain.
First, the firm needs to carefully examine the market and determine (a) ways in which it
can differentiate itself from Wal-Mart (such as Target’s slightly up-scale market
approach) and (b) whether it possesses or at least has access to sufficient assets to survive
in the current environment. As part of that decision-making process, Commercial
Mexicana should attempt to get lower prices from its suppliers and also attempt to source
and sell some truly distinctive products. Commercial Mexicana also needs to consider
both the available sourcing and market opportunities it enjoys, given its location within
the NAFTA region. Finally, it should assess (a) what it can offer to and (b) what it would
desire from a local or foreign partner. With that information in hand, Commercial
Mexicana will be in a better position to make effective operating decisions.
Additional Exercises: The Economic Integration Process
Exercise 7.1. Ask students to compare the market entry strategies of exporting, licensing
and foreign direct investment in (a) a free trade area, (b) a customs union, (c) a common
market and (d) an economic union. What barriers and what incentives are they likely to
encounter? (Be sure students assume the perspective of a firm located outside of the
regional bloc of interest.)
Exercise 7.2. Prior to the breakup of the USSR, COMECON (also known as the Council
for Mutual Economic Assistance (CMEA)) held the Soviet bloc together economically. It
represented a trade association that existed to help fulfill the output goals of the central
planning authorities of Russia and its satellite countries. Ask students to discuss the
reasons they believe COMECON disintegrated in a post-Soviet environment
Exercise 7.3. Ask students to think of the major geographic areas of the world: Europe,
Asia (including Oceania), Africa, South America and North America. Have them
speculate the extent to which they expect regional economic integration to occur in each
of those areas (a) in 10 years and (b) in 25 years. Then ask them to discuss the extent to
which they expect global economic integration to occur in the next 25 years. Which
organization(s) do they expect will play a major role in that process?
Factor Mobility and Foreign Direct Investment
Objectives
! Show why the production factors of labor and capital move internationally.
! Evaluate the relationship between foreign trade and international factor mobility.
! Explain why investors and governments view direct investments and portfolio
investments differently.
! Describe companies’ motivations for and advantages from foreign direct investment.
! Demonstrate how companies make foreign direct investments.
! Show the major global patterns of foreign direct investment.
Chapter Overview
Foreign direct investment (FDI) comprises a large and increasingly important part of firms’
international activities and strategies. Chapter 8 explains what FDI is, how it is accomplished,
and the advantages it offers to firms that engage in it. The chapter first discusses the reasons for
and the effects of factor movements. It then explores the reasons firms engage in foreign direct
investment and the required resources and methods for doing so, i.e., the buy-vs.-build decision.
The chapter concludes with an examination of direct investment patterns and the role of FDI in
firms’ competitive strategies.
Chapter Outline
OPENING CASE: LUKoil [See Figure 8.1]
In 2001, Russia surpassed Saudi Arabia as the world’s largest producer of oil. That same
year LUKoil, Russia’s largest oil company, acquired 100 percent of Getty Petroleum in the U.S.
LUKoil is one of several companies created in 1991 out of the Russian state-owned petroleum
monopoly. Its decision to invest abroad by purchasing existing firms in more than 20 countries is
due to a combination of company-specific, industry-specific and global environmental
conditions. Forward integration into the ownership of foreign distribution outlets will reduce
LUKoil’s operating costs as well as its dependence on downstream customers. In addition, it will
assure the firm of market access when there is an excess of oil supply in the global marketplace.
Through its acquisitions, LUKoil also hopes to gain the latest in petroleum technology,
competitive know-how, marketing skills and operating efficiencies. Finally, LUKoil can reduce
both its currency and operating risks by holding a portion of its assets outside of Russia.
find most useful for enhancing your lecture and class discussion. For an additional visual
summary of key chapter points, also review the figures and tables in the text.
I. INTRODUCTION
Factors of production represent inputs into the production process, such as labor, capital
and know-how. Increasingly, those factors move internationally. In fact, a country’s
relative factor endowment may change because of factor movements. Foreign direct
investment (FDI) occurs when an investor gains a controlling interest in a foreign
operation either through acquisition or a start-up investment, i.e., FDI represents a
company controlled through ownership by a foreign firm or individuals. Sales from
foreign-owned operations are now about double the value of world trade.
II. FACTOR MOBILITY

A. Why Production Factors Move
Factor mobility concerns the free movement of factors of production, such as
labor and capital, across national borders. While capital is the most internationally
mobile factor, short-term capital is the most mobile of all. Capital is primarily
transferred because of differences in expected returns, although firms may also be
responding to government incentives. People may also transfer internationally in
order to work abroad, either on a temporary or a permanent basis. Often it is
difficult to distinguish between economic and political motives for international
labor mobility, because poor economic conditions often parallel repressive and/or
uncertain political conditions.
B. Effects of Factor Movements
Neither international capital nor population movements are new occurrences.
Immigrants bring human capital, thus adding to the base of a country’s skills and
enabling competition in new areas. Likewise, inflows of capital to those same
countries can be used to develop infrastructure and natural resources, thus leading
to its increased participation in the international trade arena.
C. The Relationship of Trade and Factor Mobility
Factor movement is an alternative to trade that may or may not be a more efficient
allocation of resources. When factor proportions vary widely among countries,
pressures exist for the most abundant factors to move to countries with greater
scarcity.
1. Substitution. The inability to gain sufficient access to foreign production
factors may stimulate efficient methods of domestic substitution, such as
the development of alternatives for traditional production methods. In
countries where labor is relatively abundant as compared to capital,
workers tend to be poorly paid; many will attempt to go to countries that
offer higher wages. Likewise, capital tends to move away from countries
where it is abundant to those where it is relatively scarce. [See Figure 8.3]
2. Complementarity. Factor mobility via foreign direct investment may in
fact stimulate foreign trade because of the need for equipment or
components by a foreign subsidiary. Alternatively, trade may be restricted
by local content laws or when FDI production leads to import substitution.
III. FOREIGN DIRECT INVESTMENT AND CONTROL
Firms naturally want to control their foreign operations in order to achieve their set
objectives, but governments often worry the activities of foreign companies may reflect
to decisions contrary to their countries’ best interests.
A. The Concept of Control
If ownership is widely dispersed, then a small stake may be sufficient to establish
effective managerial control of an investment. However, even sole ownership may
not guarantee effective control if a local government dictates policies and
procedures.
B. The Concern about Control
1. Government Concern. Many critics of FDI claim the host country’s
national interests may suffer if a multinational firm makes decisions from
afar on the basis of its own overall corporate benefit.
2. Investor Concern. Multinationals want what is best for their overall
corporate benefit, rather than what is best for a single operation in a
specific country. Without control, firms are less likely to transfer
technology and other competitive assets to foreign operations. With
control, they are more likely to transfer strategic assets and also achieve
lower overall operating costs. Appropriability theory concerns the idea of
denying either potential or existing rivals access to a firm’s strategic
resources. Internalization represents the self-handling, i.e., the internal
control, of business functions and operations, as opposed to the
outsourcing of those activities.
IV. COMPANIES’ MOTIVES FOR FDI

Foreign direct investment is a way for firms to fulfill any one of three major operating
objectives: to expand sales, to acquire resources and/or to minimize competitive risk.
[See Table 8.1.]
A. Factors Affecting the Choice of FDI for Sales Expansion
The liability of foreignness represents the disadvantage a firm suffers relative to
local companies when operating in a foreign country.
1. Transportation. When firms add the cost of transportation to those of
manufacturing, some products become impractical to ship great distances.
(When companies invest abroad in order to produce basically the same
products they make at home, the investment process is called horizontal
expansion.)
2. Excess Capacity. When firms have excess capacity, they may be able
compete in limited export markets in spite of additional transport costs. In
such situations, firms may choose to determine foreign prices on the basis
of variable rather than total costs. However, when firms need to add
capacity in order to meet foreign demand, it is likely they will do so within
or near the markets they intend to serve.
3. Scale Economies and Product Alterations. Firms that can achieve
significant economies of scale will often centralize production activities
and export to foreign markets. When they need to adapt products to
individual markets, however, firms will be more likely to produce
differentiated products in various foreign locations. The greater the
adaptation, the greater the likelihood production will shift abroad.
4. Trade Restrictions. In spite of the progress to reduce barriers to trade
through the GATT and the WTO, many restrictions still exist. In those
instances, firms may be forced to invest in operations in foreign markets in
order to overcome market imperfections.
5. Country-of-Origin Effects. Customers sometimes prefer (or are
required) to buy domestic rather than foreign-produced products; in other
instances they may prefer to source certain products (such as perfume or
cars) from particular foreign countries, believing them to be of superior
quality and/or value. In those instances, inherent benefits exist to
producing nationally-based products in their traditional countries of origin.
6. Changes in Comparative Costs. Shifts in comparative production costs
may cause firms to pursue resource-seeking investments.
B. Factors Affecting Motives to Acquire Resources through FDI
A firm may engage in foreign direct investment in order to source products from
abroad.
1. Vertical Integration. Vertical integration represents a firm’s ownership,
and hence control, of either upstream suppliers (backward integration)
and/or downstream customers (forward integration) in the value chain.
Firms integrate vertically in order to assure that inputs, outputs and
processes all flow efficiently and effectively. Because supplies and/or
markets are better assured via integration, firms may be able to reduce
inventories, spend less on promotion and avoid the costs of negotiating
and enforcing contracts.
2. Rationalized Production. Rationalized production characterizes the
situation in which different components or portions of a firm’s product
line are manufactured in different parts of the world in order take
advantage of lower-cost labor, capital and/or materials. Another possible
advantage of this strategy is smoother profits when exchange rates
fluctuate across national currencies.
3. Access to Knowledge. A company may invest abroad in order to gain
information for its organization as a whole.
4. The Product Life Cycle Theory. According to the Product Life Cycle
Theory, production will move from the innovating country to other
developed countries and then finally to developing nations. Ultimately a
product may be imported by the country where it was initially developed.
5. Government Investment Incentives. In addition to restricting imports,
governments frequently encourage direct investment inflows by offering
tax concessions and/or other subsidies. Such incentives may shift a firm’s
least-cost production location. [See Chapter 12 for an in-depth discussion
of this topic.]
C. Risk Minimization Objectives
Diversification through foreign direct investment is often a means of reducing
risk.
1. Following Customers. In the organizational (industrial) sector, suppliers
are often compelled to follow their downstream customers abroad if they
wish to capture the associated potential business.
2. Preventing Competitors’ Advantage. Firms in an oligopolistic industry
may follow their competitors abroad to prevent their gaining a first-mover
advantage. (Oligopolistic industries consist of relatively few producers
and sellers of a given product.)
D. Political Motives
Governments may provide incentives to their domestic firms to engage in foreign
direct investment in order to gain access to strategic resources (such as oil) or to
develop spheres of influence.
V. RESOURCES AND METHODS FOR MAKING FDI

A. Assets Employed
While FDI usually involves an international capital movement that crosses
international borders with the expectation of a higher return, other types of assets
such as managerial skills, technology, market information, etc. may be transferred
as well. Some or all of the required capital may also be borrowed in the host
country.
B. Buy vs. Build Decision
Firms can invest in foreign operations either through acquisition or through the
construction of new facilities.
1. Reasons for Buying. The advantages of acquiring an existing operation
include the avoidance of adding unneeded capacity to the industry, the
acquisition of a trained workforce and the possibility of acquiring an
existing brand. Thus, firms also avoid the inefficiencies of an initial start-
up process and generate an immediate cash flow.
2. Reasons for Building. The advantages of building a start-up operation
may include access to local financing, particularly if the firm plans to tap
development banks. In addition, start-up may be the only viable
investment option if no desirable company is available for acquisition; ill-
conceived acquisitions can lead to serious carry-over problems.
VI. INVESTOR’S ADVANTAGES

FDI can improve performance in several ways if a firm holds one or more advantages
over its competitors. A monopoly advantage accrues to a firm if it is able to gain a
unique advantage regarding technology, management skills, market access, etc. that is not
available to local (either domestic or foreign) competitors. Some firms may be able to
borrow capital at a lower interest rate than others, some may enjoy increased buying
power because of currency fluctuations and others may gain from spreading the costs of
product differentiation, R&D and advertising across markets. Still others hold advantages
because of their patents, differentiated products, management skills and market access.
VII. DIRECT INVESTMENT PATTERNS

The recent growth in foreign direct investment flows is the result of more receptive
attitudes by governments, the process of privatization and the growing interdependence
of the world economy.
A. Location of Ownership [See Table 8.2.]
Industrialized countries account for more than 90 percent of all direct investment
outflows. This is because firms from those countries are more likely to have the
capital, technology and managerial skills required for successfully investing
abroad.
B. Location of Investment [See Figure 8.5]
The major recipients of FDI are developed countries, which received nearly 80
percent of the world’s total in 2001. Their markets tend to be larger and better
developed, they face less political turmoil and they tend to have liberal direct
investment policies.
C. Economic Sectors of FDI
Over time, the portion of FDI accounted for by raw materials (including mining,
smelting and petroleum) declined. At the same time, the portion devoted to
resource-based production grew. Since the early 1970s, FDI has grown rapidly in
the service sector (especially banking and finance), as has investment in
technology-intensive manufacturing.
VII. FDI IN COMPANIES’ STRATEGIES

Foreign direct investment serves the goal of global efficiency by transferring resources
to places where they can be used most effectively. While marketing-seeking investments
generally favor multi-domestic strategies, resource-seeking investments generally lead
to vertical integration or rationalized production.
ETHICAL DILEMMA:
Critics Debate the Ethics of FDI and Employment
Critics of FDI argue it is unethical for governments to lure operations away from existing
locations by offering lucrative incentives. Critics also argue it is unethical for companies to
accept those incentives. For their part, companies say they cannot decline such incentives
because of competitive conditions. Nonetheless, newly unemployed workers suffer if they cannot
find new jobs of equal pay, and large-scale under- or unemployment is a strain on any economy.
Do governments in countries where production facilities are currently located have special
ethical obligations to their citizens and firms to attempt to retain operations? Are such
obligations any greater for those governments with burdensome environmental regulations and
high taxes?

Will Factor Movements and FDI Continue to Grow Worldwide?
From year to year, FDI flows fluctuate both in their direction and rate of growth. The
receptiveness of governments, the growing interdependence of the world economy and the
increasing foreign experience of firms all encourage future growth. On the other hand, declining
trade restrictions and new political realities (such as 9/11) serve to diminish the urgency of many
import-substitution activities in the manufacturing sector. Since many barriers remain in the
service sector, however, FDI may continue to grow in importance in that arena. At the same
time, anti-immigration feelings appear to be curtailing international labor flows, regardless of the
skills of the affected workers.
WEB CONNECTION

_________________________
CLOSING CASE: Cran Chile [See Map 8.1]
1. What are the motivations and factors that influenced the foreign investment decision for
Cran Chile? Compare these with those in the LUKoil case.
Because of the uncertain production and marketing conditions it has encountered,
Cran Chile represents a high-risk but potentially high-return resource-seeking investment.
Initially, a shortage of fresh cranberries caused Simmons to investigate the industry. He
concluded for a variety of reasons that North American production could not be expanded
rapidly enough to meet growing demand. His based his subsequent decision to invest in
cranberry production near Lanco, Chile, on the relatively stable Chilean government and
currency, the strong legal system, fertile soil, favorable climatic conditions and an ample
water supply. While LUKoil also faced uncertain production and marketing conditions,
its reasons for integrating into foreign distribution outlets were to reduce both its
operating and currency risks, to reduce its operating costs as well as its dependence on
downstream customers, to assure market access for its output and to gain the latest in
technology, competitive know-how and marketing skills.
2. Relate Simmons’ process of international expansion with companies’ usual
internationalization processes (see Chapter 1).
Often a firm commits to gradually expanding internationally as part of its overall growth
and operating strategies via exporting or licensing and eventually foreign direct
investment. In this case, however, Simmons began by diversifying into an entirely new
business that he chose to locate in a foreign country. He did so because of the difficulty
of acquiring sufficient additional suitable land in the U.S. or Canada, i.e., the difficulty of
adding capacity in North America. To begin production, Simmons needed to find a
location suitable for growing cranberries and that location proved to be Lanco, Chile.
3. Cran Chile is essentially a contractor that supplies components to other companies.

What risks and opportunities does this relationship present to Cran Chile? Should
Cran Chile begin marketing its own products to final consumers?
Given its place at the beginning of the value chain, demand for Cran Chile’s output
is derived from downstream markets. Because fruit concentrate represents a commodity-
type product, price is primarily driven by the level of global supply, which to some extent
depends upon annual climatic conditions. Because Cran Chile’s customers have
developed production processes based on just-in-time inventory systems, Cran Chilehas
the opportunity of entering into long-term supply contracts with them, thus guaranteeing
a substantial amount of demand for its output. At the same time, Cran Chile must also be
mindful about the potential risks of committing too much output to any single customer.
Cran Chile should think carefully before marketing its own products to final customers.
First, Ocean Spray and Northland represent formidable competitors in established
markets. Just as important, however, is the fact that Cran Chile’s current customers view
the firm as an important source of concentrate because Cran Chile does not compete at
the consumer level. The entire dynamic of customer loyalty will change the moment Cran
Chile chooses to become a competitor as well as a supplier.
4. Simmons knew very little about cranberry production or marketing when he decided to
enter the cranberry business. What did he do to overcome his deficiencies?
To overcome his own lack of knowledge and experience, Simmons hired Chilean
technicians with formal training in agronomy. He also retained as a consultant a U.S.
grower whose own farm had excellent yields. Together this team determines the use of
fertilizers, water, herbicides and pesticides, when to hire part-time labor for hand
weeding and when to bring in bees for pollination. In addition, Cran Chile uses capital-
intensive technology on its corporate-size farm to increase yields and reduce costs.
Additional Exercises: Foreign Direct Investment

Exercise 8.1. Ask students to compare the potential advantages of establishing a foreign
direct investment operation in Asia, South America, the NAFTA region and the European
Union. Where would an investment most likely be market-seeking? Where would it most
likely be resource-seeking?
Exercise 8.2. Many governments in both developed countries and transition economies
have sold state-owned enterprises to foreign investors. Ask students to debate whether
governments should grant either monopoly power or other special incentives to these new
enterprises. Be sure they consider the interests of (a) the investors, (b) possible local
competitors, (c) local customers and (d) other local stakeholders.
Exercise 8.3. As a result of the economic process, member countries of the European
Union now enjoy the free movement of capital and labor. Ask students to compare the
advantages that would accrue to a firm investing in operations in the European Union to
those that would accrue to a firm investing in operations in the NAFTA region. Then ask
them speculate on the future possibility of the free flow of (a) capital and (b) labor within
the NAFTA region.
Chapter 9
The Foreign-Exchange Market
Objectives
! Learn the fundamentals of foreign exchange.
! Identify the major characteristics of the foreign-exchange market and how governments
control the flow of currencies across national borders.
! Understand why companies deal in foreign exchange.
! Describe how the foreign-exchange market works.
! Examine the different institutions that deal in foreign exchange.
Chapter Overview
The foreign-exchange market consists of all those players who buy and sell foreign-exchange
instruments for business, speculative, or personal purposes. Primarily, foreign exchange is used
to settle international trade, licensing and investment transactions. Chapter 9 explains in detail
basic concepts (such as rates, instruments and convertibility) and explores the major
characteristics of the foreign-exchange markets. The chapter concludes with a discussion of the
foreign exchange trading process that focuses upon both the over-the-counter and the exchange-
traded markets, i.e., banks and securities exchanges, and the respective roles they play.
Chapter Outline
OPENING CASE: Foreign Travels, Foreign-Exchange Travails: Excerpts from the Travel
Journal of Lee Radebaugh [See Map 9.1.]
This case describes Lee Radebaugh’s experiences during a trip
to Chile, Argentina and Brazil. Brazil has changed the name of its currency seven times since
1967. Chile and Argentina both call their currencies the peso, although the respective value of
each is vastly different. The case describes the challenges of converting one currency into
another as well as Radebaugh’s attempts to use traveler’s checks along the way.
find most useful for enhancing your lecture and class discussion. For additional visual
summaries of key chapter points, also review the figures, tables and maps in the text.
I. INTRODUCTION
Foreign exchange is money denominated in the currency of another nation or group of

nations, i.e., it is a financial instrument issued by countries other than one’s own.
An exchange rate is the price of one currency expressed in terms of another, i.e., the
number of units of one currency needed to buy a unit of another.
II. MAJOR CHARACTERISTICS OF THE FOREIGN-EXCHANGE MARKET

The foreign-exchange market consists of the different players who buy and sell foreign
currencies and other exchange instruments. Their combined activities affect the supply of
and demand for currencies. The market is comprised of two major segments. The over-
the-counter market (OTC) includes banks (both commercial banks and other financial
institutions)—this is where most foreign-exchange activity occurs. Theexchange-traded
market includes certain securities exchanges (e.g., the Chicago Mercantile Exchange and
the Philadelphia Stock Exchange) where particular types of foreign-exchange instruments
(such asfutures and options) are traded.
A. A Brief Description of Foreign-Exchange Instruments
Several types of foreign exchange instruments are available for trading. In
addition, several types of transactions may occur. Spot transactions involve the
exchange of currency “on the spot,” or technically, transactions which are settled
within two business days after the date of agreement to trade. The spot rate is the
exchange rate quoted for transactions that require the immediate delivery of
foreign currency, i.e., within two business days. Outright forward transactions
involve the exchange of currencies beyond two days following the date of
agreement at a set rate known as the forward rate. In an FX swap(a simultaneous
spot and forward transaction), one currency is swapped for another on one date
and then swapped back on a future date. In fact, the same currency is bought and
sold simultaneously, but delivery occurs at two different times. FX swaps account
for nearly 45 percent of all foreign-exchange transactions. In addition to the
traditional instruments, several other ways now exist with which to participate in
the foreign-exchange market. Currency swaps deal with interest-bearing financial
instruments (such as bonds) and involve the exchange of principal and interest
payments. An option is a foreign-exchange instrument that guarantees the
purchaser the right (but does not impose an obligation) to buy or sell a certain
amount of foreign currency at a set exchange rate within a specified amount of
time. A futures contract is a foreign exchange instrument that specifies an
exchange rate, an amount and a maturity date in advance of the exchange of the
currencies, i.e., it is an agreement to buy or sell a particular currency at a
particular price on a particular future date.
B. The Size, Composition and Location of the Foreign-Exchange Market
The Bank for International Settlements (BIS) estimated in 2001 that $1.2 trillion
in foreign exchange was traded each day. The substantial decline from earlier
years is thought to be the result of the consolidation of the banking industry
(fewer trading desks) and the introduction of the EURO. The U.S. dollar remains
the most important currency in the foreign-exchange market, comprising one side
(buy or sell) of 90 percent of all foreign currency transactions worldwide in 2001.
This is because the dollar:
 is an investment currency in many markets
 is held as a reserve currency by many central banks
 is a transaction currency in many international commodity markets
 serves as an invoice currency in many contracts
 is often used as an intervention currency when foreign monetary
authorities wish to influence their own exchange rates.
Nonetheless, the largest foreign exchange market is in the United Kingdom,
which is strategically situated between Asia and the Americas, followed by
the United States, Japan and Singapore.
III. MAJOR FOREIGN-EXCHANGE INSTRUMENTS

A. The Spot Market
The spot market consists of players who conduct those foreign exchange
transactions that occur “on the spot,” or technically, within two business days
following the date of agreement to trade. Foreign exchange traders always quote
a bid (buy) and offer (sell) rate. The bid is the rate at which traders buy foreign
exchange; the offer is the rate at which traders sell foreign exchange.
The spread is the difference between the bid and offer rates, i.e., it is the profit
margin of the trade. Exchanges can be quoted in American terms, i.e., a dollar-
direct quote that gives the value in dollars of a unit of foreign currency,
or European terms, i.e., an indirect quote that gives the value in foreign currency
of one U.S. dollar. The base currency, or the denominator, is the quoted,
underlying, or fixed currency; theterms currency is the numerator. The cross
rate represents the exchange rate between non-U.S. dollar currencies; it is derived
by using currency A to buy currency C (US $1) and then using currency C to buy
currency B.
B. The Forward Market
The forward market consists of those players who conduct foreign exchange
transactions that occur at a set rate beyond two business days following the date
of agreement to trade. The forward rate is the rate quoted today for the future
delivery of a foreign currency. A forward contract is entered into whereby the
customer agrees to buy (or sell) over the counter a specified amount of a specific
currency at a specified price on a specific date in the future. The difference
between the spot and forward rates is either the forward discount (the forward
rate, i.e., the future delivery price, is lower than the spot rate) or the forward
premium (the forward rate is higher than the spot rate).
C. Options
An option is a foreign exchange instrument that guarantees the right, but does not
impose an obligation, to buy or sell a foreign currency within a certain time
period or on a specific date at a specific exchange rate (called the strike price).
Options can be purchased over the counter from a commercial or investment bank
or on an exchange. The writer of the option will charge a fee, known as
thepremium. An option is more flexible, but it is more expensive than a forward
contract.
D. Futures
A foreign currency future resembles a forward contract because it specifies an
exchange rate sometime in advance of the actual exchange of the currency.
However, a future is traded on an exchange, not OTC. While a forward
contract is tailored to the amount and time frame the customer needs, futures
contracts have preset amounts and maturity dates. The futures contract is less
valuable to a firm than a forward contract, but it may be useful for small
transactions or speculation.
E. Foreign-Exchange Convertibility
Fully convertible currencies are those that governments allow both residents and
nonresidents to purchase in unlimited amounts, i.e., currencies freely traded and
accepted in international business. Hard currencies are fully convertible,
relatively stable and tend to be comparatively strong. Soft (weak) currencies are
not fully convertible. To conserve scarce foreign exchange, governments may
impose exchange restrictions on individuals and/or companies. Under a multiple
exchange rate system the government sets different rates for different types of
transactions. If the government imposes an advance import deposit, importers
will be required to make a deposit with the central bank, often for a long as one
year, to cover the full price of the products being sourced from abroad.
With quantity controls,the government limits the amount of foreign currency that
can used for a given transaction. Such currency controls significantly add to the
cost of doing business and can serve as serious impediments to trade.
IV. HOW COMPANIES USE FOREIGN EXCHANGE
The most obvious use of foreign exchange is for the settlement of international business
transactions, i.e., trade, licensing and investment activities. Profit-seekers may engage
in arbitrage, i.e., they may purchase foreign currency on one market for immediate resale
on another market (in a different country) in order to profit from a price
discrepancy. Interest arbitrage involves investing in debt instruments (such as bonds) in
different countries in order to maximize profits by capturing interest-rate and exchange-
rate differentials. Currency speculation involves buying (or selling) a currency based on
the expectation it will gain (or lose) in strength against other currencies. Although
speculation offers the chance to profit, it also contains an element of risk. Foreign
exchange instruments such as outright forwards, FX swaps, options and futures can all be
used to hedge (insure) against the risk associated with foreign-exchange transactions.
V. THE FOREIGN-EXCHANGE TRADING PROCESS

When a firm needs foreign exchange, it typically goes to its commercial bank. If the bank
is large enough, it may have its own foreign-exchange traders. A smaller bank, dealing
either on its own account or for a client, can trade foreign exchange directly with another
bank or through a foreign exchange broker, who matches the best bid and offer quotes of
interbank traders. The Bank for International Settlements (BIS) based
in Basel, Switzerland (effectively the central banks’ central bank), estimates there are
about 2,000 dealer institutions worldwide that comprise the foreign-exchange market. Of
these, approximately 100 to 200 are market markers and, of this group, only a select few
are major players.
A. Commercial and Investment Banks
Commercial banks and other financial institutions comprise the over-the-counter
market (OTC). This is where most foreign-exchange activity occurs. Top banks in
the interbank market are so ranked because of their abilities to:
 trade in specific market locations
 handle major currencies
 engage in cross-trades
 deal in specific currencies
 handle derivatives (forwards, options, futures, and swaps)
 conduct key market research.
Other factors often mentioned are price, quote speed, liquidity, back
office/settlement, strategic advice, trade recommendations, out-of-hours
service/night desk, systems technology, innovation, risk appraisal and e-
commerce capabilities. A large firm may use more than one bank to conduct its
foreign-exchange dealings, given their particular strategic capabilities. Exotic
currencies, i.e., currencies from developing and transitional economies, allow
certain banks to develop market niches because such currencies are difficult for
businesses to work with.
B. Exchanges
The exchange-traded market is composed of certain securities exchanges (e.g.,
the Chicago Mercantile Exchange and the Philadelphia Stock Exchange) where
particular types of foreign-exchange instruments (such as futures and options) are
traded. The Chicago Mercantile Exchange (CME) offers futures and futures
options contracts (contracts that are options on futures contracts, rather than
options on foreign exchange per se) in more than a dozen foreign currencies.
The Philadelphia Stock Exchange (PHLX) is the only exchange in the U.S. that
trades foreign-currency options. It lists six dollar-based standardized currency
options contracts. Although options cost more than futures, large firms
prefer options because of their greater flexibility and convenience.
ETHICAL DILEMMA:
The Need for Checks and Balances
One of the most publicized events in the derivatives market in recent years involved Nicholas
Leeson and the 233-year-old Barings PLC. A Barings trader, Leeson was sent to Singapore in the
early 1990s. Within a year he was promoted to chief trader and began both trading securities and
booking the settlements, which meant there were no checks and balances on Leeson’s trading
actions. Soon he lost over $1 billion on Tokyo stock index futures; he assumed the market would
rise, but instead it fell. Leeson was using Barings’ funds to cover positions he was taking for
himself, not for clients, and he also forged documents to cover his transactions. He later fled the
country, but was caught in Germany and returned to Singapore for trial. He was imprisoned until
1999, when he was released and returned to his native Britain. Although banks have since
implemented measures to prohibit actions such as Leeson’s, rogue trading continues to happen.
In 2002, Allied Irish Banks lost $750 million in foreign-exchange derivatives as a result of trades
made by one of its employees at its U.S.subsidiary. The bank suspects he was involved with
fictitious trades and collusion.

Exchange Markets in the New Millennium
The lessening of exchange restrictions and capital controls and continuing technological
developments will all lead to greater efficiencies and opportunities for foreign-exchange trading.
In addition, the introduction of the EURO will serve to reduce exchange-rate volatility and take
pressure off the U.S. dollar. Furthermore, the increasing use of the Internet will allow more
entrants to participate in the foreign exchange market and will also increase currency price
transparency.
WEB CONNECTION

_________________________
CLOSING CASE: HSBC and the Peso Crisis in Argentina
1. What are the major factors that caused the peso to fall in value against the dollar?
When the Convertibility Law pegged the Argentine peso 1:1 with the U.S. dollar, the
government’s ability to respond to external shocks was severely reduced. In effect,
Argentina’s exchange-rate and monetary policies were determined de facto by the United
States, and Argentina’s interest rates were determined by the U.S. Federal Reserve. When
world commodity prices declined, the U.S. dollar, and hence the
Argentine peso, strengthened against other currencies. Concurrently, Argentina’s main
trading partner, Brazil, devalued its currency. As deflation set in, both the Argentine
government and many private companies found it difficult to pay their debts. Tax
revenues fell, while public spending increased. Interest rates payments went primarily to
overseas investors, thus further draining the economy. When Argentine banks were
pressured to buy government bonds, a bank run ensued. Following the government’s
default on its debt, the currency board was abandoned, and the peso was allowed to float
against the dollar. In the latter half of 2002, the Argentine peso was trading at about 27
cents to the dollar.
2. What should President Duhalde do to stabilize Argentina’s currency?

Both economic and political stability need to be restored if Argentina is to succeed in
stabilizing and restoring confidence in the peso. One of the most important things that
must be accomplished is to secure the aid of the International Monetary Fund.
Admittedly, this will be difficult as it will require changes in Argentina’s exchange-rate
policy, fiscal policy and banking system, and many of those measures are unpopular with
provincial governors and the courts. Certain economists believe Argentina should
proceed with the full dollarization of its currency at a rate that would be even more
binding than its previous policy. Others argue for a system of “managed floating plus” in
order to provide the government with the flexibility to adjust its monetary policy while
maintaining certain targets and reducing its currency mismatching. To a certain extent,
the IMF requirements will likely influence that decision.
3. What are HBSC’s options in Argentina, and what do you think they should do?
HBSC can choose to continue to fight losses in Argentina or cease its operations there.
The pesification instituted by the Argentine government has resulted in deeply discounted
loan repayments, which will result in further losses, so time is of the essence. Recently
HBSC injected $211 million into its Argentine operations in order to keep them stable
while the IMF stalls. Clearly, the firm is committed to remaining in Argentina if possible.
Already two foreign banks have withdrawn from the country and others are threatening to
do the same. The remaining banks, including HBSC, should in concert approach both the
IMF and the Argentine government, explain their plight and offer to work together to find
a solution. Meanwhile, HBSC may need to consolidate some of its Argentine operations
so that it can minimize its costs (and losses) while a turnaround is effected. In addition,
definite guidelines for exiting should be established in the event that the situation
worsens and HBSC is forced to withdraw from Argentina.
Additional Exercises: The Foreign-Exchange Market
Exercise 9.1. Many students will have had experience with foreign currency conversion.
Ask them to describe the differences they have encountered in rates quoted at the airport,
in hotels and banks and on the street. Then ask students to describe their experiences
using credit cards and ATM cards in particular foreign countries. How were the
transactions reported on their statements? Were they charged processing fees?
Exercise 9.2. Take copies of the most recent editions of The Wall Street Journal and
the Financial Times to class. Explain to students where to find foreign exchange rates,
forward rates, cross rates, commodity prices, etc. Select the home countries of various
students in your class. Using information in the papers, have the students calculate
the cross rates for various currencies. Then use the forward rates to engage the students
in a discussion as to which currencies appear to be stronger. Explore the possible
underlying reasons for a given currency’s strength or weakness.
Exercise 9.3. More than 150 currencies exist today. Some countries share a common
currency (e.g., those that participate in the EURO), while certain countries peg their
currencies to others (e.g., Chile’s currency is pegged to the U.S. dollar). Many nations,
however, maintain their own independent currencies. Ask students to debate the potential
for additional regional currencies such as the EURO. If they support the concept, should
those currencies necessarily be tied to regional economic blocs?
The Determination of Exchange Rates
Objectives
! Describe the International Monetary Fund and its role in the determination of
exchange rates.
! Discuss the major exchange-rate arrangements countries use.
! Identify the major determinants of exchange rates in the spot and forward
markets.
! Show how managers try to forecast exchange-rate movements using factors
such as balance-of-payments statistics.
! Explain how exchange-rate movements influence business decisions.
Chapter Overview
From a managerial point of view, it is critical to understand how exchange-rate

movements influence business decisions and operations. Chapter 10 first describes the
International Monetary Fund and the role it plays in exchange-rate determination.
Next the chapter examines the various types of exchange-rate regimes countries may
choose, as well as the role central banks play in the currency valuation process. It then
presents the theories of purchasing power parity, the Fisher Effect and the
International Fisher Effect and discusses their contributions to the explanation of
exchange-rate movements. The chapter concludes with a brief examination of the
potential effects of exchange-rate fluctuations on business operations.
Chapter Outline
OPENING CASE: The Chinese Renminbi

This case describes China’s efforts to manage the renminbi (RMB), also known as
the yuan, as the country moves toward a more market-based economy. Prior to
1994, China operated under a dual-track system that provided for two government-
approved exchange rates: the official rate and the swap-market rate (primarily used by
multinationals). As part of the move to the new exchange rate system, the Chinese
government closed the swap centers in 1994. Although it announced it would allow
the RMB to float according to market forces, the government then pegged the RMB to
the U.S. dollar (roughly 8.2 RMBs per dollar) and also retained its controls on both
current and capital account transactions. In 1996, the RMB was made fully
convertible on a current account (trade), but not a capital account (investment), basis.
Thus, Chinese citizens have a difficult time moving their money elsewhere, and
foreigners are unable to invest in China’s stock market (except for special stocks
priced in foreign currency). While there are several
steps China could take before letting its currency float freely, the government does not
appear to be planning any moves in the near future.
Teaching Tip: Carefully review the PowerPoint slides for Chapter 10 and
select those you find most useful for enhancing your lecture and class
discussion. For additional visual summaries of key chapter points, also review
the figures, tables and maps in the text.
I. INTRODUCTION
An exchange rate represents the number of units of one currency needed to
acquire one unit of another currency. Managers must understand how
governments set exchange rates and what causes them to change so they can
make decisions that anticipate and take those changes into account.
II. THE INTERNATIONAL MONETARY FUND (IMF)

In 1944, the major allied governments met in Bretton Woods, NH, to discuss
post-war economic needs. One of the results was the establishment of
the International Monetary Fund (IMF). Its objectives are to promote
exchange-rate stability, to facilitate the international flow of currencies and
hence the balanced growth of international trade, to establish a multilateral
system of payments and to serve as the lender of last resort to governments.
Initially, the Bretton Woods Agreement established a system of fixed exchange
rates under which each IMF member country set a par value (benchmark) for
its currency based on gold and the U.S. dollar. Par values were later done away
with when the IMF moved toward greater exchange-rate flexibility. When a
country joins the IMF, it contributes a certain sum of money, i.e., a quota,
relating to its national income, monetary reserves, trade balance and other
economic indicators. The quota then becomes part of a pool of money
the IMF can draw on to lend to member countries. It also forms the basis for
the voting power of each country, as well as the allocation of its special
drawing rights.
A. IMF Assistance
When a member country experiences economic difficulties, the IMF will
negotiate loan criteria designed to help stabilize its economy. However,
such stabilization measures are often unpopular with a country’s citizens
and firms and, ultimately, its government officials.
B. Special Drawing Rights (SDRs)
The help increase international reserves, the IMF created special
drawing rights (SDRs), an international reserve asset designed to
supplement members’ existing reserves of gold and foreign exchange.
The SDR is used as the IMF’s unit of account and for IMF transactions
and operations. The value of the SDR is based on the weighted average
of four currencies. At the end of 2002 those weights were: the U.S.
dollar 45%, the EURO 29%, the Japanese yen 15% and the British
pound 11%. Although the SDR was intended to serve as a substitute for
gold, it has not assumed the role of either gold or the U.S. dollar as a
primary reserve asset.
C. Evolution to Floating Exchange Rates

The IMF’s original system was one of fixed exchange rates; the U.S.
dollar remained constant with respect to the value of gold and other
currencies operated within narrow bands of value relative to the dollar.
Following President Nixon’s suspension of the dollar’s convertibility to
gold in 1971, the international monetary system was restructured via
the Smithsonian Agreement, which permitted a devaluation of the U.S.
dollar, a revaluation of other currencies and a widening of the exchange-
rate flexibility bands. These measures proved insufficient, however, and
in 1976 the Jamaica Agreementeliminated the use of par values by
abandoning gold as a reserve asset and declaring floating rates to be
acceptable.
III. EXCHANGE-RATE ARRANGEMENTS [See Table 10.1 and Map 10.1]

The IMF surveillance and consultation programs are designed to monitor the
economic policies of member nations to be sure they act openly and
responsibly with respect to their exchange-rate policies. Member countries are
permitted to select and maintain their exchange-rate regimes, but they must
communicate those choices to the IMF.
A. From Pegged to Floating Currencies
The IMF now recognizes several categories of exchange-rate regimes
that begin with pegging (fixing) the rate for one currency to that of
another (or to a basket of currencies) under a very narrow range of
fluctuations in value (e.g., no separate legal tender, currency boards,
conventional pegs). The next category, pegged exchange rates within
horizontal bands, is characterized by a broader band of fluctuations than
the first three. The last four categories exhibit at least some degree
of floating exchange-rate arrangements from crawling pegs to crawling
bands to managed floats to independent floats.
B. Black Markets
The less flexible a country’s exchange-rate system, the more likely there
will be a black market, i.e., a foreign exchange market that lies outside
the official market. Black markets are underground markets where prices
are based on supply and demand; the adoption of floating rates
eliminates the need for their existence.
C. The Role of Central Banks
Each country has a central bank responsible for the policies affecting the
value of its currency. Central banks are primarily concerned with
liquidity, in order to ensure they have the cash and flexibility needed to
protect their countries’ currencies. Their reserve assets are kept in three
forms: gold, foreign-exchange reserves and IMF-related assets. The
EURO is administered by the European Central Bank which, although
independent of all EU institutions and governments, works with the
governors of Europe’s various central banks to establish monetary policy
and manage the exchange-rate system. The central bank in the U.S. is the
Federal Reserve System, i.e., the Fed, a system of 12 regional banks. The
New York Fed, representing both the Fed and the U.S. Treasury, is
responsible for intervening in foreign-exchange markets to achieve
dollar exchange-rate policy objectives. Selling U.S. dollars for foreign
currency puts downward pressure on the dollar’s value; buying U.S.
dollars for foreign currency puts upward pressure on the dollar’s value.
The New York Fed also acts as the primary contact with other foreign
central banks. Depending on market conditions, a central bank may:
 coordinate its actions with other central banks or go it alone
 aggressively enter the market to change attitudes about its views
and policies
 call for reassuring action to calm markets
 intervene to reverse, resist, or support a market trend
 be very visible or very discrete
 operate openly or indirectly through brokers.
The Bank for International Settlements (BIS) in Basel, Switzerland,
acts as the central bankers’ central bank and serves as a gathering place
where central bankers meet to discuss monetary cooperation. Although
just 50 central banks are shareholders in the BIS, it regularly deals with
some 130 central banks worldwide.
IV. THE DETERMINATION OF EXCHANGE RATES

Exchange-rate regimes are either fixed or floating, with fixed rates varying in
terms of just how fixed they are and floating rates varying with respect to just
how much they are allowed to float.
A. Floating Rate Regimes [See Figure 10.2]
Floating rates regimes are those whose currencies respond to the
conditions of supply and demand. Technically, an independent floating
currency is one that floats freely, unhampered by any form of
government intervention. Equilibrium exchange rates are achieved when
supply equals demand.
B. Managed Fixed-Rate Regimes
In a managed fixed exchange-rate system, a nation’s central bank
intervenes in the foreign exchange market in order to influence the
currency’s relative price. To buy foreign currencies, it must have
sufficient reserves on hand. When economic policies and market
intervention don’t work, a country may be forced to either revalue or
devalue its currency. A currency that is pegged to another (or to a basket
of currencies) is usually changed on a formal basis. In 1999, the G7
group of industrial countries was expanded to the G20 for the purpose of
including some developing countries in the discussion of effective
exchange-rate policies.
C. Purchasing-Power Parity
The theory of purchasing-power parity states that the prices of tradable
goods, when expressed in a common currency, will tend to equalize
across countries as a result of exchange-rate changes. Put another way,
the theory claims a change in the comparative rates of inflation in two
countries necessarily causes a change in their relative exchange rates in
order to keep prices fairly similar. (An interesting illustration of this
theory is the “Big Mac Index” (see Table 10.2).) While purchasing-
power parity may be a reasonably good long-term indicator of exchange-
rate movements, it is less accurate in the short run because it is difficult
to determine an appropriate basket of commodities for comparison
purposes, profit margins vary according to the strength of competition,
different tax rates will influence prices differently and the theory falsely
assumes no barriers to trade exist and transportation costs are zero.
D. Interest rates
Although inflation is the most important long-run influence on exchange
rates, interest rates are also important. While the Fisher Effect theory
links inflation and interest rates, the International Fisher Effect
(IFE) theory links interest rates and exchange rates. The Fisher
Effect theory states a country’s nominal interest rate r (the actual
monetary interest rate earned on an investment) is determined by the real
interest rate R (the nominal rate less inflation) and the inflation rate i as
follows:
(1 + r) = (1 + R)(1 + i).
Because the real interest rate should be the same in every country, the
country with the higher interest rate should have higher inflation. Thus,
when inflation rates are the same, investors will likely place their money
in countries with higher interest rates in order to get a higher real return.
The International Fisher Effect implies the currency of the country with
the lower interest rate will strengthen in the future, i.e., the interest-rate
differential is an unbiased predictor of future changes in the spot
exchange rate. The country with the higher interest rate (and higher
inflation) should have the weaker currency. In the short run, however,
and during periods of price instability, a country that raises its interest
rate is likely to attract capital and see its currency rise in value due to
increased demand.
E. Other Factors in Exchange-Rate Determination
A key factor affecting exchange-rate movements is confidence in a
country’s economy and administration. Technical factors such as the
seasonal demand patterns for a given currency, the release of national
economic statistics and events such as 9/11, corporate scandals and
budget deficits also exert their influence.
V. FORECASTING EXCHANGE-RATE MOVEMENTS
Managers must be able to formulate at least a general idea of the timing,
magnitude and direction of exchange-rate movements.
A. Fundamental and Technical Forecasting
While fundamental forecasting uses trends regarding fundamental
economic variables to predict future exchange rates, technical
forecasting uses past trends in exchange-rate movements to spot future
trends. Smart managers develop their own exchange-rate forecasts and
then use the fundamental and technical forecasts of outside experts to
corroborate their analyses.
B. Factors to Monitor
When forecasting exchange-rate movements, key variables to monitor
include:
 the institutional setting (the extent and nature of government
intervention)
 fundamental factors (PPP rates, balance-of-payments levels, the
level of foreign-exchange reserves, macroeconomic data, fiscal
and monetary policies, etc.)
 confidence factors
 critical events
 technical factors (market trends and expectations).
VI. BUSINESS IMPLICATIONS OF EXCHANGE-RATE CHANGES

Exchange-rate fluctuations can affect all areas of a company’s operations.
A. Marketing Decisions
Exchange-rate changes can affect demand for a firm’s products both at
home and abroad. For instance, the strengthening of a country’s currency
could create price competitiveness problems for exporters; on the other
hand, importers would favor that situation.
B. Production Decisions
Firms may choose to locate production operations in a country whose
currency is weak because initial investment there is relatively
inexpensive; it could also be a good base for exporting the firm’s output.
Exchange-rate differentials contribute to this situation across
industrialized nations, as well from industrialized to developing nations.
C. Financial Decisions
Exchange-rate fluctuations can affect financial decisions in the areas of
sourcing funds (both debt and equity), the timing and the level of the
remittance of funds and the reporting of financial results. (Translation,
transaction and economic exposure will all be considered in Chapter 20.)
ETHICAL DILEMMA:
Black Market Issues Aren’t Black and White
On a local black market, one can obtain more local currency in exchange for hard
currency, but relatively less hard currency for local currency. While it’s always
tempting to trade on the black market, governments have differing ethical and legal
attitudes toward such transactions. If trading on the black market is illegal, the
government’s objections will be emphatic, although the law is often unevenly applied.
It is easier to eliminate ablack market by letting a country’s currency float freely and
thus removing the temptation to circumvent the law than by police enforcement.

Changing Times Will Bring Greater Exchange-Rate Flexibility
The trend toward greater flexibility in exchange-rate regimes will surely extend well
into the future. The EURO will continue to strengthen and claim market share from
the U.S. dollar as a prime reserve asset, just asEurope’s transition economies will
progress in their moves toward floating exchange-rate regimes. Regional trading
relationships will also encourage South American governments to move still closer
toward dollarization, or at least some form of regional monetary union. Likewise, the
U.S. dollar should continue to be the benchmark currency in Asia, because so many
countries there (including China) rely on the U.S. market as an export destination.
Although one of the most widely traded currencies in the world, the Japanese yen
remains specific to the Japanese economy.
WEB CONNECTION
Teaching Tip: Visit www.prenhall.com/daniels for additional information

and links relating to the topics presented in Chapter 10. Be sure to refer your
students to the on-line study guide, as well as the Internet exercises for Chapter
10.
_________________________
CLOSING CASE: Pizza Hut and the Brazilian Real [See Figure 10.3]
1. Do you think it makes sense for Pizza Hut to get out of Brazil, or should it try
to weather the storm and stay in? Justify your position.
Given the strategic role that Brazilian operations are likely to play in Pizza
Hut’s worldwide strategy, withdrawing from Brazil could have serious long-
term consequences. Nonetheless, while the worst problems associated
with Brazil’s rampant inflation and currency revaluation appear to be under
control, Pizza Hut must carefully consider the nature of the pizza business
in Brazil. Largely made up of small entrepreneurs,pizzarias typically charge
one set price for all the pizza a customer can eat; toppings are different, and
dessert pizzas are popular. Pizza Hut must determine the extent to which it is
willing to modify its image and operations in order to fit local tastes
in Brazil (and elsewhere). Problems related to corporate expansion and
management strategy must also be resolved. Though the Brazilian economy is
still shaky, its ability to weather the Mexican currency crisis in 1994 and the
speed with which it recovered from its own currency crisis in 1999 are
reassuring. The size of the potential market, Brazil’s proven taste for pizza and
its affinity for American products all bode well for Pizza Hut’s eventual
success there as its gains expertise in effectively managing in the Brazilian
context.
2. Where does the Brazilian real fit in the exchange-rate regimes in Table
10.1? What does that imply in terms of how you would predict future values of
the real?
Having suffered the inflationary effects of very weak currencies for many
years, maintaining the relative stability of Brazil’s currency value is critical to
controlling inflation and thus protecting the Brazilian economy. In the early
years of the Real Plan, the real was allowed to move within a 7% band again
the U.S. dollar (a pegged exchange rate with horizontal bands). Each year,
the real moved 7% against the dollar, and a new 7% band was established (an
exchange rate with a crawling band). In January, 1999, keeping the real within
its band was costing the Brazilian government billions of U.S. dollars per day;
therefore, the government decided to let it float. Since that time, the
government has intervened to stabilize the real at its new, lower rate. The
Brazilian government has clearly demonstrated its willingness to intervene in
the foreign exchange market when necessary to support the real.
3. Discuss whether or not you think the Brazilian government should dollarize its
economy and get rid of the real.
Dollarization could be a powerful tool in Brazil’s fight against rampant
inflationary pressures; it could also help curtail the speculative pressures on the
Brazilian real. Nonetheless, there is a strong argument against doing so. If
Brazil were to dollarize its economy, or even simply fix the exchange rate
between the U.S. dollar and the real, the Brazilian government would no longer
be able set its own monetary policy to manage its economy. Brazil’s money
supply would have to be set at the level necessary to maintain the fixed rate
between the real and the dollar. Further, full dollarization would not sit well
with Brazilian patriotic and nationalistic sentiments. Unlike Argentina, whose
currency is fixed at parity with the U.S. dollar, Brazil has resisted pressures to
follow suit. Nonetheless, Brazil has expressed some willingness to consider the
idea of a single currency for MERCOSUR member countries because of the
importance of its trade with Argentina, and its strong links to the economies of
Uruguay and Paraguay as well.
4. What are some of the ways instability in the real might be affecting Pizza
Hut’s operations in Brazil?
Because of the relatively high price of its product, Pizza Hut’s success in Brazil
depends upon a growing, increasingly affluent middle class. However, a
prolonged period of economic instability tends to increase the gap between the
rich and the poor and reduce the size of the middle class. Further, consumers
are less likely to spend money on “luxury” items during times of economic
stress, even when they can afford to do so. An overvalued real makes imported
products cheaper and thus encourages Pizza Hut to export inputs and supplies
to its Brazilian operations. On the other hand, an undervalued real makes local
products cheaper and encourages Pizza Hut to source locally. Thus, currency
instability makes it very difficult for businesses to plan effectively.
Additional Exercises: Exchange-Rate Determination
Exercise 10.1. A dozen or so years ago, the Canadian and U.S. dollars were
close to par. At the end of June 2003, the Canadian dollar was worth about US
$0.7374. Ask students to discuss the reasons they believe the Canadian dollar
has lost so much ground against its American counterpart. Be sure they raise
factors such as the implementation of the North American Free Trade
Agreement and the separatist movement in Quebec. Then, note the importance
of U.S. trade to the Canadian economy and ask students if they think Canada
should consider “Americanizing” (pegging) its dollar to its neighbor’s. Why or
why not?
Exercise 10.2. Use the IMF International Financial Statistics to identify

countries that use the SDR as a basis for the value of their currencies and those
that use the EURO. Then engage the students in a discussion as to why certain
countries have chosen to use the SDR while others have chosen the EURO. In
what ways are the SDR and the EURO similar? In what ways are they
different?
Exercise 10.3. Historically, the International Monetary Fund has prescribed

strict monetary policies and reduced government spending for developing
countries that sought aid in dealing with currency crises. Ask students to debate
the wisdom of the IMF’s approach. Do they believe it was effective? Then ask
the students to suggest ways in which the IMF might change its approach in the
future. Be sure they consider the implications of their suggestions for
international businesses.
Government Attitudes Toward

Foreign Direct Investment
Objectives
! Examine the conflicting objectives of MNE stakeholders.
! Discuss problems in evaluating the activities of MNEs.
! Evaluate the major economic impacts—specifically, balance of payments and growth—of
MNEs on home and host countries.
! Provide an overview of the major political controversies surrounding the activities of
MNEs.
Chapter Overview
Government policies both encourage and restrict foreign direct investment activities. Chapter 11
examines the major assertions about MNE practices, as well as the evidence supporting or
refuting those assertions. It begins by discussing the impact of FDI among stakeholders both at
home and abroad, and notes the inevitable trade-offs that must be considered. It then explores the
economic impact of foreign direct investment in terms of its balance of payments, economic
growth and employment effects. The chapter concludes with a discussion of the major legal and
political controversies of FDI.
Chapter Outline
OPENING CASE: Foreign Direct Investment in China [See Map 11.1]
This case details China’s “love-hate” relationship with foreign direct investment. Since
1993, China has ranked second to the United States for FDI inflows among all
countries. Japan, Taiwan and the U.S. are China’s largest sources of FDI. Until the mid-
1990s, China required most foreign firms to agree to an equity joint venture with a local partner
as a condition of market access. MNEs are attracted to China because of its market potential of
1.3 billion people, increasing purchasing power, improving infrastructure, relatively inexpensive
natural and labor resources, and strategic position within the global economy. Over time, the
Chinese government has begun to encourage FDI—but only in certain sectors of the economy,
and subject to evolving constraints. Foreign firms welcomed China’s joining the World Trade
Organization because the required policy changes would largely be to their benefit. It remains to
be seen, however, how China interprets and enforces its WTO commitments. Its long march
toward an open-market economy will surely be a challenging one as ideological legacies serve as
obstacles to block its path.
Teaching Tip: Review the PowerPoint slides for Chapter 11 and select those you find
most useful for enhancing your lecture and class discussion. For additional visual
summaries of key chapter points, review the figures and table in the text. Also, note the
reference to the CultureQuest video at the end of the chapter’s closing case.
I. INTRODUCTION
Government policies both encourage and restrict foreign direct investment flows and
operations. A principal concern about FDI is that MNEs’ global orientation will make
them insensitive to national interests and concerns. Many MNEs are so large the value of
their annual sales exceeds the GNP of certain countries. Because of their considerable
power, the executives of MNEs often deal directly with heads of state when negotiating
the terms under which their firms will conduct operations.
II. EVALUATING THE IMPACT OF FOREIGN DIRECT INVESTMENT

Although many governments have moved from a position of opposition to one of
suspicion to one of cooperation regarding FDI, the relevant benefits and costs must
always be weighed in light of the concerns of a variety of stakeholders.
A. Trade-off among Constituencies
Stakeholders represent those parties directly or indirectly affected by an
organization’s activities. They include stockholders, employees, customers,
suppliers, governments, competitors and society at large. Each group will likely
have different interests and priorities, which may vary from country to country as
well. The principal difficulty for MNEs lies in the challenges that arise from
trying to serve multiple interest groups while maximizing the performance of the
firm.
B. Trade-offs among Objectives
The effects of an MNE’s activities may be simultaneously positive with respect to
one national objective and negative for another. Thus, countries must recognize
both the associated costs and benefits. Further, even when all parties gain, they
may ultimately disagree over the equitable distribution of benefits.
C. Cause-Effect Relationships
Opponents of FDI try to link the actions of MNEs to matters such as inequitable
income distribution, political corruption, environmental debasement and societal
deprivation. Proponents, on the other hand, view MNEs as sources of increased
tax revenues, higher employment, technology, innovation and exports. However,
it is very difficult to determine the true cause-effect relationship of FDI because
competitors’ actions, technological developments and government policies all
serve to intervene.
D. Individual and Aggregate Effects
Whether evaluating foreign investments on an individual or an aggregate basis, it
is very difficult to assess their impact. This is because the philosophy, actions and
goals of each MNE are quite unique.
E. Potential Contributions of MNEs
The sheer scale of MNEs means they have assets that can ultimately contribute to
a wide range of national objectives. MNEs not only control a large portion of the
world’s assets, but they account for most of the world’s imports and exports of
goods and services and are also major producers and organizers of technology.
Thus, MNEs can directly contribute to a host country’s national objectives in the
areas of investment, human resources, technology, trade and the environment.
III. ECONOMIC IMPACT OF THE MNE

Multinational enterprises affect countries’ economies in a variety of ways. Effects may be
positive or negative for both the home and the host countries.
A. Balance-of-Payments Effects
Ultimately, FDI inflows may lead to increased exports for a country via
the import-substitution effect. Nonetheless, FDI can lead both to capital inflows
and outflows as well as a net balance-of-payments effect that is either positive or
negative.
1. Place in the Economic System. When a country runs a long-term trade
deficit, it must compensate either by reducing its capital reserves (or
borrowing) or by attracting an influx of capital. Countries’ attempts to
regulate trade and investment flows through incentives, prohibitions and
other types of government intervention will influence firms’ investment
and operating decisions and strategies.
2. Effects of Individual FDI. Both home and host governments need to
assess the effects of individual and aggregate FDI movements. Although
the formula to do so is relatively simple, the data used must be estimated
and are subject to assumptions; therefore, the formula must be used with
caution. The equation for the potential balance-of-payments effect of FDI
is:
B = (m - m1) + (x - x1) + (c - c1)
where B = balance of payments effect, m = import displacement, m1 =
import stimulus, x = export stimulus, x1 = export reduction, c = capital
inflow for other than import and export payment, andc1 = capital outflow
for other than import and export payment. The marginal propensity to
import principle states that the recipients of increased incremental income
will spend some portion of it on imports. The net import change (m - m1),
the net export effect (x - x1) and the net capital flow combine to determine
the effect of FDI on a country’s balance of payments.
3. Aggregate Assumptions and Responses. Initially, the balance-of-
payments effects of FDI are generally positive for the host country and
negative for the home country. Therefore, home countries may attempt to
establish outflow restrictions, while host countries may impose
repatriation restrictions, asset-valuation controls and other forms of
constraints.
B. Growth and Employment Effects
Although stakeholders in both home and host countries may gain from FDI, some
constituencies may argue they are economic losers. However, when a firm
establishes a foreign production facility to serve foreign markets and does so
without decreasing resource employment at home, both home and host countries
may benefit.
1. Home-country Losses. Home countries may be disadvantaged when
firms outsource production to foreign subsidiaries. Not only are jobs
exported, but home country wages and benefits may also be reduced. In
addition, critical technology and other proprietary information are often
transferred abroad.
2. Host-country Gains. Host countries generally gain through the receipt of
FDI because it stimulates local development through the employment of
idle resources. In addition to the gains of capital, technology and
employment, the upgrading of resources may also lead to increased
productivity and competitiveness within the nation.
3. Host-country Losses. Host countries may lose if investments by MNEs
replace local firms, attract the best resources, discourage local
entrepreneurship and/or decrease local research and development. By
increasing the demand for scarce labor, wages may be driven up, thus
further challenging local competitors.
4. General Conclusions. Not all MNE activities have the same effect on
growth in the home or host countries. However, FDI is likely to make a
positive contribution in a host country when FDI is not a substitute for
domestic investment, the product or process technology is highly
differentiated and scarce resources not locally available can be accessed.
IV. POLITICAL AND LEGAL IMPACTS OF THE MNE

Another major concern about MNEs is that because the majority of their sales and assets
tend to be located in their home countries, the firms will function as foreign-policy
instruments of their governments. Critics are also concerned that because many MNEs
are so large, they will be beyond the control of either home or host country.
A. Extraterritoriality
Extraterritoriality refers to the situation under which governments extend their
laws to the foreign operations of their domestic firms. In some instances, home
country laws may conflict with those of a firm’s host country.
1. Trade Restrictions. The primary focus of this criticism has been upon
the U.S. government’s attempts to apply its Trading with the Enemy Act
to the foreign subsidiaries of U.S. firms in order to prevent them from
selling to or sourcing from unfriendly countries. Both the Cuban
Democracy Act of 1992 and the Helms-Burton Act have also led to strong
disapproval from other countries.
2. Antitrust Laws. A recurring problem for U.S. firms has been the
ambiguity of the U.S. antitrust policy regarding their relationships with
other companies abroad and the possible resulting harm to home-country
firms and consumers. In the past, the U.S. government has acted
against U.S. firms whenever it had concerns about their participating in
(international) cartels that set prices or production quotas, their granting of
exclusive distributorships abroad and/or their forming joint research and
development or manufacturing operations in foreign countries.
B. Key Sector Control
Closely related to the extraterritoriality issue is the fear that if foreign-owned
firms dominate key national industries (those industries that affect a large
segment of the population by virtue of their size or influence), decisions made
outside of the country may have adverse economic and/or political effects in the
host country. MNE home country headquarters often decide what, where and how
their foreign subsidiaries will operate. Although various countries have selectively
prevented the foreign domination of key industries, they have quite different ideas
as to the definition of “key.” Special concern surrounds foreign government-
owned enterprises that participate in foreign direct investment activities abroad.
C. MNE Independence
Some observers worry MNEs play one country against another (and that countries
join their game) and thereby evade regulation by all countries. Similarly, they
worry MNEs play states or provinces within a particular country against each
other. In addition, MNEs may develop ownership structures that minimize their
payment of taxes anywhere. However, once a firm has committed fixed assets to a
foreign subsidiary, it is less likely to abandon its operations there than previously.
D. Host-Country Captives
Many MNEs have lobbied their home country governments to adopt policies
more amenable to the foreign countries where they operate. Often the firms fear
retaliation against home-country trade sanctions.
E. Bribery [See Table 11.1 and Figure 11.4]
Bribery influences the performance of both countries and companies. Anecdotal
information indicates questionable payments by MNEs to government officials
have been prevalent in both industrial and developing countries. High levels of
corruption tend to correlate with lower growth rates and lower levels of per-capita
income. Also, corruption may erode the legitimacy of a government. Bribery
occurs for a variety of reasons and takes many forms. The Foreign Corrupt
Practices Act of 1997 appears to be a useful deterrent, although an apparent
inconsistency permits payments to foreign officials to expedite their compliance
with the law, but not to other officials not responsible for carrying out the law.
V. DIFFERENCES IN NATIONAL ATTITUDES TOWARD MNEs
Countries tend to be more concerned about large foreign corporations than small ones. In
fact, governments of developing countries may actually prefer small firms because of
their better fit with local concerns and needs. In theory, host countries may take positions
toward MNEs that range from completely restrictive to laissez-faire; in actuality, national
policies tend to lie somewhere between the two extremes and ebb and flow over time. To
further complicate the issue, the perception of a given company’s operations in one
country may affect the perceptions of its stakeholders in other countries. As a firm
expands the geographical scope of its operations, the odds of negative perceptions
regarding its impact are likely to increase.
ETHICAL DILEMMA:
Are Some Bribes Justifiable?
Both the Foreign Corrupt Practices Act and the OECD Bribery Convention are designed to stop
the practice of bribing foreign officials and executives, but many complain that while businesses
are forbidden to engage in such practices, governments often do. Thus, companies have devised
their own legal means to influence those same parties—indirectly. The question is whether any
of these actions is justifiable. Can unethical “means” ever justify a desirable “end” with respect
to an international business transaction? Further, there is the issue of foreign firms’ contributions
to local political parties in host countries. Can political donations made to ensure host country
policies will be formulated according to the interests of foreign firms ever be justified?

Will FDI Be Welcome as the 21st Century Progresses?
In all likelihood, governments will continue to aggressively compete for a larger share of the
investment flows and benefits generated by the presence of MNEs in their countries, although
some will simultaneously impose strict regulations. Also, some will choose to fault FDI as the
cause of their country’s increasing poverty, loss of sovereignty, cultural disintegration and
whatever other malady may be affecting their society. Control will continue to be an issue. At the
dawn of a new century, MNEs may be forced to heed calls by both home and host governments
to make their decision processes more transparent.
WEB CONNECTION
study guide, as well as the Internet exercise for Chapter 11.
_________________________
CLOSING CASE: FDI in South Africa [See Map 11.2, plus reference to CultureQuest video.]
1. What are the costs and benefits to South Africa of having more foreign direct investment?
of having less?
The fact that the South African Reserve Bank considers FDI inflows a “prerequisite for
faster economic growth and development” illustrates the expectation the benefits will
significantly outweigh the costs. Primary benefits would include:
 the creation of jobs
 capital inflows
 the transfer of technology
 the transfer of skills
 the diversification of the economy
 improved productivity
 import substitution
 increased exports, and hence, an overall improvement in South Africa’s balance
of payments account.
Costs would primarily be related the type of FDI that might be attracted (e.g., acquisition
vs. newly built operations), the potential harm to the natural and cultural environments as
a result of the industrialization process and the potential influence of foreign firms on
South Africa’s domestic policies.
2. How might a company try to weigh fairly the opportunities and threats of investing
in South Africa?
A firm should initially investigate the economic, cultural and political environments
in South Africa in light of its own mission, objectives and operations. Given a positive
result, it should then specifically assess its potential investment (either resource-seeking
or market-seeking) in light of local competition, as well as the government’s attitude with
respect to foreign direct investment in that particular industry. A firm should carefully
examine its own expectations with respect to the potential benefits and costs of the
venture and match them to the South African government’s expectations and
requirements for such an investment. The firm may also wish to calculate the venture’s
potential contribution to the country’s balance-of-payments account by applying the
following formula: B = (m - m1) + (x - x1) + (c - c1).
3. If South Africa is to receive more foreign direct investment, how should it prioritize
policies to attract it?
First and foremost, political and economic stability are critical if South Africa expects to
attract foreign direct investment. Given that, it is vital the policies developed to attract
FDI reflect the economic priorities of the South African government. To quickly create
employment, the government should target investment in labor-intensive industries. To
build infrastructure (e.g., water, electricity and telecommunications projects), it should
privatize existing government-controlled firms and also allow for increased foreign
competition in these industries. Further, South Africa’s FDI policy should remain quite
consistent over time and be very competitive when compared to policies offered by
similar countries. Finally, the government needs to promote the long-term development
of a stable, reliable and well-trained workforce.
4. Assume you work for a non-South African company and are in charge of identifying
countries where your company might expand. What factors would you consider when
comparing South Africa with other developing countries? What about in terms of
developed markets?
Whether considering resource-seeking or market-seeking investments, the factor of

distance will certainly come into play with respect to South Africa. While it is
strategically located for sourcing from or serving the markets of southern Africa, it is at a
distinct disadvantage with respect to the distances to other markets or sources of supply.
In the final analysis, firms will presumably select those investments that provide the best
returns. In addition to political and economic stability, government policies, incentives
and restrictions will also be critical factors. South Africa has much to offer in terms of
both market-seeking and resource-seeking investments. When compared to a developed
country, South Africa offers extensive natural resources and a growing market; per capita
income, however, is significantly lower, and while the available workforce is large, it is
generally not as highly skilled as the workforce in a developed nation. In addition, neither
its infrastructure nor its financial system is as extensively developed as that of an
industrialized nation.
Additional Exercises: Government Attitudes Toward FDI
Exercise 11.1. Identify the various home countries of students in your class. Then lead
the class in a comparative discussion of the importance of foreign direct investment in
their home countries. To what extent do their governments encourage it? In what ways do
they encourage it? If there are regulations, what are they? What MNEs have foreign
subsidiaries there? Conclude by asking the students to discuss both the positive and
negative effects of foreign direct investment on their national economies and cultures.
Exercise 11.2. Political ideologies can have a major impact upon the foreign direct
investment policies of nations. Ask students to debate the following idea:
The continuing liberalization of foreign direct investment policies and
activities by developing countries will necessarily move those nations toward
democracy.
Exercise 11.3. All countries have trade and investment policies, which have grown in
importance as trade and investment flows have become more and more relevant to the
well being of most nations. Ask students to discuss the impact of foreign direct
investment upon a country’s international trade activities. Is it in a country’s best interest
to encourage one at the expense of the other? Explain. Be sure to incorporate the span of
potential stakeholders in the coverage of the discussion.
International Business Negotiations and Diplomacy
Objectives
! Show the common and conflicting interests between countries and MNEs.
! Illustrate negotiations between business and government in an international context.
! Trace the changing roles of home-country governments in settling MNE’s disputes with
host governments.
! Clarify the role of companies’ public affairs and political behavior in international
business.
! Profile the major types of intellectual property.
! Explain the positions of companies and governments in the uneven global enforcement of
intellectual property rights.
Chapter Overview
Business-government relationships become much more complicated when negotiations are
involved. Chapter 12 explores the dealings between MNEs and governments and examines the
ways in which they strike agreements and how those agreements may change over time. It begins
with a comparison of the relative strengths of each party and discusses the behavioral factors that
will surely affect the progress of the negotiation process. It then discusses the involvement of
home country governments in asset protection issues, including expropriations and intellectual
property rights. The chapter concludes with an examination of the various ways firms and
governments seek to improve their positions in dealing with each other.
Chapter Outline
OPENING CASE: Saudi Aramco [See Map 12.1]
This case explains how power ebbs and flows between nations and oil companies in response to
changing economic, social and political situations. Saudi Arabia’s state-owned oil company,
Saudi Aramco, is the largest in the world in terms of sales, production and reserves, and it ranks
third in refining. Originally begun as a joint venture in the 1930s by Standard Oil of California
and Texaco, who were subsequently joined by Exxon and Mobil in 1948, Aramco was
unilaterally bought out by the Saudi government during the 1970s. The company then set about
replacing its foreign management with Saudi management and generally decreased its
dependence upon its former owners. In the late 1990s, however, economic events pushed crude
oil prices to a record low, causing Saudi Aramco to cut spending on its upgrading and expansion
projects, delay downstream expansion at overseas sites and lay off 8,000 workers. Subsequently,
the Saudi Crown Prince reversed the policy prohibiting foreign ownership and invited the
international oil companies back into Saudi Arabia. As the 21st century dawned, Saudi Aramco’s
CEO commented, “The realities of the business world have changed, and we have to adjust.”
summaries of key chapter points, review the figures in the text. Also, note the reference
to the CultureQuest video at the end of the chapter’s closing case. Finally, consider
taking time to use the Foreign Investment Simulation Negotiation from R. Moxon
Publishing; see Additional Exercise 12.3 for a description of the simulation and the web
address.
I. INTRODUCTION
Negotiation is a process for executing mutually desirable transactions, or for resolving
disagreements, through one or more meetings at which attempts are made to reach
consensus through discussion and compromise. Diplomacy and negotiations between
(home and host) governments and companies determine the terms of international
business operations. Because all that is at stake, negotiations often become very
complicated.
II. GOVERNMENT VS. COMPANY STRENGTH IN NEGOTIATIONS

The terms of international business operations are influenced by the governments of both
home and host countries. Tensions shift as the priorities of the vested parties shift and as
the relative strengths of those parties change.
A. Hierarchical View of Government Authority
In the hierarchical view of government authority, companies accept regulations
as “givens.” In that case, firms can choose to comply with, to circumvent, or to
avoid the regulations.
B. Bargaining View
Bargaining school theory states that the negotiated terms for a foreign investor’s
operations depend on how much the investor and the host country need each
other’s assets. The bargaining relationships between firms and governments will
depend on whether the parties view agreements as zero-sum or positive-sum gains.
1. Country Bargaining Strength. Industrialized countries are particularly
attractive to foreign investors because those countries offer large markets,
lower business risk and political stability, while developing nations may
offer potentially large markets, resource availability and/or competitive
wage rates.
2. Company Bargaining Strength. A company’s bargaining strengths may

include critical technology, marketing expertise, export capabilities,
product diversity and the value of the FDI.
C. Joint Company Activities
On the one hand, host governments may encourage joint company activities to
strengthen national capabilities, to lessen their dependence on foreign companies,
to spread risk and to deal more effectively with other governments. On the other
hand, two or more firms may invest jointly abroad, not so much to strengthen
their initial negotiating terms as to improve their positions in later negotiations,
and to spread their risk. In the event of a conflict, a host government may be much
more reluctant to deal simultaneously with more than one firm and home
government.
D. Home-Country Needs
Home-country governments are rarely neutral with respect to FDI. They, too,
have objectives such as economic growth and full employment. The political
relationship of two governments may also influence their participation in and the
outcome of business negotiations.
E. Other External Pressures on Negotiation Outcomes
Other interested stakeholders who may bring pressure to bear upon the outcome
of a negotiation could include local firms, political opponents, local pressure
groups (such as labor unions and environmental protection organizations),
stockholders, employees, customers, suppliers, etc.
III. NEGOTIATIONS IN INTERNATIONAL BUSINESS

Negotiations are the means by which a firm may initiate, conduct, or terminate operations
in a foreign country. The process itself often leads to multi-tiered bargaining before a
successful agreement is reached.
A. Bargaining Process
Comprehensive bargaining among governments and companies may begin long
before the terms of agreement begin to evolve. Besides the given economic
conditions, behavioral factors will affect both the bargaining process and the
actual terms of agreement. Often the parties renegotiate these terms as their
relationship evolves.
1. Acceptance Zones. In the bargaining process, agreement occurs only
when overlapping acceptance zones can be identified. If such zones do not
overlap, positive negotiations simply are not possible. [See Figure 12.3]
2. Range of Provisions. Most countries offer investment incentives in order

to attract FDI. Direct incentives could include tax holidays, employees
training, research and development grants, accelerated depreciation, low-
interest loans, subsidized energy and transportation, exemption of import
duties, etc. Countries may also provide indirect incentives, such as trained
labor forces and labor laws that prevent work disruptions. For their part,
companies generally agree to performance requirements that are ultimately
designed to help countries attain economic and non-economic objectives,
such as a positive balance of payments or local control over important
decisions.
B. Renegotiations
The theory of the obsolescing bargain states that an MNE’s bargaining position
will gradually erode once it transfers fixed assets to a host country. Although an
MNE’s position is usually stronger before entering a country, it may improve its
bargaining position over time by offering (or withholding) additional resources
the host country desires.
C. Behavioral Characteristics Affecting Negotiations
In international negotiations, misunderstandings may occur because of differences
in culture, nationalities, language and professions.
1. Cultural Factors. [Refer to Chapter 2] Cultural differences may be
evident during negotiations because of the different levels of power vested
in the negotiators, low-context vs. high-context communication styles,
pragmatic vs. holistic views, monochronic vs. polychronic approaches to
problem-solving, differing attitudes with respect to time and punctuality,
etc. Further, the importance of these factors may be different at the time of
renegotiations because the parties are by then better acquainted.
2. Language Factors. Often it is difficult to find words in a second
language (much less a third) that correctly express the intended meaning
of an original statement. Further, cultural factors determine the
acceptability of the use of interpreters.
3. Culturally Responsive Strategies. There is no guarantee negotiators on
either side will necessarily behave according to the norms of their home
culture. Thus, managers should determine at the outset whether to adjust
to their counterparts, help their counterparts adjust to them, or follow
some sort of hybrid adjustment pattern.
4. Professional Conflict. Government and business negotiators may begin
with mutual mistrust due to historical attitudes or differences in their
professional status; often they do not fully understand each other’s
objectives. Such conflicts have been particularly evident, as developing
economies have attempted to sell state-owned enterprises to foreign
investors.
5. Termination of Negotiations. When termination is necessary,
negotiators should find means to allow all parties to minimize stress, save
face, avoid publicity and perhaps reinstitute future contacts.
6. Preparation for Negotiations. By practicing their own roles and those of

their counterparts, and by thoroughly researching all aspects of a
negotiation, participants should be better able to anticipate responses and
plan their own actions.
IV. HOME COUNTRY INVOLVEMENT IN ASSET PROTECTION
Companies may fear foreign countries will appropriate their assets without giving them
adequate compensation. Thus, firms often press their home-country governments to deal
directly with other governments to help protect both their tangible and intangible assets.
A. The Historical Background of Home-Country Protection
The international standard of fair dealing states that foreign investors should
receive prompt, adequate and effective compensation in cases of expropriation.
Historically, home countries were known to use military force and coercion to
ensure such treatment, but the current view is that they should not intervene
militarily to protect foreign investments. This position has been reinforced by a
series of UN resolutions and also the fact that host country priorities have shifted
toward attracting FDI. Nonetheless, dependencia theory holds that developing
countries have practically no power when dealing with MNEs as host countries;
while largely out of vogue today, certain developing countries still hold this view
and use it to delay or prevent MNE investments.
B. The Use of Bilateral Agreements
To improve foreign-investment climates for their MNEs, many industrialized
countries have concluded bilateral treaties with other countries. Generally, such
treaties provide for insurance to cover losses from expropriation, political
violence, government contract cancellation and currency controls.
C. Multilateral Agreements and Settlements: FDI and Trade
When MNEs cannot reach agreement with organizations in a host country, they
may agree to a third-party settlement to be handled by a neutral organization or
group of countries. Government-to-government trade disputes are now largely the
domain of the WTO, which is considering expanding its mandate from matters of
trade to aspects of investment issues and dispute settlement.
D. Multinational Agreements: Intellectual Property Rights (IPRs)
Intellectual property involves the creative ideas, innovative expertise and

intangible insights that give an individual, company, or country a competitive
advantage. Intellectual property rights (IPRs)represent the ownership rights to
intangible assets, such as patents, trademarks, copyrights and know-
how. IPRs cover both industrial and artistic property. The Uruguay Round of the
GATT provides forIPR reciprocity, i.e., a country must grant to foreigners the
same property rights available to its own citizens. That said, countries differ
substantially in the laws they pass and enforce to protect IPRs.Generally,
developing countries offer weaker legal protection than do industrial countries,
and even when two countries institute similar levels of legal protection, their
enforcement policies may be quite different.
1. Patents. A patent represents the right granted by a sovereign power or
state for the protection of an invention or discovery against infringement.
The Patent Cooperation Treaty (PTC), the European Patent Convention
(EPC) and the EEC Patent Convention allow firms to first make a uniform
patent search and application, and then to apply for patents in all signatory
countries. The International Bureau for the Protection of Industrial
Property Rights (BIRPI) grants reciprocity to foreigners whose countries
are Convention members.
2. Trademarks. A trademark is a name/logo that distinguishes an
organization and/or its products. Cross-national cooperation for trademark
protection is found in the Trademark Registration Treaty (commonly
known as the Vienna Convention), which states that a firm must use a
trademark within three years of registering it internationally.
3. Copyrights. A copyright represents the right to produce, publish and sell
literary, musical, or artistic works.
4. Piracy. Piracy represents the unauthorized use of property rights that are
protected by patents, trademarks, or copyrights. It is estimated that
international trade in counterfeit products runs as high as $500 billion a
year, i.e., about 9 percent of the total value of world trade.
V. COLLECTIVE ACTIONS TO DEAL WITH INTERNATIONAL COMPANIES

Just as MNEs are concerned about governments’ actions, governments are concerned
about the actions of MNEs. The UN Center on Transnational Corporations, the OECD
and a variety of non-governmental organizations (NGOs) and industry associations have
instituted codes to deal with specific MNE practices. Generally, such codes are voluntary,
but they symbolize a collective attitude toward specific business practices that helps
governments regulate the local activities of MNEs.
VI. CORPORATE CITIZENSHIP AND PUBLIC RELATIONS

Many firms strongly believe that by being good corporate citizens abroad they can reduce
local animosity and remove concerns that might affect their competitive abilities. They
may publicize the ways their activities help satisfy social objectives and strive to increase
the number of local proponents by sharing ownership, avoiding direct confrontations,
installing local management and shifting part of the R&D function to host countries.
Nonetheless, it is almost impossible to please all stakeholders.
ETHICAL DILEMMA:
Pharmaceuticals and Intellectual Property Rights [See reference to the CultureQuest video
following the closing chapter case.]
The illegal copying of pharmaceutical products has been rampant for decades. Local
manufacturers routinely copy and market medicines that MNEs have invented. Although MNEs
lose million of dollars in revenues, many argue that copying is justified “in some circumstances”
because it is the only way to give poor people access to vital medicines—especially in low-
income countries. A growing number of activists, charities and governments are challenging
pharmaceutical firms over the high cost of drugs and are pressuring the WTO to relax the
conditions of the TRIPS accord that protect the IPRs of pharmaceutical firms. Should consumers
in industrialized countries pay higher prices for medicines in order to finance lower-priced
medicines in poorer countries? If so, how can MNEs and industrialized countries deal with the
threat of parallel imports?

New Roles for Diplomacy in the New Century
With the end of the Cold War came new alignments of countries based on economic factors to
replace many of the political-military rivals of the past. However, government-to-government
cooperation in dealing with MNEs is apt to develop slowly on a global scale. There are simply
too many competing interests among countries that tend to divide them on issues of economic
development, product-specific agendas, and regional viewpoints. One such major issue is that of
the protection of intellectual property.
WEB CONNECTION

_________________________
CLOSING CASE: Global Software Piracy [See Table 12.1, Map 12.2]
1. What has been the relationship among the various organizations combating software
piracy?
Companies, industry associations and governments have tried to negotiate practical
solutions to this problem. Until recently, the problem was generally approached by first
relying on software companies to develop technical and business measures to thwart
counterfeiters. Governments would then support their efforts by passing laws to specify
punishments for lawbreakers. Companies, governments and associations, singly and
jointly, have also successfully lobbied transnational institutions to help police piracy.
Collectively, the results of their actions testify to the usefulness of market-based solutions
to software piracy. Practical solutions developed by the software companies pre-empted
the need for governments to formulate and enforce antipiracy standards and technologies.
2. In your opinion, should software companies, industry associations, home governments,
or transnational institutions take the lead in negotiating with the governments of
countries with high piracy rates? Why?
Given the events of the 1990s, it is tempting to argue transnational institutions should
take the lead in negotiating with governments. With member nations numbering 170, the
World Intellectual Property Organization (WIPO) casts a formidable presence, as does
the World Trade Organization. Once a country ratifies anti-piracy treaties, its government
can no longer close its eyes to piracy. However, given the recent up-tick in software
piracy, neither companies, associations, governments, nor institutions dare let their guard
down. It is a problem about which they must be ever vigilant and continually to work
together to minimize.
3. Can the software industry expect to move forward without resorting to government-
devised standards in the area of antipiracy technologies?
Although practical solutions developed by the software companies have been reasonably
effective to date, the problem is very worrisome. In spite of an ever-expanding set of
laws, policies and treaties, the tenacity and pervasiveness of software pirates raises
several questions for the industry. A major loophole associated with government-devised
standards is that the variety of legal traditions in the world makes universal standards
next to impossible to legislate and enforce. Even if that hurdle were to be overcome,
given the rapid pace of software development, globally-devised standards may be
outdated before they’re ever implemented.
4. What kind of solutions can the software industry plan to apply to the piracy problem if
the problem steadily worsens?
If the piracy problem steadily worsens, the software industry is likely to become even
more proactive in its attempts to confront it. For example, more companies may choose to
use search engines to prowl the Internet in search of sites that distribute or sell pirated
software. They are likely to continue to stage software stings and then provide
information to prosecutors for use in criminal cases. The industry will also take legal
action against thousands of law-breaking web sites. In addition, software firms will surely
continue to work closely with governments, simply because the protection of software is
in every country’s national interest.
Additional Exercises: Negotiations and Diplomacy
Exercise 12.1. Although most companies would prefer to see intellectual property rights
consistently protected on a global basis, many governments would prefer to retain the
authority to decide such issues locally. Ask students to debate the trade-offs between
globalization and national or regional sovereignty in the context of intellectual property.
Would their positions change if the focus moved from the software to the pharmaceutical
to the aluminum and to the commercial aircraft manufacturing industries, for example?
Exercise 12.2. It is generally thought that a firm’s bargaining power is greatest before an
investment agreement is signed. At some time in the future, however, a firm may
consider moving a production facility from one foreign country to another, rather than
upgrade or replace an existing facility. What are the bargaining strengths of an MNE and
a host government at that point? Ask students to discuss the ebb and flow of power shifts
that occur over time between governments and firms as economic opportunities and
conditions change.
Exercise 12.3. Richard Moxon’s Foreign Investment Negotiations Simulation

Negotiation (FINS) simulates a negotiating situation among multinational corporations,
the governments of five large emerging market countries and firms based in those
countries. The negotiations concern the development of a high technology manufacturing
industry by those nations via foreign investments, joint ventures, licensing agreements, or
other arrangements. Further information and the FINS Participant Manual can be found
at: http://cba.fiu.edu/mgmt/gomezc/mana6608/general/8.2FINS.doc.
Country Evaluation and Selection
Objectives
! Discuss company strategies for sequencing the penetration of countries and for
committing resources.
! Explain how clues from the environmental climate can help managers limit geographic
alternatives.
! Examine the major variables a company should consider when deciding whether and
where to expand abroad.
! Provide an overview of methods and problems when collecting and comparing
information internationally.
! Describe some simplifying tools for determining a global geographic strategy.
! Introduce how managers make final investment, reinvestment and divestment decisions.
Chapter Overview
The country evaluation and selection process determines the geographical opportunities firms
choose to pursue. Chapter 13 first discusses the challenges of marketing and production site
location. It goes on to carefully examine the process by describing the choice and weighting of
variables used for opportunity and risk analysis as well as the inherent problems associated with
data collection and analysis. The chapter then introduces the use of grids and matrices for
country comparison purposes, discusses resource allocation possibilities and concludes by noting
the different factors considered as part of start-up, acquisition and expansion decisions.
Chapter Outline
OPENING CASE: Carrefour [See Figure 13.1, Map 13.1]
This case explores the location, pattern and reasons for Carrefour’s international operations.
Carrefour opened its first store in 1960 and is now the largest retailer in Europe and Latin
America and the second largest worldwide. Its stores depend on food items for nearly 60 percent
of sales and on a wide variety of non-food items for the remainder. Worldwide Carrefour has
five different types of outlets: hypermarkets, supermarkets, hard discount stores, cash-and-carry
stores and convenience stores. Country selection criteria include a country’s economic evolution,
sufficient size to justify additional store locations and the availability of a viable partner. Aside
from financial resources, Carrefour brings to a partnership expertise on store layout, clout in
dealing with global suppliers, highly efficient direct e-mail links with suppliers and the ability to
export unique bargain items from one country to another. Recently, Carrefour has used
acquisition as a way to capture additional scale economies. Carrefour depends primarily on
locally produced goods but also engages in global purchasing when capable suppliers are found.
Whether Carrefour can ultimately succeed as a global competitor without a significant presence
in the U.S. and the U.K. remains to be seen.
summaries of key chapter points, review the figures and tables in the text.
I. INTRODUCTION
Because companies lack the resources to take advantage of all international opportunities
they identify, they must determine both the order of country entry as well as the rates of
resource allocation across countries.
II. CHOOSING MARKETING AND PRODUCTION SITES, AND GEOGRAPHIC

STRATEGY
In choosing geographic sites, a firm must determine both where to market and where to
produce. The answer can be one and the same place if transportation costs are high and/or
government regulations make local production a necessity. In many industries, facilities
must be located near foreign customers; in others, market and production sites are
continents away. Developing a site location strategy that helps a firm maximize its
resources and competitive position is very challenging, given that many estimates and
assumptions about factors such as future costs and prices and competitors’ reactions must
be made.
III. SCANNING FOR ALTERNATIVE LOCATIONS

Scanning is useful insofar as a company might otherwise consider either too few or too
many possibilities. Through the use of scanning, decision makers can perform a detailed
analysis of a manageable number of geographic locations.
IV. CHOOSING AND WEIGHTING VARIABLES

To evaluate and compare countries, scanning techniques based on broad environmental
variables that identify both opportunities and risks should be used. Ultimately, variables
must be weighed against each other to effectively evaluate the potential success of a
particular venture and to compare various ventures.
A. Opportunities
Opportunities are determined by competitiveness and profitability factors.

Variables weighing heavily on the selection of market and production sites would
include market size, ease and compatibility of operations, costs, resource
availability and red tape.
1. Market Size. Market size is determined by sales potential. In some
instances, past and current sales for either an existing product or a similar
or complementary product are available on a country-by-country basis. In
addition, data such as GNP, per capita income, population, income
distribution, economic growth rates and levels of economic development
will also be useful.
2. Ease and Compatibility of Operations. Companies are naturally
attracted to countries that are located nearby, share the same language and
offer market conditions similar to those in their home countries. Beyond
that, proposals may then be limited to those countries that offer, among
other factors, the appropriate plant size, the local availability of resources,
an acceptable percentage of ownership and the sufficient repatriation of
profits. However, the more time, money and energy a firm expends in
examining a particular alternative, the more likely it is to accept it,
regardless of its merits. This situation is known as the escalation of
commitment. Feasibility studies should have clear decision points that
prevent such a situation from occurring.
3. Costs and Resource Availability. Costs are a critical factor in
production-location decisions. Productivity-related factors include the cost
of labor, the cost of inputs, tax rates, and available capital, utilities, real
estate and transportation. Often firms need to be located near suppliers and
customers in an area where infrastructure will allow them to move
supplies and finished products very efficiently. If a given production site
will be used to serve multiple markets, the cost and ease of moving
materials and products in and out the country will be especially important.
4. Red Tape. Red tape (disincentives) includes the difficulty of getting
permission to operate, bringing in expatriate personnel, obtaining licenses
to produce and market goods and satisfying government agencies on
matters such as taxes, labor conditions and environmental compliance.
Although not a directly measurable cost, red tape increases the cost of
doing business.
B. Risks
Is it ever rational for a firm to invest in a country with high economic and political
risk ratings? Such questions must be carefully weighed when making international
capital-investment decisions.
1. Risk and Uncertainty. Firms usually experience higher risk and

uncertainty when they operate abroad. In fact, the liability of
foreignness refers to the fact that foreign firms have a lower rate of
survival than local firms for the initial years after the start of operations.
However, those foreign firms that manage to overcome their initial
problems have long-term survival rates comparable to those of local firms.
Firms use a variety of financial techniques to compare potential
investments, including discounted cash flows, economic value added,
payback period, net present value, return on sales, return on equity, return
on assets employed, internal rate of return and the accounting rate of
return. Given the same expected return, most decision makers prefer a
more certain outcome to a less certain one. Often firms may choose to
reduce risk through some form of insurance. As part of a feasibility study,
the degree of acceptable risk should be determined so a firm does not
incur unacceptable costs.
2. Competitive Risk. A firm’s innovative advantage may be short-lived,
particularly if a country offers little protection with respect to intellectual
property rights. When pursuing a strategy known asimitation lag, a firm
moves first to those countries most likely to adapt and catch up to the
advantage. In some instances firms may seek those countries where they
are least likely to confront significant competition; in others they may gain
advantages by moving into countries where competitors are already
present. Firms may also seek “clusters” like Silicon Valley that attract
multiple suppliers, customers and highly trained personnel in order to gain
access to new products, technologies and markets.
3. Monetary Risk. If a firm’s expansion occurs through foreign-direct
investment, foreign-exchange rates and access to investment capital and
earnings are key considerations. Liquidity preferencerefers to the theory
investors want some of the holdings to be in highly liquid assets on which
they are willing to take a lower return. Firms must carefully evaluate a
country’s present capital controls, recent exchange-rate stability, balance-
of-payments account, inflation rate and level of government spending.
4. Political Risk. Political risk reflects the expectation the political climate
in a given country will change in such a way that a firm’s operating
position will deteriorate. It relates to changes in political leaders’ opinions
and policies, civil disorder and animosity between a home and host
country. When evaluating political risk, decision makers refer to past
patterns in a given country, expert opinions and country analysts. They
also look for economic and social conditions that could lead to political
instability, but there is no consensus as to what constitutes dangerous
instability or how it can be predicted.
V. COLLECTING AND ANALYZING DATA

Firms perform research to reduce uncertainties in their decision processes, to expand or
narrow the alternatives they consider and to assess the merits of their existing programs.
The costs of data collection should always be weighed against the probable payoffs in
terms of revenue gains or cost savings.
A. Problems with Research Results and Data
Numerous countries have agreed to standards for collecting and publishing
various categories of national data. However, the lack, obsolescence and
inaccuracy of data on other countries can make research difficult and expensive to
undertake. Further, data discrepancies further increase uncertainty in decision-
making.
1. Reasons for Inaccuracies. For the most part, incomplete or inaccurate
data result from the inability of governments to collect the needed
information. Both economic and educational factors will affect the
quantity and quality of available data. Of equal concern, however, is the
publication of false or purposely misleading information, as well as the
non-reporting or under-reporting of information people wish to hide or
distort.
2. Comparability Problems. Comparability problems result from
definitional differences across countries (e.g., family categories, literacy
levels, accounting rules), differences in base years, distortions in foreign
currency conversions, the measurement of investment flows, the presence
of black market activities, etc.
B. External Sources of Information
Both the specificity and cost of information will vary by source.
1. Individualized Reports. Market research and business consulting firms
conduct country studies for a fee. The fact that a firm can specify the
information it wants may make the cost worthwhile.
2. Specialized Studies. Certain research organizations generate specific
studies about countries, regions, industries, issues, etc., that they make
available for general purchase. The price is much lower than for an
individualized study.
3. Service Companies. Most international service-related firms publish
reports that are usually geared toward either the conduct of business in a
given country or region or about some specific subject of general interest,
such as tax or trademark legislation.
4. Government Agencies. Governments and their agencies publish tomes
of information designed to stimulate business activity both at home and
abroad.
5. International Organizations and Agencies. The United Nations, the
World Trade Organization, the International Monetary Fund, the World
Bank (IBRD) and the Organization for Economic Cooperation and
Development are but a few of the multilateral organizations and agencies
that collect and disseminate data. Many of the international development
banks even help fund investment feasibility studies.
6. Trade Associations. Many trade associations collect, evaluate and
disseminate a wide variety of data dealing with competitive and technical
factors in their industries. Their reports may or may not be available to
non-members.
7. Information Service Companies. Certain companies offer information-
retrieval services; they maintain databases from hundreds of sources from
which they will access data for a fee.
8. The Internet. The quantity of information available via the Internet is
increasingly extensive. As with other sources, a researcher must be
concerned about the reliability and validity of information gathered from
Internet sources.
C. Internal Generation of Data
When firms have to conduct studies in foreign countries, they may find traditional
data gathering and analytical methods do not reveal critical insights. In that case,
a researcher must be extremely imaginative and observant. In some instances,
useful information may be found by analyzing indirect or complementary
indicators.
VI. COUNTRY COMPARISON TOOLS
Two common tools for analyzing information collected via scanning
are grids and matrices. Also, once a firm commits to a location, it will need continuous
updates regarding external conditions that might affect its operations there.
A. Grids [See Table 13.2]
A grid can be used to make country comparisons according to a wide variety of
relevant factors, such as ownership rules, potential returns and perceived risk.
Variables can be ranked and weighted according to specific criteria that reflect a
firm’s situation and objectives. Although useful for establishing minimum scores
and for ranking countries, grids often obscure interrelationships among countries.
B. Matrices [See Figures 13.5, 13.6]
Two matrices frequently used when doing country comparisons are
the opportunity-risk matrix and the country attractiveness-company
strength matrix.
1. Opportunity-Risk Matrix. An opportunity-risk matrix plots a country

according to the perceived value of the opportunity the country offers, on
the one hand, and the expected level of risk associated with operating in
that country on the other. Which factors are good indicators of risk and
opportunity and the weight assigned to each must be identified and
assigned by the firm. Once scores are determined for each country being
considered, they can be plotted and reviewed from a comparative
perspective. A useful application of this technique is to develop both
present and future scores for countries (e.g., five years hence) because a
significant shift in a score in the future could have serious implications
with respect to the country selection process.
2. Country Attractiveness-Company Strength Matrix. A country
attractiveness-company strength matrix highlights a company’s specific
product advantage on a country-by-country basis. Firms should
concentrate their activities in those countries where both the country
attractiveness and the competitive strength ratings are high. When
opportunity ratings are high but company strength is not, a firm may
decide to try to remedy its competitive weakness.
C. Environmental Scanning
Environmental scanning provides a systematic assessment of external conditions
that might affect a firm’s operations. For country assessment, firms will likely
collect economic, competitive, societal and political/legal information.
VII. ALLOCATING AMONG LOCATIONS

Over time, most of the value of a firm’s FDI comes from reinvestment. Thus, in deciding
where to invest, firms must consider whether to reinvest or harvest, to what degree there
is interdependence among their locations and whether they should diversify or
concentrate their activities.
A. Reinvestment vs. Harvesting
Once a firm makes an initial investment, it will then need to decide whether to
continue investing in that operation or to harvest the earnings (and possibly divest
the assets) and use them elsewhere.
1. Reinvestment Decisions. Reinvestment refers to the use of retained
earnings to replace depreciated assets or to add to a firm’s existing stock
of capital. Aside from competitive factors, a company may need several
years of almost total reinvestment (and often allocation of additional
funds) in order to realize its objectives at a given location.
2. Harvesting. Harvesting refers to the reduction in the amount of an

investment; a firm may choose to simply harvest the earnings of an
operation or divest the assets there as well. If an operation no longer fits a
company’s overall strategy, or if better opportunities exist elsewhere, it
must determine how to exit that operation. When selling or closing
facilities, firms must consider possible government performance contracts
as well as potential adverse publicity, plus the possible difficulty in re-
establishing operations in that country in the future.
B. Interdependence of Locations
It is often difficult to assess the true impact a particular foreign subsidiary has on
other operations within an MNE if several operations are interdependent. In the
case of intra-firm sales, transfer pricingstrategy will definitely affect the relative
profitability of one unit as compared to another. Likewise, the net value of a
particular operation may be similarly distorted for corporate profit maximization
purposes.
C. Geographic Diversification vs. Concentration
A firm may take different paths en route to gaining a sizable presence in most
countries. At one end of the spectrum is geographic diversification, whereby a
firm moves rapidly into many foreign countries and then gradually builds its
presence in each. At the other end of the spectrum is geographic
concentration, whereby a firm moves into a limited number of countries and
develops a strong competitive position there before moving into others. When
deciding which strategy, or perhaps some hybrid of the two, is desirable, a firm
must consider a number of variables.
1. Growth Rate in Each Market. When the growth rate in each market is
high, a firm will likely concentrate on a few markets because of the cost
of keeping up with market expansion.
2. Sales Stability in Each Market. The more stable sales and profits are
within a single market, the less advantageous a diversification strategy
will be.
3. Competitive Lead Time. Sequential entry into multiple markets is more
common than simultaneous entry. If a firm has a long lead time before
competitors can copy or supercede its advantages, then it may be able to
follow a concentration strategy and still beat competitors to other markets.
4. Spillover Effects. Spillover effects represent situations in which a
marketing program in one country results in the awareness of a product in
other countries. When a single marketing program can reach many
countries (via cross-country media, for example), a diversification strategy
is advantageous.
5. Need for Product, Communication and Distribution
Adaptation. When companies find it necessary to alter products,
promotion and/or distribution strategies in foreign markets,
aconcentration strategy will be advantageous because the associated costs
cannot be spread over sales in other countries to capture economies of
scale.
6. Program Control Requirements. The more a company needs control

over a foreign operation, the more appropriate a concentration strategy
because additional resources will be required to maintain that control.
7. Extent of Constraints. When a firm is constrained by limited resources,
it will likely follow a concentration strategy because spreading resources
too thinly can be a recipe for failure.
VIII. MAKING FINAL COUNTRY SELECTIONS

At some point, firms must make resource allocation decisions. For new investments they
will need to develop detailed estimates of all costs and expenses and consider whether to
enter a particular venture alone or with a partner. For acquisitions, firms will need to
examine financial statements in great detail. For expansion within countries where they
are already operating, country managers will most likely submit capital budget requests
that include details of expected returns. To maximize expected gains, decisions must be
made in a timely fashion.
ETHICAL DILEMMA:
Economic Efficiency, Non-economic Concerns, and Competitive Strategies: Are They
Compatible?
Should countries work toward regulating FDI with global efficiency as their objective, or should
each country continue to serve its own interests by competing for FDI? MNEs are frequently
criticized when they shift their geographic emphasis in response to changing legal, political and
economic environments. In particular, they are criticized for selling dangerous products abroad
when domestic demand is dampened. MNEs tend to justify their moves on the grounds they
promote global efficiency through low-cost production and high-level sales; they also note they
may be responding to trade restrictions or government incentives, or to competitive
conditions.Relativists maintain it is unethical to prohibit foreign sales because those sales are
considered to be ethical in the countries in which they are made. Normativists, on the other hand,
maintain it is unethical for a government to permit its firms to do abroad those things they are
prohibited from doing domestically.

Will Locations and Location-Models Change?
The receptiveness of more countries to FDI and the global move toward privatization have
combined to create even more opportunities for MNEs. However, international geographic
expansion is a two-tiered decision. First, how much of a firm’s sales and production should be
located abroad, and second, how should those activities be allocated across countries? A further
consideration is the location of managers. Although technology may permit them to work from
anywhere, evidence shows business travel has increased in concert with advances in
communications.
WEB CONNECTION

_________________________
CLOSING CASE: Royal Dutch Shell/Nigeria [See Map 13.2]
1. What specific political risk problems does Shell face in Nigeria? What are the underlying
reasons for these problems?
First, Shell faces micropolitical risk in Nigeria because its investment there is so visible
and so dominant. Such pressures could come from within Nigeria (e.g., sabotage) as well
as from external stakeholders (e.g., boycotts of Shell products or opposition to their
operations in other countries). Second, it faces macropolitical risk in the form of civil
disorder and political leadership. In response to the shareholder resolution of 1997, Shell
has worked to improve both the social and environmental impact of its Nigerian
operations. It is investing heavily in community development programs. Nonetheless,
potential civil disorder and disagreements about the fair distribution of revenues within
Nigeria are ever present. Historically, many of the problems facing oil companies in
Nigeria are linked to government mismanagement. If the government does not address
development problems adequately and respond to concerns of its citizens, then all MNEs
will find operating in Nigeria an increasingly risky and expensive proposition.
2. Given the high political risk in Nigeria, why doesn’t Shell go somewhere else?
The key to this question lies in whether Shell considers the risk of operating in Nigeria to
be too high relative to the opportunity and sunk costs associated with operating there.
Shell is in Nigeria primarily to secure oil-based resources, not to serve the Nigerian
market. Thus, the opportunity side of Shell’s decision revolves around the probability of
finding and refining oil-based resources there at an acceptable cost.
3. What actions can Shell take to quell criticism about its operations in Nigeria?
Shell has begun to take action in response to criticism from pressure groups, including
becoming more transparent about its practices concerning human rights and the
environment. In 2002 the firm announced a $7.5 billion oil and gas investment to be
made in Nigeria over a period of five years. It reasons that such a massive expansion will
demonstrate its commitment to the Nigerian people, the environment and to Nigeria’s
civilian democratic government. However, whether the subsequent revenues generated by
the investment go to neglected regions remains to be seen. On the other hand, Shell’s
community development program in the Niger delta region should have a more
immediate and direct impact.
Additional Exercises: Country Evaluation and Selection
Exercise 13.1. As the phenomenon of economic integration progresses, the process of
country selection takes on new dimensions. Ask students to compare and contrast the
opportunities and risks associated with establishing operations in the European Union to
those in the NAFTA region. Would such investments be primarily resource or market
seeking? Be sure students explain and give examples to support their ideas.
Exercise 13.2. Ask students to compare the costs and benefits of investing in an
industrialized economy to the costs and benefits of investing in a developing economy
from the standpoint of an MNE. Then ask the students to debate the idea that MNEs have
a responsibility to work toward developing global efficiency, i.e., that economic
considerations should be weighted more heavily than other factors in the country
selection process.
Exercise 13.3. During the 1970s, a number of MNEs such as Coca-Cola and IBM made
decisions to abandon operations in certain developing countries and not to enter others
because of government restrictions. Ask the students to discuss the likelihood that MNEs
will face such decisions in the future, given the progress of the WTO and movements
toward economic integration in many parts of the world. Do the students foresee other
factors that might cause more divestments in the future?
Collaborative Strategies
Objectives
! Explain the major motives that guide managers when they choose a collaborative
arrangement for international business.
! Define the major types of collaborative arrangements.
! Describe some considerations for not entering into arrangements with other companies.
! Discuss what makes collaborative arrangements succeed or fail.
! Discuss how companies can manage diverse collaborative arrangements.
Chapter Overview
Collaborative strategies allow firms to spread both assets and risk across countries by entering
into contractual agreements with a variety of potential partners. Chapter 14 first discusses the
motives that drive firms to engage in collaborative arrangements. It then examines the various
types of possible arrangements, including licensing, franchising, joint ventures and equity
alliances. It goes on to explore the various problems that may arise in collaborative ventures and
concludes with a discussion of the various methods for managing these evolving arrangements.
Chapter Outline
OPENING CASE: Cisco Systems [See Map 14.1]
Globalization has pushed Cisco Systems into a broader range of markets in order to follow the
expansion patterns of its customers, solicit new business and study new ideas and products.
Cisco’s worldwide alliances spur the company to continue learning and to refine its
competencies. They enable it to meet customer needs that fall outside its areas of core
competencies, while simultaneously permitting Cisco and its partners to enhance their
competitiveness by focusing on their respective competencies. Alliances have also permitted
Cisco to limit its capital outlays in potentially lucrative but risky ventures. Cisco believes
alliances improve its processes, reduce its costs and expose it to the best competitive practices.
The firm’s official Strategic Alliances Team manages crucial partnerships with industry-leading
technology and integrator firms, and it is the driving force behind the collaborative development
effort to accelerate new market opportunities. Cisco has generally standardized the mechanics of
partnership agreements. However, it continues to work to improve the odds of collaborative
success by better managing the matters of trust, commitment and culture that shape what Cisco
calls “interwoven dependencies and relationships” with its partners.
summaries of key chapter points, review the figures in the text. Also, note the reference
to the CultureQuest video regarding collaborative ventures in China at the end of the
chapter’s closing case.
I. INTRODUCTION
Many of the modes of entry from which firms may choose involve some form
of collaboration with other companies, i.e., a formal, long-term contractual agreement
between or among partners. A strategic alliance represents a collaborative agreement
between firms that is of strategic importance to one or both partners’ competitive
viability.
II. MOTIVES FOR COLLABORATIVE ARRANGEMENTS

Each participant in a collaborative arrangement has its own basic objectives for
operating internationally as well as its own motives for collaborating with a partner.
A. Motives for Collaborative Arrangements: General
Companies collaborate with other firms in either their domestic or foreign
operations in order to spread and reduce costs, to specialize in particular
competencies, to avoid or counter competition, to secure vertical and/or horizontal
linkages and to learn from other companies.
1. Spread and Reduce Costs. When the volume of business is small, or one
partner has excess capacity, it may be less expensive to collaborate with
another firm. Nonetheless, the costs of negotiation and technology transfer
must not be overlooked.
2. Specialize in Competencies. The resource-based view of the firm holds
that each firm has a unique combination of competencies. Thus, a firm can
maximize its performance by concentrating on those activities that best fit
its competencies and relying on partners to supply other products,
services, or support activities.
3. Avoid Competition. When markets are not large enough for numerous
competitors, or when firms need to confront a market leader, they may
band together in ways to avoid competing with one another or combine
resources to increase their market presence.
4. Secure Vertical and Horizontal Links. If a firm lacks the competence
and/or resources to own and manage all of the activities of the value-added
chain, a collaborative arrangement may yield greater vertical access and
control. At the horizontal level, economies of scope in distribution, a
better smoothing of sales and earnings through diversification and an
ability to pursue projects too large for any single firm can all be realized
through collaboration.
5. Gain Market Knowledge. Many firms pursue collaborative

arrangements in order to learn about their partners’ technology, operating
methods, or home markets and thus broaden their own competencies and
competitiveness over time.
B. Motives for Collaborative Arrangements: International
Companies collaborate with other firms in their foreign operations in order to gain
location-specific assets, overcome legal constraints, diversify geographically and
minimize their exposure in high-risk environments.
1. Gain Location-Specific Assets. Cultural, political, competitive and
economic differences among countries create challenges for companies
that operate abroad. To overcome such barriers and gain access to
location-specific assets (e.g., distribution access or a competent
workforce), firms may pursue collaborative arrangements.
2. Overcome Legal Constraints. Countries may prohibit or limit the
participation of foreign firms in certain industries, or discriminate against
foreign firms via tax rates and profit repatriation. Firms may be able to
overcome such barriers via collaboration with a local partner.
3. Diversify Geographically. By operating in a variety of countries, a firm
can smooth its sales and earnings; collaborative arrangements may also
offer a faster initial means of entering multiple markets or establishing
multiple sources of supply.
4. Minimize Exposure in Risky Environments. The higher the risk
managers perceive with respect to a foreign operation, the greater their
desire to form a collaborative arrangement.
III. TYPES OF COLLABORATIVE ARRANGEMENTS

While collaborative arrangements allow for a greater spreading of assets across
countries, the various types of arrangements necessitate trade-offs among objectives.
Finding a desirable partner can be problematic. A firm has a wider choice of operating
forms and partners when there is less likelihood of competition and when it has a desired,
unique, difficult-to-duplicate resource.
A. Some Considerations in Collaborative Arrangements
Two critical variables that influence the choice of collaborative arrangement are
a firm’s desire for control over its foreign operations and its prior expansion into
foreign ventures.
1. Control. The loss of control over flexibility, revenues and competition is
a critical variable in the selection of forms of foreign operation. The more
a firm depends on collaborative arrangements, the more likely its control
will be lessened over decisions regarding quality, new product directions
and production expansion.
2. Prior Expansion of the Company. If a firm already owns and controls
operations in a foreign country, the advantages of collaboration may not
be as attractive as otherwise.
B. Licensing
Under a licensing agreement, a firm (the licensor) grants rights to intangible

property to another company (the licensee) to use in a specified geographic area
for a specified period of time; in exchange, the licensee ordinarily pays a royalty
to the licensor. Such rights may be exclusive or nonexclusive. Usually
the licensor is obliged to furnish technical information and assistance, while
the licensee is obliged to exploit the rights effectively and pay compensation to
the licensor. Intangible property may be classified as:
 patents, inventions, formulas, processes, designs, patterns
 copyrights for literary, musical, or artistic compositions
 trademarks, trade names, brand names
 franchises, licenses, contracts
 methods, programs, procedures, systems.
1. Major Motives for Licensing. Licensing often has an economic motive,
such as the desire for faster start-up, lower costs, or access to additional
property rights (e.g., technology). For thelicensor, the risks and costs of a
given venture are lessened; for the licensee, costs are less than if it had to
develop a product or process on its own. Cross-licensing represents the
situation in which companies in various countries exchange technology
rather than compete with each other with every product in every market.
2. Payment. (See Figure 14.4) The amount and type of payment for
licensing arrangements may vary. Each contract tends to be negotiated on
its own merits; the bargaining range is based on dual expectations. Both
agreement-specific and environment-specific factors may affect the value
of a license.
3. Sales to Controlled Entities. Many licenses are given to firms owned in
part or in whole by the licensor. From a legal standpoint, subsidiaries are
separate companies; thus, a license may be required in order to
transfer intangible property.
C. Franchising
Franchising represents a specialized form of licensing in which
the franchisor not only sells an independent franchisee the use of the intangible
property essential to the franchisee’s business, but also operationally assists the
business on a continuing basis. In a sense, the two partners act like a vertically
integrated firm because they are interdependent and each produces a part of the
product that ultimately reaches the customer.
1. Organization of Franchising. A franchisor may penetrate a foreign
country by dealing directly with its foreign franchisees, or by setting up
a master franchise and giving that organization the right to open outlets on
its own or to develop sub-franchises in the country or region.
2. Operational Modifications. Franchise success is derived from three

factors: product standardization, effective cost control and high
recognition. Nonetheless, franchisors face a classic dilemma: the more
they standardize on a global basis, the lower the potential for product
acceptance in a given country; the more they permit adaptation to local
conditions, the less the franchisor can offer thefranchisee, the higher the
costs and the less the control by the franchisor.
D. Management Contracts
A management contract represents an arrangement in which one firm provides
management personnel to perform general or specialized functions to another firm
for a fee. A firm usually pursues such contracts when it believes a partner can
manage certain operations more efficiently and effectively than it can itself.
E. Turnkey Operations
Turnkey operations represent a type of collaborative arrangement in which one
firm contracts with another to build complete, ready-to-operate facilities. Usually,
suppliers of turnkey facilities are industrial-equipment and construction
companies; projects may cost billions of dollars; customers most often are
government agencies or large MNEs.
F. Joint Ventures
A joint venture represents a direct investment in which two or more partners
share ownership. As a firm’s share of the equity declines, its ability to control a
given operation also declines. A consortiumrepresents the joining together of
several entities (e.g., companies and governments) to combine resources and/or to
strengthen the possibility of pursuing a major undertaking. Other forms of joint
venturesinclude:
 two firms from the same country joining together in a foreign market
 a foreign firm joining with a local firm
 firms from two or more countries establishing an operation in a third
country
 a private firm and a local government
 a private firm joining a government-owned firm in a third country.
G. Equity Alliances
An equity alliance represents a collaborative arrangement in which at least one of
the collaborating firms takes an ownership position (usually a minority) in the
other(s). The purpose of an equity alliance is to solidify a collaborating contract,
thus making it more difficult to break.
IV. PROBLEMS OF COLLABORATIVE ARRANGEMENTS

Dissatisfaction with the results of collaboration can cause an arrangement to break down.
Problems arise for a number of reasons.
A. Collaboration’s Importance to Partners
One partner may give more attention to the collaboration than the other—often
because of a difference in size. An active partner will blame the less active partner
for its lack of attention, while the less active partner will blame the other for poor
decisions.
B. Differing Objectives
Although firms may enter into collaborative arrangements with complementary

capabilities and objectives, their views regarding such things as reinvestment vs.
profit repatriation and desirable performance standards may evolve quite
differently over time.
C. Control Problems
When no single party has control of a collaborative arrangement, the venture may
lack direction; if one party dominates, it must still consider the interests of the
other. By sharing assets with another firm, a company may lose some control over
the extent and/or quality of the assets’ use. Further, even when control is ceded to
one of the partners, both may be held responsible for problems.
D. Partners’ Contributions and Appropriations
One partner’s ability to contribute technology, capital and other assets may
diminish (at least on a relative basis) over time. Further, in almost
all collaborations the danger exists that one partner will use the others’
contributed assets, or take more than its fair share from the operation, thus
enabling it to become a direct competitor. Such weaknesses may cause a drag on a
venture and even lead to the dissolution of the agreement.
E. Differences in Culture
Differences in both national and corporate cultures may cause problems
with collaborative arrangements, especially joint ventures. Firms differ by
nationality in terms of how they evaluate the success of an operation (e.g.,
profitability, strategic market position and/or social objectives). Nonetheless, joint
ventures from culturally distant countries tend to survive at least as well as those
between partners from similar cultures.
V. MANAGING FOREIGN ARRANGEMENTS

As a collaborative arrangement evolves, partners need to reassess certain decisions in
light of their resource bases and external environmental changes.
A. Dynamics of Collaborative Arrangements
The evolutionary costs of a firm’s foreign operations may be very high as it
switches from one operational mode to another, especially if it must pay
termination fees. Thus, a firm must develop the means to evaluate performance by
separating the controllable and uncontrollable factors at its various profit centers.
B. Finding Compatible Partners
A firm may actively seek a partner for its foreign operations, or it can react to a
proposal from another company to collaborate with it. Potential partners should be
evaluated both for the resources they can offer and their willingness to work
together. The proven ability to handle similar types of collaboration is a key
professional qualification.
C. Negotiating Process
Certain technology transfer considerations are unique to collaborative

arrangements; often pre-agreements are set up to protect concerned parties. The
secrecy of financial terms, especially when government authorities consult their
counterparts in other countries, is an especially sensitive area. Market conditions
may dictate the need for different terms in different countries.
D. Contractual Provisions
To minimize potential points of disagreement, contract provisions should address
the following factors:
 the termination of the agreement if parties do not adhere to its directives
 methods of testing for quality
 the geographical limitations on the asset’s use
 which company will manage which parts of the operation
 the future commitments of each partner
 how each partner will buy from, sell to, or use intangible assets that come
from the collaborative arrangement.
E. Performance Assessment
All parties should establish mutual goals so all involved understand what is
expected, and a contract should spell out expectations. In addition to the
continuing assessment of the venture’s performance, a firm should also
periodically assess the possible need for a change in the type of collaboration.
ETHICAL DILEMMA:
When What’s Right for One Partner Isn’t Right for the Other Partner
One potential problem arising from collaborative arrangements is a firm’s skirting of unethical
practices by having a partner handle them; a second is that a firm might treat its partner
unethically. How should a company deal with foreign partners whose practices on pollution,
labor relations and bribery are different from those in its home country? Increasingly, NGOs
criticize firms for what their suppliers do. All partners put resources into collaborative
arrangements. Can any partner ethically take resources from an operation that are not specified in
an agreement?

Why Innovation Breeds Collaboration
Because the cost of invention is often so high, it follows that firms of considerable size will carry
out most innovation. Although firms can become ever larger through mergers and
acquisitions, collaborative arrangementsare likely to be increasingly important in the future as
governments opt to restrict such activities because of antitrust concerns. At the same
time, collaborative arrangements will bring forth both opportunities and problems as firms move
simultaneously into new countries and to new types of contractual arrangements with new
partners. The more partners in a given alliance, the more strained the decision-making and
control processes will likely be.
WEB CONNECTION

_________________________
CLOSING CASE: International Airline Alliances [See Map 14.2]
1. Discuss a question raised by the manager of route strategy at American Airlines: Why
should an airline not be able to establish service anywhere in the world simply by
demonstrating that it can and will comply with the local labor and business laws of the
host country?
When considering either the international or simply the domestic environment, a major
consideration is whether economic interests in the airline industry are better served
through regulation via the market. Proponents of deregulation argue that competition has
forced carriers to become efficient or else go out of business, instead of being subsidized
by regulated route and fare structures. Proponents also argue that the survival of mega-
carriers leads to economies of scale in handling passengers and cargo. Opponents argue
that local interests are often ill-served by deregulation since airlines are free to
discontinue service and to wage predatory price wars that put competitors out of business,
at which point the survivors will then raise prices. Opponents also raise fears there may
eventually be too few survivors to allow for the competition that was envisioned by the
proponents of deregulation; the high barriers to entry in the industry further exacerbate
this situation. Another major consideration deals with the political dimensions of the
question. Because most governments see airlines as a key national industry, they oppose
giving foreign carriers access to domestic routes on grounds of both national security and
consumer welfare.
2. The president of Japan Air Lines has claimed that U.S. airlines are dumping air services
on routes between the U.S. and Europe, meaning they are selling below their costs
because of the money they are losing. Should governments set prices so that carriers
make money on routes?
It is very difficult to separate profits and losses on a route-by-route basis. While fares and
loads on certain routes may seem to be low, they may in fact be generating marginal
revenues that make major routes profitable. A second issue is that of price elasticity. If
governments were to set prices above the equilibrium point, traffic and revenues, and
hence profitability, would all fall. A third issue is that of ownership. If privately owned
carriers abandon routes to government-owned airlines, they could well give advantages to
those airlines that could then be used against them on other routes. Finally, the issue of
profitability raises the question of subsidies. It is nearly impossible to determine whether
dumping is taking place when competitors receive so many direct and indirect subsidies.
3. What will be the consequences if a few large airlines or networks come to dominate
global air service?
The consequences would be both positive and negative. On the positive side, passengers
should be able to travel almost anywhere in the world on a single airline (or network).
That in turn should minimize the risk of missed connections and lost baggage. Operating
economies should be realized as a result of the higher utilization of airport gates and
ground equipment—consequent savings may or may not be passed along to passengers
through lower prices. On the negative side, it is quite possible that minimal competition
would lead to poor service and/or high prices. In addition, competition among the
destinations associated with particular airlines would likely decline, as would the special
services offered by the “niche” airlines.
4. Some airlines, such as Southwest and Alaska Air, have survived as niche players without
going international or developing alliances with international airlines. Can they continue
this strategy?
When there is sufficient traffic on the city pairs that a route serves, there is little need to
have feeder or connecting routes for an airline to be profitable. In fact, without the need
for hubs to make connections, some airlines can operate in smaller but closer-to-
downtown airports, such as Midway in Chicago or La Guardia in New York. They can
avoid the costs associated with the transfer of bags to connecting flights and the payment
of overnight expenses to passengers who miss connections. In addition, they may be able
to overcome any disadvantages from small-scale operations by targeting their promotion
to regional and niche groups and by running low-cost operations that charge low fares.
Conventional wisdom would suggest they can in fact survive in their present operational
mode and that attempts to expand and/or modify their operations might make them more,
rather than less, vulnerable.
Additional Exercises: Collaborative Strategies

Exercise 14.1. Ask students to name companies, both domestic and foreign, that operate
internationally. Then ask them to discuss the potential types of collaborative
arrangements they feel would be appropriate for the various firms. Conclude the
discussion by examining the list of firms and asking students if there are particular
industries that seem to lend themselves to particular types of collaborative arrangements
more readily than others. Be sure the students discuss why this might be so.
Exercise 14.2. Identify the various home countries of students in your class. Then lead
the class in a discussion of the likely types of collaborative arrangements foreign firms
might pursue in those countries. Be sure students cite the various economic, political and
cultural factors that would influence decisions regarding viable collaborative strategies.
Exercise 14.3. While offering desirable advantages, licensing agreements also limit the
amount of control a licensor can exercise over a foreign production process. Engage the
students in a discussion of the type of firm that would most likely be willing to allow a
licensee to use its established brand name, and the type of firm that would not be willing
to do so. Explore the reasons for each position as well as the reasons a licensee would be
willing to accept a license that did not include rights to the use of the associated brand
name.
Control Strategies
Objectives
! Explain the special challenges that confront MNEs trying to control foreign operations.
! Describe organizational structures for international operations.
! Show the advantages and disadvantages of decision-making at headquarters and at foreign
subsidiary locations.
! Highlight both the importance of and the methods for global planning, reporting and
evaluation.
! Give an overview of some specific control considerations affecting MNEs, such as the
handling of acquisitions and the dynamics of control needs.
! Summarize major means of control.
! Introduce the differences between a branch and a subsidiary.
Chapter Overview
The control process aids in keeping an organization on track as it strives to accomplish its
objectives. Chapter 15 examines the ways in which firms group their operations for the purpose
of control, as well as the particular factors to consider when deciding where control should be
located. The chapter begins with a discussion of the planning loop and then explores the
dynamics of various organizational structures. It considers the trade-offs between centralizing
and decentralizing the decision-making process and discusses the various mechanisms that can
be used to help ensure control measures are in fact implemented. The chapter concludes with an
examination of the role of legal structures in the control process.
Chapter Outline
OPENING CASE: Johnson & Johnson [See Map 15.1]
Since beginning operations in 1886, Johnson & Johnson (J&J) has evolved into the most broadly
based health-care corporation in the world. It markets its products in more than 175 countries,
generates annual global revenues of more than $36 billion and employs more than 108,300
people (of which 60% are located outside the U.S.). J&J’s business strategy aims for leadership
in the firm’s three core areas: pharmaceuticals, medical devices and consumer products. It
pursues this strategy via a complex organizational structure that combines responsibility across
37 product groups and 14 health-care areas (known as platforms) that act as staging areas from
which J&J leverages its knowledge, development skills, marketing expertise and global reach.
Formal planning at the business-unit level includes initiatives on major issues such as
biotechnology, the restructuring of the health-care industry and globalization. Although J&J’s
operating units are largely decentralized, headquarters managers are responsible for coordinating
production and marketing on a global basis and dealing with issues common to many or all
operating units. Successful employees are rotated among units. Self-directed councils (research,
operations, etc.) meet regularly to swap ideas.
summaries of key chapter points, also review the figures in the text.
I. INTRODUCTION
Control represents the planning, implementation, evaluation and correction of
performance in order to ensure organizational objectives are achieved. Five major
dimensions of control are: planning, organizational structure, the location of decision-
making, control mechanisms and control dynamics. The control-related issues MNEs
must confront are where decision-making power resides, how foreign operations relate to
headquarters and how to ensure the firm meets its global objectives. The control of
foreign operations is especially difficult because of distance, country diversity,
uncontrollable environmental factors and the degree of uncertainty.
II. PLANNING [See Figure 15.2]

A. The Planning Loop
Planning represents the process of meshing objectives with internal and external
constraints and resources in order to set the means to implement, monitor and
correct operations. Strategic intent reflects the long-term objective that provides
cohesion while a firm builds global competitive viability. A strategic
plan represents a long-term scheme involving major commitments that is
designed to guide a firm in the achievement of its objectives. The six steps in the
international planning process include:
 determining long-range strategic intent
 analyzing internal corporate resources
 setting international corporate objectives
 analyzing host country conditions
 identifying alternatives and priorities
 implementing the international strategy.
The selection of alternatives will be guided by a firm’s decision to pursue
a multidomestic, a global, or a transnational strategy (see Chapter 1). Major
factors to consider include:
 determining long-range strategic intent
 analyzing the location of value-added functions
 the location of markets
 the desired level of involvement
 product strategy
 promotion and distribution strategy
 competitive strategy
 factor movement and start-up strategy.
B. Uncertainty and Planning
A firm’s international operations are by their very nature more complex and less
certain than its domestic ones. The more foreign subsidiaries, the more products,
the more foreign markets involved, i.e., the greater the uncertainty, the more
difficult the planning process.
III. ORGANIZATIONAL STRUCTURE

Organizational structure concerns the reporting relationships within a firm. The choice
of structure depends upon a firm’s choice of a multidomestic, global, or transnational
strategy, the location and type of foreign facilities and the impact of international
operations on total corporate performance.
A. Separate vs. Integrated International Structures
Most companies will follow one of the structures shown in Figure 15.3. However,
no form of organizational structure is without drawbacks.
1. International Division Structure. An international division groups all
international activities into a single division within a firm. While this
structure creates a critical mass of international expertise, the relationship
between the international and domestic divisions is often complicated.
2. Functional Division Structure. A functional division groups personnel
according to business function. It is ideal when products and production
methods are undifferentiated across countries. However, as new and
different products are added, the structure becomes cumbersome.
3. Product Division Structure. A product division groups activities
according to the product line with which they are associated. It is well
suited for firms with diverse products and for firms that choose to pursue a
global strategy.
4. Geographic Division Structure. A geographic division groups activities
on a regional basis and is used when a firm has extensive foreign
operations that are not dominated by a single country or area. The
structure is useful when maximum economies of scale and scope can be
captured on a regional rather than a global basis.
5. Matrix Division Structure. A matrix division is a two-tiered structure
designed to give functional, product and/or geographic groups a common
focus. It is based on the theory that the groups will become interdependent
and thus will more readily exchange information and resources with each
other. However, the dual reporting/oversight responsibilities can also
create conflicts across groups with differing objectives.
B. Dynamic Nature of Structures
A firm’s structure should evolve as the business evolves, changing as the level
and type of international activities change.
C. Mixed Nature of Structures
Because of growth dynamics, firms seldom if ever get all of their activities to
neatly correspond to a single organizational structure. Most exhibit a mixed
structure, particularly with respect to foreign operations.
D. Nontraditional Structures
As firms grow in size, as their product lines increase in number and as they
become more dependent on foreign operations, control becomes more complex.
Consequently, new organizational structures continue to evolve.
1. Network Organizations. Because of the increase in alliances among
firms, effective control will increasingly come from negotiation and
persuasion, rather than from authority. A network alliancerepresents an
interdependent group in which each firm is a customer of and a supplier to
the other firms. Heterarchy describes the organizational structure in which
the management of an alliance of companies is ambiguous, i.e., so-called
equals share power. Many Japanese firms are linked through keiretsus,
i.e., networks in which each firm owns a small percentage of the others in
the network. Keiretsus may be either vertical or horizontal in nature.
2. Lead Subsidiary Organizations. The major competency for designing,
producing and/or marketing a product does not always lie in a firm’s home
country. In that case, a firm may choose to locate divisional headquarters
in a strategic foreign country.
IV. LOCATION OF DECISION-MAKING

Decisions made at the foreign-subsidiary level are considered to be decentralized; those
made above that level are considered to be centralized. The location of decision-making
may vary within a firm over time, as well as by product line, function and country.
Usually, decentralized decision-making is associated with a multidomestic
strategy, centralized decision-making with a global strategy and a combination of the
two with a transnational strategy. Reasons for choosing one over the other is partially a
function of orientation, i.e., ethnocentric, polycentric, or geocentric (see Chapter 2).
Several trade-offs must be weighed with respect to the location of decision-making as it
pertains to international operations.
A. Pressures for Global Integration vs. Local Responsiveness
The higher the pressure for global integration, the greater the need
to centralize decision-making; the higher the pressure for responsiveness to local
conditions, the greater the need to decentralizedecision-making.
1. Resource Transference. Decisions about moving products, inputs and
other resources internationally are most likely to be centralized because
information will be required from all operating units; often only
headquarters possesses all the relevant data.
2. Standardization. Standardization is highly unlikely if each subsidiary is

free to make its own decisions. Worldwide uniformity of an MNE’s
products, inputs, processes and policies usually reduces the firm’s global
costs substantially, even though some revenue may be lost in particular
niche markets.
3. Systematic Dealings with Stakeholders. In certain instances firms need
to take a consistent stand with respect to a variety of policies that affect
their international operations; in others, global competition may cause a
firm to make decisions with respect to one country in order to improve its
performance elsewhere. In both instances, centralized decision-making is
required.
4. Transnational Strategy. A transnational strategy takes advantage of the
different competencies and contributions that emanate from anywhere
within an organization and integrates them into worldwide operations.
A meganational is considered to be a company that thrives on the process
of seeking uniqueness it can exploit elsewhere or that complements its
existing operations. To the extent that such firms need to coordinate
activities across subsidiaries, decision-making should be centralized.
B. Capabilities of Headquarters vs. Subsidiary Personnel
Upper management’s perception of the competence of corporate vs. local
managers will influence the location of decision-making. The greater the
confidence placed in foreign managers, the greater the extent of delegation that
will occur. Centralization often reduces the chances for foreign nationals to reach
upper level headquarters positions. On the other hand, granting autonomy to local
managers in certain areas may attract a higher caliber of management talent at the
subsidiary level.
C. Decision Expediency and Quality
A poor decision may be better than a good one that comes too late, but such a
situation should be avoided whenever possible.
1. Cost and Expediency. Although corporate management may be more
experienced in making certain decisions, the time and expense involved in
the centralization process may not always justify the better advice.
2. Importance of the Decision. Most critical decisions are made at high
levels within an organization. The greater the potential loss and the more
important the issue, the higher the level of decision-making and control
within a firm. Often firms will set limits on expenditure amounts, thus
allowing local autonomy for smaller outlays but requiring corporate
approval for larger ones.
V. CONTROL IN THE INTERNATIONALIZATION PROCESS

A variety of factors influence how much control a company needs at different stages of
the internationalization process.
A. Level of Importance
The greater the importance specific foreign operations hold with respect to total
corporate performance, the higher the level to which those units should report.
Organizational structure, therefore, should change over time to reflect the firm’s
increased involvement in foreign activities.
B. Changes in Competencies
As a firm’s foreign operations grow, it develops a foreign management group that
is more experienced and thus more capable of operating more independently of
headquarters. At the same time, the increasing importance of a firm’s foreign
operations to total global performance may dictate a greater need for headquarters
to be actively involved. The larger the share of foreign operations, the greater the
likelihood headquarters will have specialized staff with international expertise.
The larger the share of operations in a given country, the greater the likelihood the
country unit will have specialized staff.
C. Changes in Operating Forms
The use of multiple operating forms, such as trade, licensing and direct
investment, and the move from one to another may create the need to change
areas of responsibility within a firm. To minimize obstacles when responsibilities
shift from one group to another, a firm should plan carefully and create
organizational mechanisms that ensure the complementarity of activities.
VI. CONTROL MECHANISMS

Whether a company separates or integrates its international operations, it needs to
develop a control mechanism/structure to maximize its performance.
A. Corporate Culture
Corporate culture consists of the common values shared by the employees of an
organization that both serve as an implicit control mechanism and help enforce
other explicit bureaucratic mechanisms. By promoting closer contact among
managers across countries, firms can develop a shared understanding of global
goals and norms for reaching those goals. In addition, by facilitating the transfer
of “best practices” from one country to another and by transferring managers
among operations, firms can help assure appropriate behavior will occur, even
when an explicit set of rules does not exist.
B. Coordinating Methods
Because each type of organizational structure has its pros and cons, firms may
develop mechanisms to capture the desirable advantages of diverse functional,
geographic and product perspectives without abandoning their basic strategies and
structures. Some of these mechanisms include the development of teams with
members from different countries, the strengthening of corporate staffs, greater
and more frequent management rotation, the placing of foreign managers on
boards of directors and top-level committees and partially basing reward systems
on global results.
C. Reports
Decisions on how to allocate capital, personnel and technology continue without

interruption, so reports must be timely, accurate and informative. Written reports
are crucial for international operations because subsidiary managers so often lack
substantive personal contact with corporate staff.
1. Types of Reports. To permit comparisons across operations, most MNEs
use reports for foreign subsidiaries that resemble those they use
domestically. The primary emphasis of an operations report is to evaluate
a subsidiary’s performance; the evaluation of its management should
generally be of secondary importance.
2. Visits to Subsidiaries. Within many MNEs certain members of the
corporate staff spend considerable time visiting foreign subsidiaries in
order to collect information and provide direction.
3. Management Performance Evaluation. MNEs should evaluate a
subsidiary manager separately from the subsidiary’s performance so as not
to penalize or reward managers for conditions beyond their control. That
said, precisely what is within their control is frequently a matter for
disagreement.
4. Cost and Accounting Comparability. Headquarters needs to use
considerable discretion in interpreting the data it uses to evaluate and
change subsidiary performance, especially if it is comparing a subsidiary’s
performance with competitors from other countries whose currencies and
accounting methods are different from its own.
5. Evaluative Measurements. A system that relies on a combination of
measurements is more reliable than one that doesn’t. The most important
criteria tend to be budget-compared-with-profit and budget-compared-
with-revenue. Other non-financial criteria such as market share, quality
control and host government relations are also important.
6. Information Systems. With ever-expanding computer and global
telecommunications links, managers can share information more quickly
and easily than ever before. In fact, information technology can facilitate
both the centralization and the decentralization of operations. The primary
problems associated with information systems concern the cost of
information relative to its value, its redundancy and its irrelevance.
VII. CONTROL IN SPECIAL SITUATIONS

Acquisitions, shared ownership and changes in strategy can all create major control
problems.
A. Acquisitions
Acquisitions can result in overlapping geographic responsibilities and markets, as
well as new lines of business with which corporate management has no
experience. A further problem occurs when thecorporate culture of one company
is very different from that of the other. Attempts to centralize decision-making or
change operating methods may be met with resistance from foreign personnel and
host governments alike.
B. Shared Ownership
Shared ownership limits the flexibility of corporate decision-making and thus

makes control more difficult than it would be with wholly owned operations.
Mechanisms that can lead to effective control in this situation include spreading
the remaining ownership across many shareholders, dividing equity into voting
and non-voting stock, creating side agreements specifying who will exercise what
control and maintaining possession of a critical asset the entity needs.
C. Changes in Strategies
Changes in strategies will necessitate changes in reporting relationships, changes
in the type and amount of information to be collected and a need for new
performance-appraisal systems. However, it is often difficult to wrest control
from country subsidiaries when managers have become accustomed to a great
deal of operational autonomy.
VIII. THE ROLE OF LEGAL STRUCTURES IN CONTROL STRATEGIES
When operating in a host country, companies may choose among legal forms that affect
their decision-making, taxes, maintenance of secrecy and legal liability. Most choose a
subsidiary form for which there are additional legal alternatives that vary by country.
A. Branch and Subsidiary Structures
A foreign branch is a foreign operation not legally separate from the parent
company. Branch operations are possible only if the parent holds 100 percent
ownership. A foreign subsidiary, however, is a separate legal entity, established
through foreign direct investment; the parent may or may not own all of the
voting stock. Because a subsidiary is legally separate from its parent, legal
authorities generally limit liability to the subsidiary’s assets. This concept
of limited liability is a major factor in the choice of the subsidiary form. With few
exceptions, claims against a firm for its actions are settled by courts either where
the actions occur or where the subsidiary is legally domiciled.
B. Types of Subsidiaries and Their Effects on Control Structures
When establishing a subsidiary in a foreign country, a firm can usually choose
from among a number of alternative legal forms. In addition to differences in
liability, forms vary in terms of:
 the ability of the parent to sell its ownership
 the number of stockholders required to establish a subsidiary
 the percentage of foreigners allowed to serve on a board of directors
 the amount of required public disclosure
 whether equity may be acquired by non-capital contributions
 the types of eligible businesses
 the minimum capital requirements for establishing a subsidiary.
ETHICAL DILEMMA:
When Push Comes to Shove, Just Who’s in Control?
A corporate ethics policy requires a control system to both ensure compliance and be compatible
with the managerial reward system. However, when local managers are prodded to improve their
performance, they may be tempted to violate the firm’s ethical policy. Further, emerging
economies are concerned about control strategies that place management and technical functions
in the home country and leave only the menial and low-skilled jobs in the host country—they
want MNEs to invest control at the local level. The question then becomes to what extent should
headquarters be responsible for actions taken at the subsidiary level? Should minority
stockholders be responsible for the actions of majority stockholders?

Control/No Control—the Constant Balancing Act
Technology and government-to-government agreements tend to favor global integration and
standardization. At the same time, legal, cultural, economic and political differences often
remain firmly entrenched. Thus, the search for the most effective strategy continues. Pressures to
centralize control in order to deal with the increasing number of global competitors and to
respond to the more homogenized needs of global customers continue to mount—so does the risk
of clashes emanating from cultural and other national traditions. On the other hand, the sheer size
of some firms is pushing them toward decentralization. As MNEs encourage increasingly greater
interdependence among their subsidiaries, new heterarchical relationships and structures are
likely to surface.
WEB CONNECTION

_________________________
CLOSING CASE: GE Hungary [See Figure 15.4]
1. Define national and corporate cultures. How did GE’s and Tungsram’s cultures differ?
How did GE attempt to use its culture as a control mechanism in Hungary and
elsewhere?
National culture represents the amalgam of the cultures of various distinct groups that
reside within the borders of a country. If a country has only one predominant ethnic
group, then national culture and ethnic culture are one and the same. Corporate
culture consists of the common values shared by the employees of an organization that
both serve as an implicit control mechanism and help enforce other explicit bureaucratic
mechanisms. It represents the ways in which attitudes are expressed and the ways in
which employees are evaluated and rewarded. GE’s corporate culture partly
reflects U.S. national culture. It embodies such typical traits as individualism, self-
confidence, pragmatism, optimism, universalism, low power distance, equality and a
stronger orientation toward the present rather than the future. Hungarians, however, are
less confident, more pessimistic, more particular about relationships than rules and more
outer-directed. These national differences can largely be explained by historical
experiences. GE relies heavily on culture as a control mechanism. It expects people to
behave according to its cultural norms. The company feels strongly that the more it is
able to “internalize” its corporate values at the subsidiary level, the more successful it
will be in implementing its global strategies and policies. After a cautious start, GE
proceeded to embed its corporate culture at Tungsram. Standardization of the
manufacturing process for many of its products is but one reason. This change in
corporate culture is partly responsible for impressive improvements in Tungsram’s
productivity, quality and service. Nonetheless, GE has been accused of heavy-
handedness. Its decision to transfer its corporate culture to Tungsram has been a source of
such contention that it has resulted in unfavorable publicity for GE throughout the host
country.
2. What were the pros and cons of changing GE’s European operations from multidomestic
to regional or global? Would such a change work the same for all of GE’s product
divisions?
Multidomestic operations are more flexible and can more easily accommodate significant
national differences among the countries where a firm is operating. The disadvantage of
multidomestic operations is that decisions made on the basis of local considerations may
not yield maximum benefits to the corporate organization as a
whole. Regional or global operations are better able to take advantage of economies of
scale and scope, facilitate the exchange of personnel and cross-country experiences and
provide better organizational means of control. The disadvantage is that knowledge about
local conditions might not be sufficiently factored into decisions made centrally.
However, the change of strategy would not affect all of GE’s product divisions equally.
While some products require minimal adaptation across countries, others require
extensive changes from country to country.
3. What factors might account for (a) GE’s initial acquisition and subsequent expansion of
light-source manufacturing and R&D in Hungary? and (b) GE’s establishing new types
of businesses inHungary?
GE’s initial acquisition and subsequent expansion of its operations in Hungary were
largely due to the fact that light-source manufacturing and R&D fit well with one of GE’s
long-time established core businesses (lighting). In addition, Hungary is strategically
located in a region that GE wished to enter. Tungsram itself was specifically attractive
because of its historical presence in the East European market. Over time the firm had
developed a number of important lighting source innovations, and it traditionally sold
most of its production outside of Hungary. Although Tungsram’s market position eroded
during the closing era of Soviet rule, GE saw an opportunity to effect a turnaround
through the infusion of capital, production technology and management know-how. GE
then went on to establish several new types of businesses in Hungary (banking, medical
equipment, industrial equipment, electrical switches and airplane engine repair) and
combined them into a new holding company, GE Hungary Inc. The purpose of the joint
holding is to allow GE’s manufacturing operations to negotiate with the government of
Hungary as a single voice, to centralize and standardize purchasing, accounting, human
resource management and legal representation, thereby generating significant cost
savings and improving the firm’s competitive position.
4. In what ways does GE attempt to gain synergy among its operations in different
countries and among its different businesses?
GE has decided to position Tungsram as a lower-priced brand and to introduce its own
brand as the premium quality product in Europe. The reason is that GE’s corporate logo
ties together all of its activities worldwide. Corporate-wide benefits can be obtained
through enlarged market shares, increased specialization, increased cross-border
teamwork, the sharing of R&D, technology and other overhead costs, and because new
business problems are created for competitors. While the pursuit of such benefits was
surely a part of GE’s pre-investment calculations, they are difficult to quantify once
realized.
Additional Exercises: Control Strategies
Exercise 15.1. A recent trend among MNEs is to replace expatriates in foreign
subsidiaries with local managers. Ask students to debate the implications of that policy
from the standpoints of (a) the development and implementation of global strategies, (b)
the control of foreign subsidiaries and (c) the development of managers with significant
international experience and expertise. Does it mean decision-making will necessarily be
decentralized?
Exercise 15.2. Refer students to five recent cases: GE Hungary and Johnson & Johnson
(Chapter 15), Cisco Systems (Chapter 14) and Royal Dutch Shell/Nigeria and Carrefour
(Chapter 13). Ask the students to compare the apparent corporate cultures of the five
MNEs. Then ask them to propose and defend specific types of organizational structures
for each of the firms, given the nature and extent of their operations. Would decision-
making be centralized or decentralized?
Exercise 15.3. Historically, many foreign firms that competed in the European
marketplace established an extensive network of highly autonomous local subsidiaries.
However, as Europe has evolved into a single market via the EU, those same firms have
often been frustrated in their efforts to shift from a multidomestic to
a regional (European) strategy. Ask students to discuss the reasons for this and to suggest
mechanisms firms might use to accomplish the shift. Finally, have the students compare
the strategic advantages of a long-established multidomestic-type organization to a newly
established regionally oriented firm.
Marketing
Objectives
! Introduce techniques for assessing market sizes for given countries.
! Describe a range of product policies and the circumstances in which they are appropriate.
! Contrast practices of standardized vs. differentiated marketing programs for each country
in which sales are made.
! Emphasize how environmental differences complicate the management of marketing
worldwide.
! Discuss the major international considerations within the marketing mix: product, pricing,
promotion, branding and distribution.
Chapter Overview
Marketing is a social and managerial process through which individuals and organizations
satisfy their needs and objectives via the exchange process. Chapter 16 begins by examining the
ways in which marketing managers analyze country market potential in order to develop
effective international marketing mix strategies. It reviews the adaptation vs. standardization
debate and also considers the rationale for selecting nationally responsive vs. globally integrated
marketing strategies. The chapter discusses each of the marketing mix variables from an
international perspective and concludes with a note about international electronic commerce.
Chapter Outline
OPENING CASE: Avon [See Map 16.1]
Founded in 1886, Avon is one of the world’s largest manufacturers and marketers of beauty-
related products. This case describes Avon’s push into foreign markets via a combination of
nationally responsive and globally standardized marketing strategies. The company has foreign
direct investments in 58 countries and markets in others through licensing, franchising and
distributor arrangements. More than 60 percent of its sales come from outside the U.S. Avon
seeks to develop a global image of being a company that supports women and their needs. It
relies heavily on independent salespersons who sell directly to individual
customers. Avon emphasizes standardized products that carry its global brand, but allows
product lines and brand names to vary by country if needed. In addition, each country operation
sets its own prices to reflect local market conditions and strategic objectives. Whenever
possible, Avon transfers organizational learning and successful practices from one country to
another.
summaries of key chapter points, also review the figures and tables in the text.
I. INTRODUCTION
Although basic marketing principles are the same in both domestic and foreign markets,
environmental differences often require those principles be applied in different ways.
A marketing mix consists of the controllable variables, i.e., product and branding,
promotion, distribution (place) and price designed to create value for the customer and
achieve competitive advantage for the firm.
II. MARKET SIZE ANALYSIS

Once a firm decides to enter foreign markets, it must carefully collect and analyze data in
order to determine specific country product-market potential and the marketing mix
required to achieve its objectives.
A. Total Market Potential
Total market potential represents the total potential sales of all competitors
within a given product market (category). To determine potential demand for its
own product, a firm must first estimate the potential sales of the total market and
then derive its current and desired market-share. The major indicators for
potential sales of most products are present income and population, plus the rate
of growth in each. Other variables to be considered include the possible
obsolescence and leapfrogging of products, the costs of both essential and non-
essential products, income elasticity, income inequality, the availability of
substitute products and cultural factors and tastes.
B. Gap Analysis
Gap analysis represents a method for estimating a firm’s potential sales of a given
product by determining the difference between the total market potential and gaps
in usage, competition, product line offerings and distribution. Gap analysis helps
managers determine both the size of and the reasons for differences
between market potential and actual sales.
III. PRODUCT POLICY
Economists define a product as a bundle of benefits; marketers more elaborately state the
idea as anything that can be offered for acquisition, attention, use, or consumption that
might satisfy a need or want. Products can be tangible, intangible, or some combination
of the two. The international applications of five common product policies are
highlighted below.
A. Production Orientation
A production orientation indicates a firm is more concerned about production
variables such as efficiency, quality and/or capacity than it is about marketing.
Firms assume customers want lower prices and/or higher quality. Such an
approach is still used internationally for selling commodities, for passive exports
and for serving foreign-market segments that resemble domestic markets.
B. Sales Orientation
A sales orientation indicates a firm assumes global customers are reasonably
similar and it can therefore sell abroad the same product it sells at home. A firm
will be aided in this approach when there is also a spillover of product
information from one country to another.
C. Customer Orientation
A customer orientation indicates a firm is sensitive to customer needs, i.e., it
thinks in terms of identifying and serving the needs of the customer. Given a
particular country market, what products are needed?
D. Strategic Marketing Orientation
A strategic marketing orientation indicates a firm is committed to continuously
serving foreign target markets and to making incremental product adaptations to
satisfy local customers. It draws upon elements of the production, sales and
customer orientations, as appropriate.
E. Societal Marketing Orientation
The societal marketing orientation indicates a firm recognizes it must conduct its
activities in a way that preserves or enhances the well-being of all its
stakeholders, i.e., as it serves the needs of its customers it must also address the
environmental, health, social and work-related problems that may arise when
producing or marketing its products abroad.
F. Reasons for Product Alterations
The primary reasons behind the tendency of firms to alter their products to meet
local conditions are legal, cultural and/or economic in nature.
1. Legal Reasons. Explicit product-related legal requirements vary widely
by country but are usually meant to protect customers, the environment, or
both. Protective packaging laws and international product standards
represent two very complicated legal issues.
2. Cultural Reasons. Cultural factors affecting product demand may or
may not be easily discerned. While religious beliefs may offer clear
guidelines regarding product acceptability, other factors such as color,
design and artistic preferences may be much more subtle.
3. Economic Reasons. Levels of income, differences in income distribution
and the extent and condition of available infrastructure can all affect
demand for a particular product. Often, price-reducing alterations are
required if a firm wishes to participate in a particular country market.
G. Alteration Costs
Usually firms will choose to standardize basic components while altering critical
end-use characteristics. Certain alterations (such as packaging and color options)
may be inexpensive to make, yet they can have an important effect on demand.
H. Extent and Mix of the Product Line
When making product line decisions, managers must consider the cost and effect
on sales of offering just one or a few products internationally as opposed to an
entire family of products. Whereas narrowing a product line allows for the
concentration of effort and resources, the broadening of a product line may lead to
distribution economies.
I. Product-Life Cycle Considerations
Differences will likely exist across countries in both the shape and the length of a
product’s life cycle. A product facing declining sales in one country may have
growing or sustained sales in another. Such country differences can lead to an
extended life for a given product.
IV. PRICING
Price represents the value asked for a product. Although usually expressed as a monetary
value, in the case of barter transactions it may not be. In the long run, price must be low
enough to generate sufficient demand but high enough to yield a profit to the firm. The
complexities of pricing are exacerbated in the international arena.
A. Government Intervention
Every country has laws that either directly or indirectly affect prices to the final
customer. Price controls may set either maximum or minimum prices for
designated products. The WTO permits a government to establish restrictions
against any imports that enter the country at a price below the price charged to
customers in the exporting country (dumping). However, a firm may charge
different prices in different countries because of competitive and demand factors
(e.g., a firm may choose to exclude fixed costs in the price calculation of products
exported to developing countries in order to be price competitive in those
markets.)
B. Greater Market Diversity
Country variations lead to many ways of segmenting the market for a particular
product. Depending upon market conditions, a firm may adopt any of the
following pricing strategies.
1. Skimming. A skimming pricing strategy sets a high price for a new
product, which is aimed at market innovators. Over time, the price will be
progressively lowered in response to demand and supply conditions, i.e.,
the presence of additional competitors.
2. Penetration. A penetration pricing strategy sets an aggressively low
price to attract a maximum number of customers (some of whom may
switch from other brands) and to discourage competition.
3. Cost-plus. A simple cost-plus strategy sets the price at a desired margin
over cost.
C. Price Escalation in Exporting
If standard markups occur within distribution channels, either lengthening the

channels or adding other expenses somewhere within the network will further
increase the delivered price of the product. Common reasons for price escalation
in export sales are tariffs and the often greater distance to the market. To compete
in export markets, a firm may have to sell its products to intermediaries at a
reduced price in order to lessen the amount of price escalation.
D. Currency Value and Price Changes
Pricing in the case of highly volatile currencies can be extremely difficult,
especially under conditions of high inflation. Pricing decisions must assure the
company of sufficient funds to replenish inventory. This may result in the need
for frequent price adjustments. Further, currency fluctuations also affect pricing
decisions for any product that faces foreign competition; when a currency is
strong producers may have to accept a lower profit margin if they wish to be price
competitive.
E. Fixed vs. Variable Pricing [See Table 16.1]
The extent to which manufacturers can or must set prices at the retail level varies
substantially by country. There is also substantial variation in whether, where and
for what products customers prefer or expect to negotiate an agreed-upon price.
Local laws and customs may limit firms’ abilities to set prices as they choose. In
many cultures, prices are simply the starting point in the bargaining process.
F. Company-to-Company Pricing
Dominant retailers with substantial clout may get suppliers to offer them lower
prices, which in turn will enable them to compete as the lowest-cost retailer.
However, such clout may not exist in new foreign markets. In addition, many
industrial buyers are claiming large price reductions through Internet purchases.
V. PROMOTION
Promotion consists of the messages intended to help sell a product, i.e., direct and
indirect forms of communication designed to inform, persuade and/or remind a target
audience about an organization and its products. The promotion mix consists of personal
selling, advertising, sales promotion/support and publicity/ public relations activities.
A. The Push-Pull Mix
Promotion strategies may be categorized as push (personal selling and trade sales
promotion) or pull (advertising, consumer sales promotion and publicity). Most
firms use a combination of both. Factors that will determine the mix
of push and pull strategies include the type of distribution system, the cost and
availability of media, customer attitudes toward sources of information and the
relative price of the product as compared to disposable income.
B. Standardization of Advertising Programs
Advertising represents any paid form of media (nonpersonal) presentation.

Although savings from the standardization of advertising are not as great as those
from product standardization, they can nonetheless be substantial. However, in
addition to reducing costs, standardized advertising may also improve the quality
of advertising at the local level, prevent the confusion associated with different
national messages and images and speed the entry of products into new country
markets. Standardization usually implies using the same agency globally.
However, it is difficult to completely standardize an advertising campaign for a
number of reasons.
1. Translation. When a media transmission spans multiple countries, there
is no opportunity to translate a message into other local languages. When
messages are translated, numerous difficulties can be encountered with
both language (content and meaning) and images.
2. Legality. What is deemed to be legal advertising in one country may in
fact be illegal elsewhere. Differences result mainly from varying national
views on consumer protection, competitive protection, standards of
morality and nationalism.
3. Message Needs. An advertising theme may not be appropriate
everywhere because of national differences in how well consumers know a
product, how they perceive it, who makes the purchasing decision and
what features are most important.
VI. BRANDING
A brand is a name, term, sign, symbol and/or design that is intended to identify a product
or product line and differentiate it in the marketplace. A trademark is a brand, or a part of
a brand, that is granted legal protection because it is capable of exclusive appropriation. It
protects the seller’s exclusive rights to use the brand name and/or brand mark. MNEs
must make four major branding decisions: brand vs. no brand, a manufacturer’s brand vs.
a private brand, one brand vs. multiple brands and a global brand vs. multiple local or
regional brands.
A. Language Factors
Both the translation and pronunciation of brand names pose potential problems in
many markets. Often the problems are obvious, but other times they are quite
subtle, yet critical. In addition, brand symbols (shapes and colors) are culturally
sensitive in many societies.
B. Brand Acquisitions
When an MNE acquires a (foreign) firm, it automatically acquires its brands. In
some instances those brands will be maintained; in others they will be folded into
a larger brand in order to capture economies of scale and to promote
regional/global brand recognition.
C. Country-of Origin Images
Firms must determine whether to promote a local or foreign image for their
products. The products of some countries may be perceived as being particularly
desirable and of higher quality than products from other countries. A firm may be
able to enhance its competitive advantage by effectively exploiting this
perception.
D. Generic and Near-Generic Names
While firms want their brand names to become household words, they do not
want those names to become so common they are considered to be generic (e.g.,
Kleenex and Xerox). Generic names may either stimulate or frustrate the sales of
the firm from whom the name was expropriated.
VII. DISTRIBUTION
Distribution refers to the physical and legal path that products follow from the point of
production to the point of consumption. The distribution channel (aka the marketing
channel) consists of the set of interdependent individuals and organizations that take title
to or assist in the transfer of a title to a product from producer to final
customer. Coverage refers to the nature of a firm’s distribution strategy within a given
region (exclusive, selective, or intensive). In many instances, geographic barriers and poor
transportation infrastructure and facilities will divide a country into very distinct viable
and non-viable markets.
A. Difficulty of Standardization
Distribution is often the marketing mix variable that firms find the most difficult
to standardize. This is because each country has its own national distribution
system that is historically intertwined with its cultural, economic, and legal
environments. Other factors that influence the ways in which consumer products
are distributed within a given country include:
 people’s attitudes toward entrepreneurship
 the ability to pay retail workers
 restrictions on the size of stores and their hours of operation
 the financial ability to carry large inventories
 the efficacy of the national postal system.
B. Choosing Distributors and Channels
Just as in the case of production, a firm may choose to handle
the distribution function internally or outsource it to a specialized provider.
1. Internal Handling. When sales volume is low, it is usually more cost
effective for a firm to contract with an external distributor. On the other
hand, distribution may be handled internally when sales volume is high,
when the firm has sufficient human, capital and financial resources, when
after-sales service is extensive and complex, when customers are global
and when a firm can otherwise enhance its competitive advantage.
2. Distributor Qualifications. Common criteria for evaluating and
selecting distributors include financial strength, good relationships with
their customers, the extent of their other business commitments regarding
both complementary and competitive products and the state of a
distributor’s equipment, facilities and personnel. A final consideration is
how quickly start-up can occur.
3. Spare Parts and Repair. The more complex and expensive a product,
the more important that after-sales service will be. When after-sales
service is critical, firms may need to invest in service centers, which can in
turn become important sources of revenues and profits.
4. Gaining Distribution. Distributors choose the products and firms they

wish to represent and emphasize. A new entrant must therefore convince a
desired distributor of the viability of both its products and the company
itself. To do so it may need to provide extra incentives or be willing to
enter into exclusive arrangements provided a competitor does not already
occupy that position.
C. Hidden Costs in Foreign Distribution
Because of the differences in national distribution systems, the cost of getting
products to customers varies widely from one country to another.
1. Infrastructure. In many countries, ports, roads and warehouse facilities
are so poor that getting goods to customers in a timely fashion and at a
reasonable cost, with minimal damage or loss en route, is truly difficult.
2. Levels in the Distribution System. Many countries have multi-tiered
wholesale systems through which a product must move before reaching
the retail level. Because each intermediary adds a markup, final delivered
prices increase.
3. Retail Inefficiencies. In some countries, low labor costs and a basic
distrust by owners of all but family combine to result in retail practices
that raise consumer prices, especially when there is an insistence upon
counter (as opposed to self) service.
4. Restrictions. Many countries have laws that protect small retailers,
which in turn effectively limit the number of large retail firms and the
efficiencies they bring to their operations. Many countries also limit
operating hours.
5. Stock-outs. When retailers have little space for storing inventory,
distributors must incur the cost of making more frequent but smaller
deliveries to prevent retail-level stock-outs.
D. The Internet and Electronic Commerce
As electronic commerce increases, customers worldwide can quickly compare
prices from different distributors, thus intensifying price competition. However,
global Internet sales are not without problems. A firm cannot easily differentiate
its marketing program because the same web advertisements and prices reach
customers everywhere. At the same time, however, a firm’s Internet ads and
prices must comply with the laws of each country where it markets its product.
ETHICAL DILEMMA:
What Products Should Companies Market Internationally?
Even when MNEs strictly abide by host-country laws, they may be criticized for paying too little
attention to the product needs of developing countries. In addition, MNEs have also been faulted
for promoting products to people who either do not understand a product’s potential negative
consequences or cannot afford it (even though they may want it). It is not clear that even if
stakeholders could agree on what comprises responsible behavior, governments could effectively
legislate it. In the absence of regulation, how far companies should go to protect customers is
unclear both within and across countries. Further, is it in the best interests of a firm (and its
stakeholders) to give in to pressure groups, especially when the grounds for their protests are
highly controversial?

Will the “Haves” and the “Have-Nots” Meet the “Have Somes”?
Most projections indicate the disparities between the “haves” and the “have-nots” of the world
will continue to grow throughout the foreseeable future, both within and across countries. To
serve the “haves,” firms will offer luxury products to customer niches that cut across national
boundaries. At the other extreme, companies will have numerous opportunities to develop low-
cost standardized products designed to fit the needs of the “have-nots.” For many firms, these
two extremes present a serious dilemma. Moreover, firms will find it increasingly difficult to
charge different prices in different countries, although they will be increasingly able to cut
intermediaries out of the distribution channels for their products.
WEB CONNECTION

_________________________
CLOSING CASE: Dental News and Hotresponse [See Map 16.2]
1. Why do you believe Dental News continues to receive card responses even though people
can respond on the Web through Hotresponse?
Given the diverse markets that Dental News serves, it would be expected that access to
the Internet and the Worldwide Web would differ across markets. Thus, it is prudent
of Dental News to simultaneously run the response cards along with the web response
option through Hotresponse. It is interesting, however, that the use of Hotresponse has
not led to a significant reduction in card responses. It would appear that the two response
options complement one another very well.
2. As more people come online, will there be a need to print the editions of Dental News?
Why or why not?
There will definitely be a need to continue to print Dental News. The web will not
substitute for hard copies sent through the mail, although it may supplement them.
Posting a publication on the web does not ensure that people will actually go to the site
and look it up. Given the cost and speed of the web, it is likely that more and more of the
responses and information will be supplied electronically. For the foreseeable future,
however, printed matter will continue to play a key role. (Dental News may be able to
benefit from a web edition of its newsletter by offering differing advertising packages,
one to include only ads in a web-distributed format. This could eventually serve as a
significant source of income and profit, as the costs of web-based publishing are
minimal.)
3. As more people come online, do you believe dental product companies will sell more
directly rather than go through distributors? Do you think this may vary by type of dental
product and company? If so, why?
The propensity of dental product companies to sell more of their goods directly to their
customers (as opposed to going through distributors) will vary according to several
factors. It will depend largely on the extent to which dental product manufacturers feel
they have adequate in-house competencies to handle sales, shipping and service
functions. Those that do will tend to engage more heavily in direct sales. The type of
dental product being sold will also serve to promote or hinder a firm’s move toward more
direct sales. Companies that are a quite distant from their customers and whose products
require significant after-sales service will probably continue to use established
distribution networks to ensure customer satisfaction. Those whose products are easy to
ship and do not require after-sales follow-ups will tend to move more quickly into direct
customer sales.
4. Within the marketing mix (product, price, promotion, branding and distribution), which
are most important when Dental News tries to sell advertising to companies producing
dental products?
In this instance, both price and promotion are very important. At this stage, branding is
not critically important because Dental News operates in many markets without
significant competition. Because the advertising sold is not distributed to the people who
bought it, the distribution issue is really how to effectively get Dental News into the
hands of potential customers for the advertised products. Maintaining a large subscription
base is essential to the survival and success of the business.
Additional Exercises: International Marketing
Exercise 16.1. While many firms have moved to develop globally standardized products,
others have moved toward more product differentiation across countries. Ask students to
discuss the types of products for which they would expect to see more global
standardization, and those for which they would expect to see more local differentiation.
Be sure they consider both goods and services.
Exercise 16.2. A number of advertising agencies have expanded their operations to the
global level so they can offer their services on a worldwide basis. Ask students to discuss
the reasons an MNE might prefer to work with a single global advertising agency rather
than a series of local or regional agencies. Then ask students to explore the challenges
advertising agencies face when they choose to offer worldwide services.
Exercise 16.3. When a firm is confronted with excess capacity but its national currency is
relatively weak, it may choose to export to markets with relatively stronger currencies.
Ask students to discuss the logic and wisdom of basing a long-term international
marketing strategy on foreign currency swings. What would a firm have to do to
effectively position itself to maximize such “opportunities”?
Export and Import Strategies
Objectives
! Identify the key elements of export and import strategies.

! Compare the direct and indirect selling of exports.
! Identify the key elements of import strategies and importing.
! Discuss the roles of several types of third-party intermediaries and trading companies in
exporting.
! Show how freight forwarders help exporters with the movement of goods.
! Identify the methods of receiving payment for exports and the financing of receivables.
! Discuss the role of countertrade in international business.
Chapter Overview
In many ways, Chapter 17 is a natural extension of Chapter 16 because much of it deals with elements of
the marketing mix, especially channels of distribution. The first part of the chapter is devoted to an
examination of export and import strategies. Table 17.1 identifies the steps to consider when
developing an export (or import) business plan. Next, the roles of a wide variety of third-party
intermediaries are discussed. The chapter concludes with a discussion of the major issues related to
export financing, including the use of countertrade as a form of payment mechanism.
Chapter Outline
OPENING CASE: Grieve Corporation—A Small Business Export Strategy
A small firm located near Chicago, Grieve Corporation manufactures laboratory and industrial ovens,
furnaces and heat processing systems for the U.S. market. Grieve began losing business as (i) foreign
competitors began to penetrate the U.S. market and (ii) its customers began to move overseas and
started sourcing locally. With the help of the International Trade Administration of the U.S. Department
of Commerce, Grieve was able to identify potential Asian distributors. During a business trip to Asia, the
president of Grieve met with potential candidates and successfully recruited exclusive agents for each
country visited. Once Grieve had gained sufficient experience in the Asian market, export activities were
expanded to other regions. Moving into international markets has proved to be a major factor in the
firm’s continued growth and success.
Teaching Tip: Review the PowerPoint slides for Chapter 17 and select those you find most useful
for enhancing your lecture and class discussion. For additional visual summaries of key chapter
points, also review the figures and tables in the text.
I. INTRODUCTION
Whereas exports represent goods and services flowing out of a country, imports represent
goods and services flowing into a country. Exports result in receipts and imports result in
payments. Although export and import activities are a natural extension of distribution strategy,
they also include elements of product, promotion and pricing factors and decisions.
Both exporting and importing entail a lower level of risk thanforeign direct investment, but
while exporting offers less control over the marketing function, importing offers less control
over the production function.
II. EXPORT STRATEGY

A firm’s choice of entry mode depends on various factors, such as the ownership advantages of
the firm, the location advantages of the market and the internalization advantages of specific
assets, international experience and/or the ability to develop differentiated products (see
Chapter 8). In general, firms that possess few ownership advantages either do not enter foreign
markets, or they use the lower-risk entry modes of exporting and licensing. Still in all, the
decision to export must fit a company’s overall strategy and take into account global
concentration (the presence of relatively few major players), global synergies (the gains from
sharing corporate expertise on a global basis) and global strategic motivations (the firm’s
competitive reasons to enter a given market).
A. Characteristics of Exporters
Research conducted on the characteristics of exporters has resulted in two basic
conclusions: (i) the probability of exporting increases with size of company revenues and
(ii) export intensity (the percentage of total revenues generated by exports) is not
positively correlated with company size. Factors such as the risk profile of management
and the nature of industry competition are just as important as firm size.
B. Why Companies Export

Companies export in order to increase sales revenues, achieve economies of scale in
production, diversify markets and minimize risk.
C. Stages of Export Development

Firms tend to move through three phases of export development: pre-engagement,
initial exporting and advanced exporting. As they do so, they tend to (i) export to more
countries and (ii) expect exports to grow as a percentage of total sales. In addition, they
also tend to (i) diversify their markets to more distant countries and (ii) move into
environments that are increasingly different from those of their home countries.
D. Potential Pitfalls of Exporting

The operational mistakes associated with exporting can be very costly. In addition,
events such as 9/11 can bring international trade activities to a complete halt in the
affected region.
E. Designing an Export Strategy [See Figure 17.3, Table 17.1]
To design an effective export strategy, managers must:
 assess the company’s export potential
 obtain expert counseling on exporting
 select target markets

 formulate and implement an effective export strategy.
III. IMPORT STRATEGY
The import process involves strategic and procedural issues that basically mirror those of the
export process. (See question #1 of this chapter’s closing case for an outline of a sample import
business plan.) There are two basic types of imports: extracompany imports from independent
(unrelated) upstream sources and intracompany imports from a firm’s upstream global supply
chain that represent intermediate goods and services. The three basic types of importers are
those that:
 look for any product around the world that will generate a positive cash flow
 look to foreign sourcing as a means to minimize product costs
 use foreign sourcing as part of their global supply chain strategy.
An import broker is a certified specialist who obtains required government permissions and
other clearances before forwarding the necessary documents to the carrier(s) of the goods.
A. The Role of Customs Agencies

Customs reflect a country’s import and export procedures and restrictions. The primary
duties of a customs agency are the assessment and collection of all duties, taxes and
fees on imported products, the enforcement of customs and related laws and the
administration of certain navigation laws and treaties. National customs agencies are
increasingly involved in dealing with smuggling operations and preventing foreign
terrorist attacks. A customs broker can help an importer minimize duties by (i) valuing
products in such a way that they qualify for more favorable treatment, (ii) qualifying for
duty refunds through drawback provisions, (iii) deferring duties by using bonded
warehouses and foreign trade zones and (iv) limiting liability by properly marking an
import’s country of origin.
B. Import Documentation
The import documentation process can be both complicated and cumbersome. Without
proper documentation, customs agencies will not release shipments. Documents are of
two types: (i) those that determine whether customs will release the shipment and (ii)
those that contain the information necessary for duty assessment and data gathering
purposes. At a minimum, the required documents would include an entry manifest, a
commercial invoice and a packing list.
IV. THIRD-PARTY INTERMEDIARIES

Third-party intermediaries are independent (unrelated) firms that facilitate international trade
transactions by assisting both importers and exporters. They may perform any or all of the
following functions:
 stimulate sales, obtain orders and conduct market research
 perform credit investigations and payment-collection activities
 handle foreign traffic arrangements and shipping details
 provide support for a client’s sales, distribution and promotion staff.
Direct exports represent products sold to an independent party outside of the exporter’s home
country; indirect exports are first sold to an intermediary in the domestic market, who then sells
the products in the export market. While services are more likely to be exported on a direct
basis, goods are exported via both avenues.
A. Direct Selling
Direct selling, i.e., exporting through sales representatives to distributors, foreign
retailers, or final end users, gives exporters greater control over the marketing function
and offers the potential to earn higher profits as well. Whereas a sales
representative usually operates on a commission basis, a distributor is a merchant who
purchases goods from a manufacturer and resells them at a profit.
B. Direct Exporting through the Internet and Electronic Commerce

Electronic commerce allows companies both large and small to engage in direct
marketing quickly, easily and inexpensively. It is especially important for small and
medium-size firms that wish to reach distant markets.
C. Indirect Selling
Indirect selling, i.e., selling products to or through an independent domestic
intermediary, is carried out via export management companies and export trading
companies.
D. Export Management Companies

An export management company [EMC] is a firm that either acts as a manufacturer’s
agent or buys merchandise from manufacturers for international
distribution. EMCs generally operate on a contractual basis, provide exclusive
representation in a well-defined foreign territory and act as the export arm of a
manufacturer. Often, export management companies specialize according to product,
function and/or market area.
E. Export Trading Companies

An export trading company [ETC] is somewhat like an export management
company, but its primary purpose in becoming involved in international trade as an
independent broker is to match domestic exporters to foreign customers. Export trading
companies that are based in the U.S. may be exempt from antitrust provisions in order
to allow them to penetrate foreign markets by collaborating with otherU.S. firms.
F. Non-U.S. Trading Companies
While the original functions of a trading company were to handle the paperwork,
financing, transportation and storage services related to import and export transactions,
many have expanded the scope of their operations to include production and processing
facilities and operations, as well as fully integrated marketing systems. (There are
no U.S. trading companies that rank among the Fortune Global 500 companies;
only Japan, South Korea, Germany and China have firms on that list.) The Japanese sogo
shosha (trading company) traces its roots to the zaibatsu (large, family-owned
businesses composed of financial and manufacturing companies linked together by a
large holding company), which subsequently evolved into the keiretsu (large,
interlocking financial, manufacturing and trading company networks). South Korean
trading companies are part of a larger corporate group known as the chaebol.
Companies within a chaebol are very dependent on family patriarchs and are tightly
linked to one another via a high degree of intercompany transactions.
G. Foreign Freight Forwarders
A freight forwarder is a foreign trade specialist who deals in the movement of goods
from producer to customer. Even export management companies may use the
specialized services of foreign freight forwarders. The typical freight forwarder is the
largest export intermediary in terms of the weight and value of cargo handled. Some
may specialize in the type of mode used, others in the geographical area served. The
movement of goods across a variety of modes from origin to destination is known
as intermodal transportation. Three recent trends leading to a preference for air freight
over ocean freight are: (i) the need for more frequent shipments, (ii) lighter-weight
shipments and (iii) high-value shipments.
H. Export Documentation
An export license allows the exporter to ship goods to particular countries. Other key
export documents are the:
 pro forma invoice
 commercial invoice
 consular invoice
 bill of lading
 certificate of origin
 shipper’s export declaration
 export packing list.
V. EXPORT FINANCING
From the exporter’s point of view, four major issues relate to export financing: (i) the price of
the product, (ii) the method of payment, (iii) the financing of receivables and (iv) insurance.
A. Product Price
Export prices must factor in exchange rate fluctuations, transportation costs, relevant
duties, the costs of multiple wholesale channels, insurance fees, bank charges,
antidumping laws, etc.
B. Method of Payment
The flow of money across national borders requires the use of special documents and
may be very complicated. In descending order of security for the exporter, the basic
methods of payment for exports are:
 cash in advance
 a letter of credit (obligates the buyer’s bank to pay the exporter)
 a revocable letter of credit may be changed by any of the parties to the

agreement
 an irrevocable letter of credit requires all parties to the agreement to

consent to the change in the document
 a confirmed letter of credit adds a guarantee of payment to an additional

bank (usually an interbank agreement).
 a draft or bill of exchange
 a documentary draft instructs the importer to pay the exporter if specified

documents are presented
 a sight draft requires payment to be made immediately
 a time draft requires payment to be made at some specific date in the

future.
 an open account (the exporter bills the importer but does not require formal
payment documents—generally limited to members of the same corporate
group).
C. Financing Receivables
The increased distances and time involved in exporting often create cash flow problems
for an exporter. Further, because exporting is risky, banks may be unwilling to provide
financing for export transactions. However, exporters can get access to funds
through factoring, i.e., the discounting of a foreign account receivable, and forfaiting,
i.e., a longer-term instrument that includes a guarantee from a bank in the importer’s
country. In addition, exporters can apply for guarantees from government agencies
(such as the Ex-Im Bank) in order to get banks to lend them money until payment is
received.
D. Insurance
The two types of insurance most often used for export transactions are: (i)
transportation risks (e.g., devastating weather conditions or rough handling by carriers)
and (ii) political, commercial and foreign-exchange (environmental) risks. While private
insurers will covers these types of risks for established exporters with a proven record,
government agencies tend to be the most important insurers of export shipments.
VI. COUNTERTRADE
Countertrade involves a reciprocal flow of goods and services. It provides a means to complete a
transaction when a firm (or government) does not have sufficient convertible currency to pay for
imports, or it simply does not have sufficient funds. Countertrade transactions can be divided
into two basic types: (i) barter (based on clearing arrangements used to avoid money-based
exchange) and (ii) buybacks, offsetsand counterpurchase (all of which are used to impose
reciprocal commitments).
A. Barter
Barter occurs when goods or services are traded for other goods and services, i.e., it
represents a non-monetary transaction. (Barter is not only the oldest form
of countertrade, it is the oldest form of any type of trade
transaction.) Buybacks represent counter-deliveries the exporter receives as payment
that in fact are related to or originate from the original export.
B. Offset Trade
Offset trade occurs when the exporter sells goods or services for cash but then helps
the importer find opportunities to earn hard currency. Direct offsets include generated
business that directly relates to the export; indirect offsets include generated business
unrelated to the export.
ETHICAL DILEMMA:
Is Demand Always Just Cause to Export?
Of all of the issues associated with exporting, two of the most vexing have to do with hazardous
materials and sensitive technology. First, regulations concerning pesticides and other dangerous
chemicals are often more lax in many of the developing countries than in the industrialized world. The
concept of prior informed consent would require each exporter of a banned or restricted substance to
obtain through its home-country government the express consent of the importing country government.
Those who oppose this principle do so on grounds of ethical relativism and national sovereignty. Second,
although governments usually control the export of sensitive technology to friends and foes alike, many
firms try to bypass such controls. Documents may be falsified to hide the true nature of a transaction. In
neither instance does the mere existence of demand seem to be sufficient reason to justify export
transactions.
How Will Technology Affect Exporting?
Exporting continues to differ across countries in terms of its importance in generating GDP and
employment. Nonetheless, advances in transportation and communications will continue to facilitate
export growth and make it easier for firms to reach distant international markets. A primary advance in
communication technology is the electronic data interchange (EDI), which facilitates the electronic
transfer of information across the whole of the value chain. One of the major developments to affect
exporting is the use of the Internet, which brings producers and customers from all over the world
together in ways not possible before and allows firms to engage in direct exporting.
WEB CONNECTION
Teaching Tip: Visit www.prenhall.com/daniels for additional information and links relating to
the topics presented in Chapter 17. Be sure to refer your students to the on-line study guide, as
well as the Internet exercises for Chapter 17.
_________________________
CLOSING CASE: Sunset Flowers of New Zealand, Ltd. [See Map 17.1]
1. Using Table 17.1, develop an import-marketing plan Robertson could use.
Key issues that should be explored before developing a marketing plan would include the
following:
 the nature of the market for cut flowers in different regions of the U.S.
 the barriers to importing cut flowers into the U.S.
 the import requirements and procedures for cut flowers in the U.S.
 the channel of distribution required to get flowers from New Zealand to the U.S.
 the ways to effectively deal with problems, given the distance between New Zealand
and the U.S.
 the determination of production levels, production costs and shipping costs
 the determination of strategic prices for the cut flowers
 the determination of effective payment procedures
 the availability of wholesalers to handle the cut flowers
 the type of exclusivity that should be granted to wholesalers
 the nature of an effective organizational structure for the venture.
An effective marketing plan must consider company resources, identify specific markets,
establish specific plans for dealing with marketing, legal, manufacturing, personnel and
financial elements, and include an implementation schedule. The outline of an import-
marketing plan for Sunset Flowers of NZ, Ltd., might look like the following:
I. Executive summary
 Objective: import Leucadendrons from specific New Zealand growers
 Initial target: florists in the U.S. Pacific Northwest
 John Robertson to serve as import coordinator, using specified intermediaries
 Estimated costs, revenues and profits for the first year.
II. Business history

 History of Leucadendron growers
 Details of business operations to date
 Description of fresh-cut flower industry.
III. Market research
 Target country market: United States
 Market conditions
 Assessment of demand
 Assessment of competition
 Additional and alternative markets.
IV. Marketing decisions

 Product strategy
 Distribution strategy
 Pricing strategy
 Promotion strategy.
V. Legal decisions
 Agreements with intermediaries
 Relevant export/import regulations.
VI. Production and operations decisions
 Supplier capacity in New Zealand
 Modifications necessary for the U.S. market.
VII. Personnel decisions
 Hiring needs
 Required expertise.
VIII. Financial decisions

 Pro forma financial statements
 Need for investment funds

 Tax issues.
IX. Implementation schedule.

2. Who were the key intermediaries Robertson used? Should he try to develop the expertise
of those intermediaries so he doesn’t have to pay them for their services? Why or why
not?
Robertson used two key intermediaries and contacted a third. An export management
company handled the sample shipment from New Zealand to the U.S.; a U.S. customs broker got
the sample through customs; he also consulted a Seattle wholesaler who was willing to place a
large order for the flowers, given certain conditions. If the business were to take hold, it is
unlikely Robertson would take on the activities of these intermediaries, although he should
develop as much expertise as possible about all of the associated activities. Since Robertson is
located in Seattle, he needs an export management company to handle shipments from New
Zealand. If the value of a shipment is greater than $250, U.S. law requires he engage the services
of a customs broker. Finally, though Internet sales are certainly tempting, he
needswholesalers who are well established in the U.S. market. Further, by using wholesalers,
Robertson not only gains critical access to the market, but his risk and capital requirements will
be significantly lower.
3. What are the pros and cons of using a Web page to sell the Leucadendron flowers?
What should Robertson put on his Web page?
A web page is relatively inexpensive and easy to create. Other pros include wide-ranging
publicity and easy access to information about the Leucadendron. However, a web page might
not generate a great deal of new interest in Leucadendrons, because a visitor would already
have to be interested in flowers to find it. Because the Leucadendron flower is not well known in
the U.S. market, a web page should familiarize the visitor with the appearance and
characteristics of the flower. It should also specify ways for the visitor to get more information
and whom to contact should he or she be interested in handling the flower.
Additional Exercises: Export and Import Strategies
Exercise 17.1. Research has shown although the largest firms in the world also tend to be the
world’s largest exporters, export intensity is not positively correlated with the size of a firm.
Begin a discussion by asking students to explore the reasons for this. Then, ask students to
discuss the levels of export intensity they would expect to find with respect to a variety of
industries. Be sure they explain their reasoning and compare differences across industries.
Exercise 17.2. A major barrier to international trade activities is the issue of trust. Even when
importers and exporters are known to each other, there is a high degree of risk associated with
international trade transactions, i.e., exporters want to be sure they’ll be paid and importers
want to be sure they receive the full value of an order. Ask students to discuss the
reasons letters of credit and the various forms of a drafthelp both importers and exporters
overcome this challenge. Under what conditions might each instrument be preferred?
Exercise 17.3. Assign each student (or team of students) a given product and foreign country
market. Then have the students (or teams) consult the National Trade Data Bank to collect
information useful in developing a strategy for exporting the specific product to the designated
country market. Discuss the information the students find and its relevance to exporting in class.
Be sure to compare information across products and countries.
Global Manufacturing and Supply Chain Management
Objectives
! Describe different dimensions of global manufacturing strategy.
! Examine the elements of global supply chain management.
! Show how quality affects the global supply chain.
! Illustrate how supplier networks function.
! Explain how inventory management is a key dimension of the global supply chain.
! Present different alternatives for transporting products from suppliers to customers along
the supply chain.
Chapter Overview
Important objectives shared by the global manufacturing and supply chain functions are to
simultaneously lower costs and increase quality by eliminating defects from both processes.
Chapter 18 examines supply chain networks to see how firms can manage the various links most
effectively. The chapter begins by discussing global manufacturing strategy. It then moves on to
explore supply chain management issues, quality standards and supplier networks. The chapter
concludes with a discussion of inventory management and the development of effective
transportation networks.
Chapter Outline
OPENING CASE: Samsonite’s Global Supply Chain [See Map 18.1, Figures 18.1-3]
This case describes how Samsonite, a U.S.-based corporation that manufactures and distributes
both hardside and softside luggage, developed its global manufacturing and distribution systems.
Samsonite began its operations in 1910 in Denver, Colorado, but it took many years to become a
global firm after moving first through decentralized and then centralized supply-chain structures.
By the end of the 1960s, Samsonite was manufacturing luggage in
the Netherlands, Belgium, Spain, Mexico and Japan; it was also marketing luggage worldwide
through a variety of distributors. During the 1990s, Samsonite expanded throughout Eastern
Europe and established several joint-venture operations in China and other parts of Asia as well.
As Samsonite expanded throughout the world, it entered into subcontract arrangements in Asia
and Eastern Europe for outsourced parts and finished goods in order to supplement its own
production. By 2002, Samsonite’s European operations alone had grown to six company-owned
production facilities and one joint-venture facility, plus a series of subsidiaries, joint ventures,
retail franchises, distributors and agents set up to service the European market. R&D is done
both in Europe and the U.S.
summaries of key chapter points, also review the figures in the text.
I. INTRODUCTION
The supply chain function encompasses the sourcing and coordination of materials,
information and funds from the initial raw material supplier to the final customer. It
concerns the management of the value-addedprocess from the supplier’s supplier to the
customer’s customer. Suppliers can be part of the manufacturer’s organizational
structure, as in the case of a vertically integrated organization, or they can be independent
organizations. An important part of the supply chain function is logistics (aka materials
management), which encompasses the planning, implementation and control of the
efficient and effective flow and storage of products and information from the point of
origin to the final customer. Because the supply chain is quite broad, the coordination of
the network actually occurs through interactions within the network. The greater the
geographic spread of the firm, the more difficult it becomes to manage the supply
chain effectively.
II. GLOBAL MANUFACTURING STRATEGIES

The success of a global manufacturing strategy depends on four key factors:
(i) compatibility, (ii) configuration, (iii) coordination and (iv) control. Virtual
manufacturing describes the situation in which a firm subcontracts the manufacturing
process to another company, i.e., the firm chooses to outsource.
A. Manufacturing Compatibility
Compatibility refers to the degree of consistency between a firm’s foreign direct
investment decisions and its competitive strategy. Cost-minimization and the drive
for globalization force MNEs to pursue economies of scale in manufacturing,
often by producing at low labor-cost sites. Other key variables
include dependability, quality, flexibility and innovation. Offshore
manufacturing refers to manufacturing activities that occur beyond the borders of
a firm’s home country.
B. Manufacturing Configuration
MNEs consider three basic configurations en route to developing their global
manufacturing strategies. They are:
 centralized manufacturing in a single country
(a global export approach)
 regionalized manufacturing in the specific regions served
(a regionalized marketing and manufacturing approach)
 local manufacturing in each country market served
(a multidomestic marketing and manufacturing approach).
Rationalization represents the specialization of production by product or process
in different parts of the world in order to take advantage of varying costs of labor,
capital and raw materials.
C. Coordination and Control
Coordination represents the linking or integrating of participants all along the
global supply chain into a unified system. Control embraces systems, such as
organizational structure and performance measurement, which are designed to
help ensure strategies are implemented, monitored and revised, when appropriate.
III. GLOBAL SUPPLY CHAIN MANAGEMENT

Global supply chain management concerns the sourcing and coordination of materials,
information and funds from the initial raw material supplier to the final customer. A
comprehensive supply chain strategyshould include the following 10 elements:
 customer service requirements
 plant and distribution center network design
 inventory management
 outsourcing and third-party logistics relationships
 key customer and supplier relationships
 business processes
 information systems
 organizational design and training requirements
 performance metrics
 performance goals.
The key to making a global information system work effectively is
information. Electronic data interchange (EDI) refers to the electronic movement of
money and information via computers and telecommunications equipment in a way that
effectively links suppliers, customers and third-party intermediaries, and ultimately
enhances customer value. Enterprise resource planning (ERP) refers to the use of
software to link information flows from different parts of a business and from different
parts of the world. E-commerce refers to the use of the Internet to link suppliers with
firms and firms with customers. Theextranet refers to using the Internet to link a
company with external constituencies. Finally, the Private Technology Exchange
(PTX) refers to an online collaboration model that brings manufacturers, distributors,
resellers and customers together to execute trade transactions and to share information
regarding demand, production, availability, etc. While many networks can in fact be
managed via the Internet, others (especially those in developing countries) cannot
because of the lack of available, leading-edge technology.
IV. QUALITY
Quality refers to meeting or exceeding the expectations of the customer. More
specifically, it incorporates conformance to specifications, value enhancement, fitness for
use, after-sales support and psychological impressions (image). Acceptable quality level
(AQL) is a premise that allows for a tolerable (negotiable) level of defects that can be
corrected through repair and service warranties. Zero defects describes the refusal to
tolerate defects of any kind.
A. Total Quality Management
Total quality management [TQM] stresses three principles: (i) customer

satisfaction, (ii) employee involvement and (iii) continuous improvements at
every level of the organization. The goal of TQM is to eliminate all defects. It
focuses on benchmarking world-class standards, product and service design,
process design and purchasing practices. Kaizen represents the Japanese process
of continuous improvement, which requires identifying problems and enlisting
employees at all levels of the organization to help eliminate the problems. Six
Sigma is a highly focused quality-control system designed to scrutinize a firm’s
entire production system and eliminate defects, slash product cycle time and cut
costs across the board.
B. Quality Standards
The three different levels (types) of quality standards are: (i) a general level, (ii)
an industry specific level and (iii) a company level. The general level
includes ISO 9000:2000 certification, i.e., a set of five universal standards
initially designed to harmonize technical standards within the EU that is now
accepted worldwide; it is applied uniformly to companies in any industry and of
any size in order to promote quality at every level of an organization. Rather than
judging the quality of a product, ISO 9000:2000 evaluates the management of the
manufacturing process according to standards in 20 domains, from purchasing to
design to training. Industry-specific standards and company-specific standards
represent the quality-related requirements expected of suppliers.
V. SUPPLIER NETWORKS
Sourcing strategy is the path a firm pursues in obtaining materials, components and final
products either from within or outside of the organization and from both domestic and
foreign locations. Global sourcingrepresents the first step in the process
of global materials management (logistics). Firms pursue global sourcing strategies in
order to reduce costs, improve quality, increase their exposure to worldwide technology,
strengthen the reliability of supply, improve the supply delivery process, gain access to
strategic materials, establish a presence in a foreign market, satisfy offset requirements
and/or react to competitors’ offshore sourcing practices. The three major configurations
that have emerged for global sourcing are: (i) vertical integration (ii) arm’s length
purchases from independent suppliers and (iii) Japanese keiretsurelationships with
suppliers.
A. Make or Buy Decision
Outsourcing refers to those production activities that occur outside of the firm,
i.e., the use of external (foreign) suppliers to provide materials, components,
services, or finished goods. In determining whether to make or buy, MNEs should
focus on making those parts and performing those processes critical to a product
and in which they have a distinctive advantage. Other things can potentially be
outsourced.
B. Supplier Relations
When an MNE decides to outsource rather than integrate vertically, it must
determine the nature and extent of its involvement with suppliers.
C. Purchasing Function [See Figure 18.9]
Global progression in the purchasing function includes four phases:
 domestic purchasing only
 foreign buying based on need
 foreign buying as a part of procurement strategy
 integration of global procurement strategy.
The last phase is reached when a firm realizes the benefits from the integration
and coordination of purchasing on a global basis. At this point, the MNE may
once again be faced with the centralization vs. decentralization dilemma. Global
sourcing options include:
 assigning domestic buyers international purchasing duties
 using foreign subsidiaries or business agents
 establishing international purchasing offices
 assigning the responsibility for global sourcing to a specific business unit
or units
 integrating and coordinating sourcing on a worldwide basis.
E-sourcing, i.e., the use of the Internet in the purchasing process, is rapidly
growing in popularity.
VI. INVENTORY MANAGEMENT

Whether a firm decides to source from inside or outside the company or from domestic or
foreign suppliers, it needs to manage the flow and storage of inventory. However, the
distance, time and uncertainty associated with foreign environments will surely
complicate the inventory management process.
A. Just-in-Time Systems
A just-in-time [JIT] manufacturing system reduces inventory costs by having raw
materials and components delivered just as they are needed in the production
process. JIT typically implies sole sourcing for specific parts in order to get the
supplier to commit to the stringent delivery and quality requirements inherent in
the system. A company’s inventory management strategy determines the desired
frequency and size of shipments and whether JIT will be used.
B. Foreign Trade Zones
Foreign trade zones (FTZs) are government-designated areas in which goods can
be stored, inspected and/or manufactured without being subject to formal customs
procedures until they actually enter the country. A general-purpose zone is usually
established near a port of entry, such as a seaport, an airport, or a border crossing.
A subzone is under the same administrative domain but is usually physically
separate from a general-purpose zone. FTZs often serve as a site to store inputs
until they are needed at a particular production site.
VII. TRANSPORTATION NETWORKS
The international transportation of goods is extremely complicated with respect to

documentation, choice of carrier (air, land, ocean) and the decision to outsource the
function to a third-party intermediary or to establish internal transportation capabilities.
The key is to link manufacturers and suppliers on one end and manufacturers and final
customers on the other. Third-party intermediaries are a critical factor in transportation
networks. They can provide a host of services, including packing, storing and shipping.
ETHICAL DILEMMA:
What Supplier-Relations Approach Yields the Best Results?
A utilitarian view of ethical conduct argues the worth of actions or practices is determined by
their consequences, i.e., an action or practice is “right” if it leads to the best possible balance of
good and bad consequences for all the affected parties. Even though it is in a firm’s self-interest
to keep costs as low as possible, by treating its suppliers fairly it upholds its ethical obligations to
them and its actions result in a positive utilitarianoutcome. On the other hand, if a firm requires a
supplier to enter into a contractual agreement but then tears up the contract and forces the
supplier to renegotiate, it is acting in its own short-term self-interest at the expense of the
supplier. Given the negative impact on suppliers, such actions do not result in a
positive utilitarian outcome. As firms continue to outsource and deal with suppliers from
different countries and cultures, the issue of supplier relations and productivity outcomes will be
carefully scrutinized.

To Be Global, an MNE Must Establish Strong Supply Chain Links
In their efforts to serve worldwide markets, MNEs are discovering that to take advantage of
market imperfections and drive costs down, they need greater control over global manufacturing
operations. Improvements in communications technology will continue to facilitate the flow of
information, and firms will continue to gain critical flexibility in establishing relationships and to
improve quality, delivery time and their responsiveness to customer needs. A major decision any
firm must make is whether it wants to be in the manufacturing business or to outsource its
manufacturing activities. Whichever path they choose, MNEs will have to develop strong global
supply chain management systems in order to compete effectively in today’s dynamic global
business environment.
WEB CONNECTION

_________________________
CLOSING CASE: DENSO Corporation and Global Suppliers Relations [See Maps 18.2-3,
Figure 18.10]
1. How has DENSO’s relationship with Toyota affected its international strategy?
DENSO’s relationship with Toyota has affected its international strategy in several ways.
On the one hand, it has limited DENSO’s strategic flexibility because its operations have
been so closely linked to Toyota’s requirements. As a result, DENSO has developed an
overdependence on the automobile industry as a customer base. On the other hand,
DENSO’s association with Toyota has facilitated its becoming a viable international
competitor as the result of its supplying Toyota’s various foreign operations.
Subsequently, DENSO’s international experience helped the firm gain access to other
major automobile manufacturers.
2. What types of quality programs has DENSO adopted, and how do you think they will
affect DENSO’s future as a global supplier?
To satisfy Toyota’s rigid quality standards, DENSO has had to adopt TQM and strive for
zero defects. In addition, by complying with both ISO 9001 and QS9000, DENSO
qualifies as a supplier for auto manufacturers throughout Asia, Europe and North
America. Although kanban it thought to be on the decline, it is still widely used, and
mastery of the process gives DENSO an advantage with firms that rely on that system.
However, kanban shifts production and inventory management burdens to suppliers and
makes it more difficult for suppliers to manage their production schedules. Nonetheless,
given its expertise and certification, DENSO is well positioned to compete as a global
supplier to the automobile industry. In fact, DENSO currently supplies parts to all
companies manufacturing automobiles in Japan.
3. Why does it make a difference whether DENSO uses kanban or MRP?

The two systems represent very different approaches to production management in an
environment that heavily relies on the just-in-time delivery of products or subassemblies.
Under kanban, the supplier is truly at the mercy of the customer, who does not give much
advance notice of needing parts. Further, because kanban links the operations of the
customer and the supplier so closely, working with a variety of customers can become
extremely difficult for a single supplier. Under material requirements planning (MRP), a
computerized information system that addresses complex inventory situations, the
supplier has more lead time and can better adjust its schedules so as to optimize
operations. Also, under MRP a supplier can better mange its deliveries to multiple
customers, which is a matter of great interest to DENSO as the company tries to move
away from its overdependence on Toyota.
4. DENSO faces what challenges as it diversifies its customers and product lines?
DENSO faces two major challenges. The less difficult one to achieve is its goal of
diversifying its customer base within the automobile industry. Its ISO 9001 and QS9000
certifications will continue to open doors for DENSO; its quality track record should also
help the firm strengthen its competitive position. The more difficult goal for DENSO to
achieve is the diversification of its product lines and thus a reduced dependence on the
automobile industry for revenue growth. Although it makes products for both the
telecommunications and environmental systems markets, in 2002 nonautomotive
products generated only 6.3 percent of DENSO’s revenues. To significantly increase that
number, DENSO must intensify its R&D efforts with respect to products that lie both
within and outside of the automobile industry.
5. What do you notice in the layout of the Takatana plant that demonstrates DENSO’s
commitment to its employees?
The “green belt” DENSO has created around the plant is particularly appealing and
suggests a concern for employees that goes well beyond productivity and cost
containment. In addition, DENSO’s flexible and highly automated production facilities
and its on-site education facilities enhance working conditions and assure workers of on-
the job training.
Additional Exercises: Global Manufacturing and Supply Chain
Management
Exercise 18.1. The total cost concept is a major concern in global manufacturing and
supply chain management. Strategic reorder points and economic order quantities must
be determined. The tradeoffs between (i) customer service and cost minimization and (ii)
control and flexibility must be considered. Contractual linkages with the participants in
the system must be negotiated and honored. Ask students to discuss the challenges a firm
faces in establishing its global manufacturing and supply chain network given the
dynamics of today’s competitive environment. Use examples of firms in different types
of industries as a basis for the discussion.
Exercise 18.2. A firm is considering whether to make a component in house or to

outsource it to an independent foreign supplier. Manufacturing the part in house will
require an investment in specialized assets; quality control and the protection
of intellectual property rights are major concerns. The most efficient and reliable
suppliers are located in countries whose currencies many foreign exchange analysts
expect will appreciate in the next decade; likewise, wage rates in those countries are
expected to rise. Ask students to discuss the pros and cons of manufacturing the
component in house as opposed to outsourcing it. Should the firm consider foreign direct
investment as one of its options? Explain.
Exercise 18.3. The value-to-weight ratio is very important with respect to manufacturing
site location decisions because of its influence on transportation costs. Other things being
equal, products with a highvalue-to-weight ratio are good candidates for exporting, while
those with low value-to-weight ratios should be manufactured in multiple locations close
to major markets to minimize transportation costs. For example, many electronic
components have high value-to-weight ratios—although they are expensive, they are very
small and weigh very little. Even when shipped halfway around the world, transportation
accounts for a very small percentage of the total delivered cost. Given that, ask students
to consider why low value but heavy products such as petroleum and refined sugar are
shipped such great distances. Why are products such as automobiles, which are bulky and
can be so easily damaged, also shipped great distances, rather than being manufactured
locally?
Multinational Accounting and Tax Functions

Objectives
! Examine the major factors influencing the development of accounting practices in
different countries and the worldwide harmonization of accounting principles.
! Explain how companies account for foreign-currency transactions and translate foreign-
currency financial statements.
! Illustrate how companies report their impact on the environment.
! Investigate the U.S. taxation of foreign-source income.
! Examine some of the major non-U.S. tax practices and show how international tax treaties
can alleviate some of the impact of double taxation.
Chapter Overview
The international accounting and taxation functions comprise great challenges for today’s global
business managers. Chapter 19 presents the key accounting and taxation issues confronting firms
that do business abroad. First, the chapter examines the ways in which national accounting
systems differ and how today’s global capital markets force countries to consider the
harmonization of their accounting and reporting standards. It then explores a number of unique
issues MNEs face, such as the valuation and translation of transactions and assets that are
denominated in foreign currencies. The chapter concludes with an examination of taxation and
transfer-pricing concerns, including the use of the value-added tax and the elimination of double
taxation.
Chapter Outline
OPENING CASE: Enron and International Accounting Harmonization
This case vividly presents the arguments for changes in and the harmonization of accounting
standards on a worldwide basis. It describes the shocking demise of Enron, an energy trading
company based in Houston, Texas, and its auditor, Arthur Andersen, and the role faulty
accounting practices played in those events. The case also cites the major accounting crises at
MCI WorldCom, Tyco International, Vivendi Universal and Global Crossing to emphasize the
extent and seriousness of this problem. The basic difficulty is that today’s capital markets are
global, but the existing auditing and accounting regulations are not. Even before Enron’s
collapse, the European Union announced by 2005 all EU firms will have to follow the
International Accounting Standards (IAS). In 2002, the FASB agreed to join the IASB in the
effort to eliminate the differences between their two sets of standards. However, convincing the
FASB and the SEC to move away from their rules-based approach and toward the IASB’s
principles-based approach will not be easy. Cultural, economic and institutional factors will have
to be overcome for the global harmonization of accounting standards to actually occur.
summaries of key chapter points, also review the map, figures and tables in the text.
I. INTRODUCTION
International business managers cannot make informed decisions without relevant and
reliable accounting and taxation information. While the financial manager of any firm is
responsible for procuring and managing the company’s financial resources, today’s
corporate controller (accountant) is responsible for providing information to the firm’s
financial decision makers, and to a wide variety of other stakeholders as well.
II. FACTORS INFLUENCING THE DEVELOPMENT OF ACCOUNTING

AROUND THE WORLD
Accounting origins and traditions are as individual as the languages of the nations that
produce them. As a result, financial statements in different countries appear different
from each other both in form (format) and in content (substance). While some people
argue differences in format are a minor problem, the fact that companies can value assets
and determine income differently in different countries is not.
A. Accounting Objectives [See Figure 19.3]
Accounting is defined as a service activity whose function is to provide

quantitative information, primarily financial in nature, that will be useful in
making strategic decisions and reasoned choices among alternative courses of
action. It is crucial that the accounting process identify, record, and interpret
economic events. The private sector body that establishes financial accounting
standards in the U.S. is theFinancial Accounting Standards Board
(FASB). The FASB states that the external reporting of accounting information
should help investors (i) make investment and credit decisions, (ii) assess cash
flow prospects and (iii) evaluate enterprise resources. The international private-
sector organization that sets financial accounting standards for worldwide use is
the International Accounting Standards Board (IASB). The IASB and its
predecessor, the International Accounting Standards Committee
(IASC), identified the following key users of accounting information: investors,
employees, lenders, suppliers and other trade creditors, customers, governments
and their agencies, and the public. While equity markets are an important
influence on accounting standards in the U.S. and the U.K., banks are influential
in Switzerland and Germany, and taxation is a major influence
in France and Japan. Generally accepted accounting principles (GAAPs) are
those standards established in each country that must be followed by
organizations when generating their financial statements.
B. Cultural Differences in Accounting [See Figure 19.4]
Culture influences both measurement practices (how firms value assets)
and disclosure practices (how and what information firms provide and discuss).
From an accounting standpoint, secrecy andtransparency refer to the degree to
which corporations disclose information to the
public. Optimism and conservatism refer to the degree of caution that companies
exhibit in valuing assets and recognizing income. Anglo-Saxon countries such as
the U.K. and the U.S. have accounting systems that tend to
be transparent and optimistic, while Germanic countries, among others, tend to
be secretive andconservative.
C. Classification of Accounting Systems [See Figure 19.5]
Although accounting standards and practices vary worldwide, systems can
nonetheless be classified according to common characteristics. While macro-
uniform accounting systems are shaped more by government influences (strong,
codified, tax-based legal systems), micro-based accounting systems rely on
pragmatic business practices. International accounting standards (IAS), i.e.,
IASC-sponsored standards designed to harmonize the national treatment of
accounting issues across its members’ countries, more closely approximate the
standards used in micro-based systems. Because MNEs must adjust to different
accounting systems on a worldwide basis, the international accounting function
becomes increasingly complex and costly. Financial statements differ from one
country to another in six major ways: (i) language, (ii) currency, (iii) the type of
statement (income, statement, balance sheet, etc.), (iv) the financial statement
format, (v) the extent of footnote disclosures and (vi) the underlyingGAAPs on
which financial statements are based. Firms must deal with all six issues. Major
approaches to dealing with accounting and reporting differences include mutual
recognition (a foreign registrant need only provide information prepared
according to the GAAPs of the home country), reconciliation to the
local GAAPs (a foreign registrant reconciles its home-country financial statement
with the localGAAPs), and recasting financial statements in terms of
local GAAPs. A Form 20-F is the document used to recast financial statements in
the U.S.
III. HARMONIZATION OF DIFFERENCES IN ACCOUNTING STANDARDS
Forces encouraging the harmonization of national accounting standards include: investor

orientation, the global integration of capital markets, the need for MNEs to raise foreign
capital, regional economic integration and the pressure from MNEs to reduce their
accounting and reporting costs. The most ambitious harmonization efforts are occurring
in the EU, which promotes, among other things, the free flow of capital and the adoption
of the International Accounting Standards as set forth by the IASB by 2005. In 1981
the International Federation of Accountants (IFAC), which is comprised of more than
150 accounting organizations representing more than 2 million accountants worldwide,
agreed that the IASB would have full and complete autonomy in the setting of
international accounting standards and in the issue of discussion documents. However,
the key turning point in the significance of the IAS standards came in 1995 when
the International Organization of Securities Commissions (IOSCO) announced it would
endorse IASBcore standards if a set were developed that both organizations could agree
upon.
IV. TRANSACTIONS IN FOREIGN CURRENCIES
In addition to minimizing or eliminating foreign-exchange risk, firms must concern
themselves with the proper recording and subsequent accounting of transactions resulting
from the purchase or sale of products and the borrowing or lending of foreign currency.
A. Recording of Transactions
When accounting for assets, liabilities, revenues and expenses, foreign-currency
receivables and payables result in gains and losses whenever the relevant
exchange rate changes. Such transaction gains and losses must be included on the
income statement in the accounting period in which they arise.
B. Correct Procedures for U.S. Companies
The Financial Accounting Standards Board Statement (FASB) No. 52 requires
U.S. firms to report foreign-currency transactions at the original spot exchange
rate in effect on the initial transaction date and to report receivables and payables
at the subsequent balance sheet date at the spot exchange rate on those dates. Any
foreign-exchange gains and losses associated with carrying receivables or
payables are taken directly to the income statement. Practices vary in other
countries, although the IASB procedure is somewhat similar to that of the U.S.,
except that it permits a firm to increase the value of an asset by the amount of
foreign-exchange loss and then write it off over the useful life of the asset as part
of the depreciation charge.
V. TRANSLATION OF FOREIGN-CURRENCY FINANCIAL STATEMENTS

An MNE must eventually develop one set of financial statements in its home-country
currency. Translation involves the process of restating foreign-currency financial
statements, and consolidation is the process of combining the translated financial
statements of a parent and its subsidiaries into a single set. In the U.S., translation is a
two-step process: first, statements are recast according to U.S. GAAPs; then all foreign
currency amounts are translated into U.S. dollars.
A. Translation Methods
FASB No. 52 allows firms to use either of two methods when translating foreign-
currency financial statements into dollars. The method the firm chooses depends
on the functional currency of the foreign operation, which is the currency of the
primary economic environment in which the entity operates. If the functional
currency is that of the local operating environment, the firm must use the current
rate method, which provides that all assets and liabilities be translated at the
current exchange rate (the spot exchange rate on the balance sheet date). All
income statement items are translated at the average exchange rate, and owner’s
equity is translated at the rates in effect when the firm issued capital stock and
accumulated retained earnings. If the functional currency is the parent’s currency,
then the firm must use the temporal method, which provides that only monetary
assets such as cash, marketable securities and receivables and liabilities be
translated at the current exchange rate. Inventory and property, plant and
equipment are all translated at the historical exchange rates in effect when the
assets were acquired. In general, income statement accounts are translated at the
average exchange rate, but cost of goods sold and depreciation expenses are
reported at the appropriate historical exchange rates (not an average for the
period).
B. Disclosure of Foreign-Exchange Gains and Losses
Under the current-rate method of translating foreign-currency financial
statements, the gain or loss is called an accumulated translation adjustment and
is recognized in owners’ equity. Under thetemporal method, the gain or loss is
taken directly to the income statement, thus affecting earnings per share.
VI. ENVIRONMENTAL REPORTS

Environmental reports vary from firm to firm and country to country because they
provide voluntary information. These reports identify the impact of the firm on the
environment, focusing especially on the use of natural resources and efforts to recycle
waste. Typically, the environmental report is separate from the annual report and is not
part of the financial statements or footnotes.
VII. TAXATION
Tax planning influences both profitability and cash flow and thus impacts several
decisions including the location of the initial investment, the choice of operating form,
the legal form of a new enterprise, the method of financing and the method of setting
transfer prices.
A. Exports of Goods and Services
To gain tax advantages from exporting, a U.S. firm can set up a foreign sales
corporation (FSC) to shelter some of its income and repatriated dividends. To
qualify, a firm must be engaged in substantial business activity and maintain a
foreign office, operate under foreign management, keep a permanent set of books
at the foreign office, conduct foreign economic processes and be an established
foreign corporation. The WTO has judged the FSC tax provision to be an illegal
export subsidy and ordered the U.S. to comply with WTO guidelines—at the
moment that does not seem likely.
B. Foreign Branch
Inasmuch as a foreign branch is an extension of the parent company rather than a
separate subsidiary, any income it generates is directly included in the parent’s
taxable income; similarly, foreign branch losses are deducted from the parent’s
taxable income.
C. Foreign Subsidiary
A foreign subsidiary is a foreign operation legally separate from the parent firm,
i.e., it is incorporated in a foreign country, even if wholly-owned. Subsidiary
income is either taxable to the parent or tax-deferred, i.e., not taxed until remitted
as a dividend. Which tax status applies depends on whether the subsidiary is
a controlled foreign corporation (CFC), i.e., a firm in which U.S. shareholders
hold more than 50 percent of the voting stock. When a foreign subsidiary qualifies
as a CFC, U.S. tax law requires its income to be classified as active, i.e., derived
from the direct conduct of trade or business, or passive, i.e., derived from
operations in a tax-haven country. A tax-haven country is a nation in which tax
rates are low or non-existent on foreign-source income. Subpart F
income, i.e., passive income, is generally derived from holding company
transactions, foreign sales corporation operations and the performance of services.
D. Transfer Prices
A transfer price represents an internal company price charged as materials,
components and/or finished goods and services move from one entity within a
firm to another, i.e., it is the price at which goods and services are transferred to
another corporate entity. An arm’s-length price is thought to be a market-based
price because it is the price that would be established by two firms with no
ownership interest in one another. Arbitrary transfer prices reflect differences in
taxation rates and currency controls between countries and are designed to
maximize profitability and currency flows. As such, they make an unbiased
performance evaluation nearly impossible and may be rejected by governments.
E. Tax Credit
A tax credit is a dollar-for-dollar reduction in tax liability paid to
the U.S. government by U.S. firms that pay taxes to other countries; it must
coincide with the recognition of income. Such credits are usually capped at the
amount of tax the firm would have had to pay the U.S. government if the income
had all been generated in the U.S.
VIII. NON-U.S. TAX PRACTICES

The lack of familiarity with tax laws and customs, as well as loose enforcement, can
create problems for firms operating internationally. Taxation of corporate income is
accomplished through one of two approaches in most countries. Under the U.S.-
based separate entity approach, governments tax each entity when it earns income—
often the result is double taxation, i.e., taxing the same earnings more than once.
Anintegrated systems approach (used by most industrial countries) tries to avoid the
double taxation of corporate income through split tax rates or tax credits. Countries also
have unique systems for taxing the earnings of the foreign subsidiaries of their domestic
firms—some use a territorial approach, others use a global approach.
A. Value-Added Tax
A value-added tax represents a percentage of the value added to a product at each

stage of the business process. For a firm that is fully vertically integrated, the tax
rate applies to net sales because the firm owns everything from raw materials to
finished product. While VAT rates vary among European countries, the EU is
narrowing differences in rates for like categories of goods. In addition, the EU
effectively stimulates exports by not applying the VAT to products exported from
the bloc.
B. Tax Treaties: The Elimination of Double Taxation
The primary purpose of a tax treaty is to prevent international double taxation or
to provide remedies when it occurs. The general pattern between two treaty
countries is to grant reciprocal reductions on dividend withholding, and to exempt
royalties and sometimes interest payments from any withholding tax.
IX. PLANNING THE TAX FUNCTION
Because taxes affect both profits and cash flow, they are a major consideration in a firm’s
foreign investment decision process. Companies should set up branches in the early years
to recognize losses and subsidiaries in later years to shield profits. Debt and equity
financing also have tax ramifications. To maximize cash flow on a worldwide basis,
firms should concentrate profits in low-tax or tax-haven countries.
ETHICAL DILEMMA:
In Transfer Pricing, “Legal” Doesn’t Always Mean “Ethical”?
Arbitrary transfer pricing can create both legal and ethical problems. Establishing transfer prices
on an arm’s-length basis assures firms pay taxes on profits based on market decisions. However,
some countries lack rigid transfer pricing policies, and others, which choose to operate as tax-
havens, have none. In some instances, an MNE might use transfer pricing as a means to transfer
cash out of weak-currency countries. In others, a firm may under-invoice transfer shipments to
minimize customs payments and manipulate profits, i.e., to maximize cash flows and minimize
global tax payments. When a country has no legal requirements pertaining to transfer pricing,
management is likely to assume that (i) the absence of law implies permission to pursue the
firm’s self-interest and (ii) legal means ethical. The latter is an especially shaky assumption.

What Will Become the Coca-Cola of Accounting Standards?
It is difficult to predict future developments in international tax policy simply because policy is
subject to the whims of governments. In Europe, tax differences within the EU will surely
narrow in years to come as harmonization occurs in both the determination of taxable income
and the actual setting of tax rates. From an international accounting standpoint, however, the
question is whether the principle-based GAAPs of the IASB or the rules-based GAAPs of
the U.S. will become the globally accepted accounting standard. As the FASB continues to
cooperate with the IASB and other institutions to establish new, effective accounting
principles, U.S.accounting standards will become more international. Further, the more the
standards of these two organizations begin to converge, the more likely resistance on both sides
will begin to lessen.
WEB CONNECTION

_________________________
CLOSING CASE: Vivendi Universal [See Figures 19.9-10, Table 19.8]
[Note: information pertinent to this case is embedded throughout the chapter. ]
1. Based on this short description, do you agree with Vivendi Universal’s acquisition and
diversification strategy?
It would be useful to see the mission statement that drove Vivendi’s acquisition and
diversification strategy. Firms the world over choose to expand via diversification in
order to offset economic fluctuations and the unpredictable dynamics of the consumer
marketplace. Some choose to so by moving into an attractive industry and seeking
specific opportunities there; others will choose to acquire an attractive firm (or series of
firms) and by default expand into the industry represented. Vivendi’s expansion into the
communications and media area seems to have been carefully planned and executed; its
holdings cover the breadth of the industry, and each entity is a major player in its
respective market. Whether Vivendi’s move away from environmental services and into
communications was deliberate or opportunistic is not known. However, while Vivendi
Environment contributes substantial strength and stability to the firm, there appears to be
little synergy between the two clusters.
2. If you were to sell off $10 billion of Vivendi Universal’s assets, which divisions would
you keep and which would you eliminate?
A sale of $10 billion in assets represents a sizable divestiture; it would be helpful to be
able to review Vivendi’s income statement. For purposes of operating efficiencies,
Vivendi would likely choose to sell its non-core operations, but they alone will not yield
sufficient revenues. In considering the divestiture of an additional segment, Vivendi
should look to its mission. If in fact the firm now defines itself as a major player in the
communications and media area, it would seem logical to sell the Vivendi Environment
group. As a world leader in water services and waste management, and as a European
leader in energy services and transportation, Vivendi Environment should be very
attractive to potential investors. The sale of the group would make a major contribution to
the desired debt reduction and would permit the firm to consolidate and focus its energies
in the communication and media segment.
3. Using the 20-F reconciliation, what is the most common type of reconciliation? What
impact does this have on current and future financial statements under U.S. and French
GAAPs?
The most common type of reconciliation is probably the one in which a foreign registrant
reconciles its home-country financial statement with the local generally accepted
accounting principles. As Table 19.8 shows, there are three primary differences in
Vivendi’s statements between French and U.S. GAAPs. First, accounting for
proportionate ownership is different. Second, certain transactions (e.g., gains and losses
on foreign exchange) are reclassified. Third, adjustments represent a difference in
accounting conventions. All in all, the adjustment of a net loss of €1.135 billion under
U.S. GAAPs and €13.597 billion under French GAAPs represents a change of 1,198
percent—a difference of phenomenal proportions.
4. What do you see as the key accounting issues facing Vivendi Universal’s board of
directors? How might these be resolved through the use of International Accounting
Standards?
Key issues facing Vivendi’s board of directors include reducing the $19 billion worth of
debt associated with various acquisitions, and the restoration of investor confidence in the
firm. The use of International Accounting Standards could aid in this process because not
only do the standards tend to be transparent, but companies incorporated in EU countries
are required to adopt IAS by 2005. By implementing those standards now, investors and
analysts would be reassured of Vivendi’s commitment to meeting the highest
professional accounting standards and nurturing the long-term viability of the firm.
Additional Exercises: Multinational Accounting

Exercise 19.1. The value-added tax has been assessed by most West European countries
since 1967, and is now used by many other countries as well. Ask the students to debate
the pros and cons of the tax from the perspective of (a) businesses and (b) governments.
Are the advantages of such a tax primarily limited to regional economic blocs like the
EU?
Exercise 19.2. Tax-haven countries and tax-haven operations are appealing to certain
governments and businesses on the one hand, but are criticized by many on the other.
Ask students to debate both the practical (competitive) problems and moral challenges
associated with tax-haven countries. Then ask them to discuss the extent to which they
believe an MNE should incorporate tax-haven advantages into its strategic planning
process.
Exercise 19.3. Many transition economies such as China, Russia and the former Soviet
satellite nations have not only different accounting standards from those found in West
Europe, North America and Japan, but their accounting systems are seriously
underdeveloped, given the dynamics of today’s global business environment. Ask the
students to discuss the logic of those countries’ adopting the International Accounting
Standards as the basis of their national business accounting systems.
The Multinational Finance Function
Objectives
! Describe the multinational finance function and how its fits in the MNE’s organizational
structure.
! Show how companies can acquire outside funds for normal operations and expansion.
! Discuss the major internal sources of funds available to the MNE and show how these
funds are managed globally.
! Explain how companies protect against the major financial risks of inflation and
exchange-rate movements.
! Highlight some of the financial aspects of the investment decision.
Chapter Overview
Firms that invest and operate abroad access both debt and equity capital in large global markets
as well as in local markets. Building on Chapter 19, Chapter 20 highlights the external sources of
funds available to MNEs, as well as the internal sources that come from interfirm linkages. It
first explores global debt markets, global equity markets and offshore financial centers. Then the
types of foreign-exchange risk and the hedging strategies associated with foreign-exchange risk
management are discussed. The chapter concludes with a brief discussion of international capital
budgeting decisions.
Chapter Outline
OPENING CASE: Nu Skin Enterprises
Nu Skin Enterprises, a U.S.-based manufacturer and multi-level marketer of personal care and
nutritional products, operates in 34 countries throughout Asia, the Americas and Europe. Japan is
Nu Skin’s leading country market, followed by Taiwan and South Korea. Nu Skin generally
opens a new country market by starting with a single office, a warehouse and up to 60 employees
led by one U.S. expatriate manager. The U.S. corporate staff allocates start-up funds from
internal sources; retained earnings generally finances future growth. Exchange rate volatility has
always affected the firm’s bottom line, but never more so than in Japan, where a weakening yen
translated into millions of dollars of losses in exchange rate exposure. Consequently, Nu Skin
implemented the use of hedging strategies to reduce the risk of currency fluctuations. It entered
into forward contracts to guarantee the value of its receivables and began to borrow in local
currencies to help to stabilize its revenues.
summaries of key chapter points, also the review the map, table and figures in the text.
I. INTRODUCTION
MNEs access both local and global capital markets in order to finance their operational
and expansion activities. Critical functions associated with the management of
international cash flows are global borrowing, equity placement and foreign exchange
risk minimization.
II. THE FINANCE AND TREASURY FUNCTIONS IN THE

INTERNATIONALIZATION PROCESS
Cash flow management is divided into four major areas: (i) capital structure, (ii) capital
budgeting, (iii) long-term financing and (iv) working capital management. It is the
responsibility of an organization’s chief financial officer (CFO) to acquire (generate) and
allocate (invest) financial resources among activities and projects. This job becomes
increasingly complex in the global environment because of factors such as foreign-
exchange risk, currency flows and restrictions, differing tax rates and laws and
regulations regarding access to capital.
III. GLOBAL DEBT MARKETS

Leverage represents the degree to which a firm funds the growth of its business through
borrowing (debt). Leverage is often perceived as the most cost-effective route to
capitalization because the interest companies pay on debt is a tax-deductible expense,
whereas the dividends paid on equity (stocks or shares) are not. However, excessive
reliance on long-term debt increases financial risk and thus requires a higher rate of
return for investors. In addition, foreign subsidiaries may have limited access to local
capital markets, making it difficult for an MNE to rely on debt to fund asset acquisition.
Different tax rates, dividend remission policies and exchange controls also affect a firm’s
debt/equity decision. Firms can tap local and international banks for local
and/or Eurocurrency borrowings, as well as the longer-term bond markets.
A. Eurocurrencies
A Eurocurrency represents any currency banked outside its country of

origin. Eurocurrencies are also known as offshore currencies, while currencies
banked within their country of origin are known asonshore currencies. In essence,
the Eurocurrency market is an offshore wholesale or trade market that started
with the deposit of U.S. dollars in London banks. Eurodollars, which constitute
65 to 80 percent of the Eurocurrency market, are dollars banked outside of
the U.S. The major sources of Eurocurrencies are foreign governments or
individuals, multinational enterprises, foreign banks and countries with large
balance-of-payments surpluses. Demand, which reflects the greater convenience,
increased security, lower rates and higher yields of Eurocurrencies, comes from
governments, organizations, firms and individuals. Transactions are large and
subject to less regulation than their domestic counterparts. A Eurocredit is a type
of loan or line of credit that matures in one to five years.Syndication occurs when
several banks pool specific resources in order to spread the risks associated with a
large loan. The London Inter-Bank Offered Rate (LIBOR) reflects the interest
rate Londonbanks charge one another for short-term Eurocurrency loans.
Traditionally, Eurocurrency loans are made at a certain percentage point above
the LIBOR.
B. International Bonds: Foreign, Euro and Global
The international bond market can be divided into foreign bonds, Eurobonds and
global bonds. Foreign bonds are sold outside of the borrower’s home country but
are denominated in the currency of the country of issue (e.g., a French firm
floating a bond issue in Swiss francs in Switzerland). Eurobonds are usually
underwritten (placed in the market for the borrower) by a syndicate of banks from
different countries and sold in countries other than the one in whose currency the
bond is denominated (e.g., a U.S. firm floating a bond issue in dollars in London
and Luxembourg.) A global bond, which was first introduced by the World Bank
(IBRD) in 1989, is a large, liquid bond issue designed to be traded simultaneously
in numerous capital markets that is registered according to the requirements of
each national market. Although the Eurobond market is centered in Europe, it has
no national boundaries. Eurobonds are typically issued in denominations of
$5,000 or $10,000, pay interest annually, are held in bearer form, and are traded
over the counter (OTC). (An OTC bond is traded with or through an investment
bank, rather than on a securities exchange.) Occasionally, Eurobonds may provide
currency options, which allow the creditor to demand repayment in one of several
currencies, thus reducing the exchange-risk inherent in single-currency foreign
bonds. It is also possible to issue a Eurobond in one currency and then swap the
obligation to another currency.
IV. EQUITY SECURITIES AND THE EUROEQUITY MARKET
A second major source of funds is the global equity market, in which an investor takes an
ownership position in return for shares of stock in the firm and the expectation of capital
gains and, perhaps, dividends. Aprivate placement with a venture capitalist is a relatively
easy and inexpensive way to gain access to capital. More commonly, however, firms
access the stock market. In terms of market capitalization (the total number of shares
listed times the market price per share), the world’s three largest stock markets are New
York, Tokyo and London. A major development during the past decade has been the
growth of theEuroequity market, in which shares are sold outside the boundaries of the
issuing firm’s home country. Because it is expensive to list on a foreign exchange, firms
often list on just one big one. The most popular way for a Euroequity to get a listing in
the U.S. is to issue an American Depositary Receipt (ADR), i.e., a negotiable certificate
issued by a U.S. bank that represents underlying shares of stock of a foreign corporation
held in trust at a custodial bank in the foreign country. ADRs are traded like stocks, with
each ADR representing some number of shares of the underlying stock. There are
also global depository receipts and European depository receipts, but the U.S. dominates
the ADR market. A global share offering represents the simultaneous offering of actual
shares on different exchanges. As MNEs generate an increasing proportion of their
revenues outside of their home countries, it will be easier to attract investors from those
countries in which they operate and raise capital outside of their home markets. In the
future, a major source of competition to the stock exchanges will be Internet trading,
which is already beginning to put pressure on the major exchanges; it is expected to grow
in developing countries as well.
V. OFFSHORE FINANCIAL CENTERS

Offshore financial centers are city-states or countries that provide large amounts of
funds in currencies other than their own and are used as locations in which to raise and
accumulate cash; they represent major centers for the Eurocurrency market. Generally,
they provide a more flexible and less expensive source of funding for MNEs and exhibit
one or more of the following characteristics:
 a large foreign-currency (Eurocurrency) market for deposits and loans
 a large net supplier of funds to the world financial markets
 an intermediary or pass-through for international loan funds
 economic and political stability
 an efficient and experienced financial community
 good communications and supportive services
 an official regulatory climate that is favorable to the financial industry.
Such centers are either operational centers, with extensive banking activities involving
short-term financial transactions (e.g., London), or booking centers, in which little actual
banking activities takes place but in which transactions are recorded to take advantage of
secrecy laws and/or low or no tax rates (e.g., the Cayman Islands).
VI. INTERNAL SOURCES OF FUNDS

Funds refer to working capital, i.e., the difference between current assets and current
liabilities. Internal sources of funds include loans, investment through equity capital,
interfirm receivables and payables and dividends. Interfirm financial links become
extremely important as MNEs grow in size and complexity. Funds can flow from parent
to subsidiary, subsidiary to parent and/or subsidiary to subsidiary. Goods, services and
funds all can move within an MNE, thus creating receivables and payables. Entities may
choose to pay quickly (a leading strategy) or to defer payment (a lagging
strategy). Transfer pricing can be used to adjust the size of a payment. In addition, firms
can generate cash from normal operations. Whatever the means, international cash
management is complicated by differing inflation rates, fluctuating exchange rates and
distinct national and regional bloc policies regarding the flow of funds.
A. Global Cash Management
Global cash management strategy focuses on the flow of money to serve specific
operating objectives. Effective cash management hinges on the following
questions:
 What are the local and corporate system needs for cash?
 How can the cash be withdrawn from subsidiaries and centralized?
 Once the cash has been centralized, what should be done with it?
Cash budgets and forecasts are essential in assessing a firm’s cash needs. Cash
may be transferred within a firm via dividends, royalties, management fees and
the repayment of principal and interest on loans.
VII. FOREIGN-EXCHANGE RISK MANAGEMENT

Major financial risks arise from foreign exchange rate fluctuations. Strategies to protect
against such risks may include the internal movement of funds, as well as the use of
foreign-exchange instruments such asoptions and forward contracts. The three types
of foreign-exchange risk include translation exposure, transaction
exposure and economic exposure.
A. Types of Foreign Exchange Exposure
1. Translation Exposure. Translation exposure reflects the foreign-
exchange risk that occurs because a parent company must translate
foreign-currency financial statements into the reporting currency of the
parent, i.e., the value of the exposed asset or liability changes as the
exchange rate changes.
2. Transaction Exposure. Transaction exposure reflects the foreign-
exchange risk that arises because a firm has outstanding accounts
receivable or payable that are denominated in a foreign currency, i.e., the
receivable or payable changes in value as the relevant exchange rate
changes.
3. Economic Exposure. Also known as operating exposure, economic
exposure reflects the foreign-exchange risk MNEs face in the pricing of
products, the source and cost of inputs and the location of investment, i.e.,
it arises from the effects of exchange-rate fluctuations on expected cash
flows.
B. Exposure Management Strategy
Management must do a number of things if it wishes to protect assets
from exchange-rate risk.
1. Defining and Measuring Exposure. An MNE must forecast the degree of
exposure in each major currency in which it operates and adopt
appropriate hedging strategies for each. A key aspect of measuring
exposure is forecasting exchange rates, where the major concerns are the
direction, magnitude and timing of exchange-rate fluctuations.
2. A Reporting System. A firm must devise a uniform reporting system for

all its entities that identifies the exposed accounts it wants to monitor, the
amount of the exposure by currency of each account and the different
periods under consideration. The system should combine central control
with input from foreign operations. Exposure should be separated
into translation, transaction andeconomic components, with
the transaction exposure identified by cash inflows and outflows over
time. Specific hedging strategies can be taken at any level, but each level
of management must be aware of the size of the exposure and its potential
impact on the firm.
3. A Centralized Policy. To achieve maximum effectiveness
in hedging, top management should determine hedging policy. Most
MNEs prefer to cover exposure, rather than extract huge profits or risk
huge losses.
4. Formulating Hedging Strategies. A firm can hedge its position by
adopting operational and/or financial strategies, each with cost/benefit and
operational implications. Firms may choose to balance local assets with
local debt by borrowing funds locally, because that helps avoid the
foreign-exchange risk associated with borrowing in a foreign currency.
They may also choose to take advantage of leads and lags for interfirm
payments. A lead strategy means collecting foreign-currency receivables
before they are due when the currency is expected to weaken, or paying
foreign-currency payables before they are due when a currency is expected
to strengthen. A lag strategy means delaying collection of foreign-
currency receivables if the currency is expected to strengthen, or delaying
payment of foreign-currency payables when the currency is expected to
weaken. However, such strategies may not be useful for the movement of
large blocks of funds, and they may also be subject to government
restrictions. A firm can also hedge exposure through forward contracts,
which establish fixed exchange rates for future transactions and currency
options, i.e.,derivatives, which assure access to a foreign currency at a
fixed exchange rate for a specific period of time. A foreign-currency
option is more flexible than a forward contract because it gives the
purchaser the right, but does not impose the obligation, to buy or sell a
certain amount of foreign currency at a set exchange rate within a
specified amount of time.
VIII. THE CAPITAL BUDGETING DECISION IN AN INTERNATIONAL CONTEXT

To determine which projects and countries will receive capital investment funds, a parent
company must compare the net present value or internal rate of return of a potential
foreign project with that of its other projects to determine the best place to invest its
resources. As part of this process, parent cash flows must be distinguished from project
cash flows; legal, economic and political constraints must be taken into account; differing
rates of inflation and exchange rate fluctuations must be anticipated; and the terminal
value of a project must be determined. To deal with the variations in future cash flows,
firms may (i) determine the net present value or internal rate of return of a given project
or (ii) establish a hurdle (minimal) rate of return that a project must meet in order to be
eligible to receive funds.
ETHICAL DILEMMA:
What’s Wrong with Banking in a Tax-haven Country?
Cash flow management gives rise to numerous ethical dilemmas. Many critics question the
practice of firms establishing subsidiaries in tax-haven countries in order to take advantage of the
lower tax rates they offer and the secrecy they provide. Tax havens are natural locations in which
to hide cash—MNEs have been known to use money deposited in tax haven accounts to secretly
pay bribes, which is both unethical and illegal. While not all tax-haven transactions are illegal,
there are many gray areas. In 2002, the WTO ruled against the FSC law enacted by the U.S. on
the grounds that there was a lack of true business purpose of the operations of U.S. firms in tax-
haven countries, i.e., tax-haven offices were deemed to be mere fronts that allowed U.S. firms to
lower their prices in foreign markets.

Capital Markets and the Information Explosion
It is difficult to forecast trends in global capital markets because of the scope and pace of
economic changes worldwide. Although the major financial markets will continue to be
dominated by the world’s largest players, action will surely increase within the developing
markets of Eastern Europe, Latin America and Southeast Asia. In addition, the cash management
and hedging strategies of MNEs will be subject to further developments in information
technology, as well as the increasing number and sophistication of hedging instruments (e.g.,
options and forwards), thus enabling firms to manage cash and use interfirm resources more
effectively and efficiently.
WEB CONNECTION

_________________________
CLOSING CASE: Dell Mercosur [See Figure 20.5]
1. Given how Dell translates its foreign currency financial statements into dollars, how
would a falling Brazilian real affect Dell Mercosur’s financial statements?
Dell Mercosur’s revenues, income statement (operating income) and balance sheet
(shareholder’s equity) would all be affected by a falling real. With respect to revenues, as
the value of the real falls, the value of foreign revenues would also fall. Subsequently, the
translated value of the revenues on the consolidated, U.S.-dollar-denominated income
statement would decline as well. Foreign operating income would also decline when the
home-country’s currency strengthens. Shareholder’s equity reflects assets minus
liabilities. If all of Dell’s subsidiaries have their assets and liabilities based on financial
instruments in the same currency, then the value of the foreign- currency denominated
assets would fall, but so would the value of the foreign-currency denominated liabilities.
In relative terms, equity would remain unchanged, although it would also translate into its
U.S.-dollar equivalent at a lower value.
2. Dell imports about 97 percent of its manufacturing costs. What type of exposure does
this create for it? What are its options to reduce that exposure?
Primarily, the fact that Dell Mercosur imports nearly all of its manufacturing costs
impacts transaction exposure, because the transfer price payable changes in value as the
U.S. dollar/Brazilian real rate changes. When the value of the real declines with respect
to the dollar, the use of a lead strategy, i.e., paying for imports before they are due, will
minimize costs to Dell Mercosur. The subsidiary can also hedge its exposure
through forward contracts and foreign currency options.
3. Describe and evaluate Dell’s exposure management strategy.

Dell’s objective in managing its foreign currency exchange rate fluctuations is to reduce
the impact of adverse fluctuations on earnings and cash flows associated with foreign
currency exchange rate changes. Accordingly, Dell uses foreign-currency options
contracts and forward contracts to hedge its exposure on forecasted transactions and
company commitments. Dell also uses purchased options contracts and forward contracts
as cash flow hedges. Hedged transactions include international sales by U.S.-dollar
functional currency entities, foreign-currency denominated purchases of certain
components and interfirm shipments to certain international subsidiaries. Dell also uses
forward contracts to hedge monetary assets and liabilities that are denominated in a
foreign currency. Because Dell’s strategy is to hedge all foreign-exchange risk, it is
considered to be a very aggressive strategy. Rather than attempting to extract huge
profits, Dell has chosen to avoid huge losses.
4. What are the costs and benefits of hedging all foreign exchange risk?
The primary costs of hedging all foreign exchange risk relate to the fact that a firm will
miss out on any positive swings in exchange rate fluctuations, but the benefits are that it
will avoid the costs of any negative swings in exchange rate fluctuations. Firms that
choose to follow such a strategy are likely to accept the idea of offsetting effects, i.e., in
the long run, losses or less than maximum gains will be offset by gains or less than
maximum losses.
Additional Exercises: Multinational Finance
Exercise 20.1. When using capital budgeting techniques to evaluate a potential foreign
project, a firm needs to recognize the specific political and economic
risks (including foreign-exchange risk) arising from that foreign location. Ask students to
compare the advantages of (i) using a higher discount rate and (ii) forecasting lower cash
flows to evaluate such projects.
Exercise 20.2. Typically, the cost of capital is lower in the global capital market than in
domestic capital markets. Other things being equal, firms will likely prefer to finance
their investments by borrowing from the global capital market. However, such borrowing
may be restricted by host-country regulations or demands. Ask the students to discuss the
point at which firms should consider using the global equity markets to finance foreign
investments and operations in lieu of the global debt markets. Are firms likely to
encounter restrictions in the equity markets as well? What are the effects of such
restrictions likely to be on a firm’s investment and operating decisions?
Exercise 20.3. The number of foreign corporations listing American Depository Receipts
(ADRs) on the U.S. stock exchanges has increased dramatically since the early 1980s.
Ask students to discuss this phenomenon in light of the recent global economic downturn.
Do students foresee an increase in demand for either global depository
receipts or European depository receipts in the near future? Why or why not? Be sure
they consider the benefits of depository receipts to both firms and potential investors.
Human Resource Management
Objectives
! Illustrate the importance of human resources in international business.
! Explain the unique qualifications of international managers.
! Evaluate issues that arise when companies transfer managers abroad.
! Examine companies’ alternatives for recruitment, selection, compensation, development
and retention of international managers.
! Discuss how national labor markets can affect companies’ optimum methods of
production.
! Describe country differences in labor policies and practices.
! Highlight international pressures on MNEs’ relations with labor worldwide.
! Examine the effect of international operations on collective bargaining.
Chapter Overview
Firms the world over agree on the importance of qualified personnel to achieve their foreign
growth and operational objectives. Chapter 21 broadly deals with two primary human resource
concerns. The management discussion begins with an overview of specific international
management qualifications and characteristics; it then explores the advantages of transferring
and promoting home country vs. expatriate vs. third-country managers, plus the associated issues
of compensation and repatriation. The chapter concludes with an exploration of international
labor concerns, including comparative labor relations issues and the role of the MNE in the
collective bargaining process.
Chapter Outline
OPENING CASE: Dow’s International Management Program [See Map 21.1]
Founded in Michigan in 1897, Dow Chemical is today a global science and technology-based
firm that develops and manufactures chemical, plastic and agricultural products and services for
customers in 170 countries. Nearly three-quarters of Dow’s top-level management committee
members either were born outside the U.S. or have had extensive foreign experience. Dow’s
operations include eight global businesses that rely on 208 manufacturing sites located in 38
countries; more than half of its nearly $28 billion in annual revenues comes from foreign
markets. Making international operations an integral part of the firm’s mission required Dow to
seek the serious commitment to international business from a broad spectrum of corporate and
country managers over a period of more than 20 years. Finally, in the mid 1990s, Dow was able
to dismantle its geographical/functional organizational structure and replace it with a global
business model. Dow now encourages managers everywhere to learn from top-caliber people and
from best practices throughout the world. Every manager is part of a global team with
opportunities to take on responsibilities with a scope that transcends national borders.
summaries of key chapter points, also review the figures and tables in the text.
I. INTRODUCTION
In order to determine their human resource needs, hire qualified people, motivate
employees to excel, upgrade their employees’ skills and ultimately retain their best
people, MNEs increasingly invest in the development of their global intellectual
assets. These assets include human capital (the knowledge each individual possesses and
generates) and organizational capital (the knowledge institutionalized within the
structure, processes and culture of an organization). Factors that cause international
human resource management to be more complex than the domestic function include:
labor market differences, international worker mobility problems, national management
styles and practices, national orientations and strategy and control issues.
II. MANAGEMENT QUALIFICATIONS AND CHARACTERISTICS

International management qualifications and characteristics primarily revolve around
corporate philosophy, strategy and objectives.
A. Headquarters-Subsidiary Relationship
International management is a two-tiered process that must accommodate the
trade-offs between the competing requirements of global integration and national
responsiveness. Thus, corporate and subsidiary managers alike must consider
global and local needs and resources. The trade-offs are complex and depend on
(i) basic corporate philosophy (ethnocentric, polycentric, or geocentric) and (ii)
the operational benefits to be derived from a more independent vs. a more
interdependent relationship between corporate headquarters and local subsidiaries.
In addition to recognizing when and when not to introduce certain practices at the
local level, international managers must be able to communicate effectively at all
levels. While online collaboration technologies are enabling more efficient
decision-making cycles, communication difficulties will always arise when
functional languages differ. Although English has to a large extent become the
international language of business, cultural differences subtly color the intentions
and perceptions of messages. Further, in the aftermath of recent terrorist attacks,
international businesspersons have been constrained in their abilities to develop
important personal relationships with colleagues, customers, suppliers and other
stakeholders in foreign locations because foreign travel has been severely
curtailed by governments and companies alike.
B. Matching Style to Operations
Evidence suggests greater success can be achieved when managerial actions and
styles are congruent with subordinates’ preferences and expectations. When a
need exists for greater cross-border integration, humanist (relational) managers
are apt to be more effective than a more analytical type of manager; cooperation is
enhanced when managers take into account the perspectives of people who can
either expedite or impede integration. While MNEs that follow a multidomestic
strategy do not need to transfer human resource competencies from one entity to
another, those that follow a global strategy will, so far as is possible, transfer
home-company policies and practices to their foreign units. Those MNEs that
follow a transnational strategy will transfer best practices to all operations in all
countries, regardless of where they happened to originate.
C. Qualifications Specific to Headquarters and Subsidiaries

Both corporate and subsidiary managers have responsibilities that generally differ
from those of home-country managers at similar organizational levels.
1. Headquarters Management. Corporate managers with international
responsibilities must frequently interact with high-level authorities and
executives in foreign countries to negotiate investments, sell technology,
evaluate new market opportunities, assess monetary conditions, etc.
Because they often must be away from home for extended and indefinite
periods of time, their jobs tend to be very difficult and demanding.
2. Subsidiary Management. Foreign subsidiary managers usually have
broader duties than do managers of similar-sized home-country
operations. In addition, subsidiary managers must work more
independently because of their limited access to staff specialists.
III. INTERNATIONAL MANAGERIAL TRANSFERS

Managers are either locals, i.e., citizens of the countries in which they work,
or expatriates, i.e., noncitizens. Further, expatriates are either home-country
nationals, i.e., citizens of the country in which the firm is headquartered (chartered or
incorporated), or third-country nationals, i.e., citizens of neither the country in which
they work nor the headquarters country. In actuality, locals rather than expatriates fill
most managerial positions in both corporate headquarters and foreign subsidiaries.
A. Reasons for Staffing with Locals
Foreign managerial slots may be difficult to fill because (i) many managers prefer
not to work abroad for personal and/or professional reasons and (ii) firms
encounter legal impediments to the use of expatriates (such as professional
licensing requirements). Those who choose to accept a foreign assignment may be
given either a fixed-term or an open-ended assignment. The greater the need for
local adaptations, the more advantageous it is to employ local managers.
Furthermore, when a host-country is suspicious of foreign-controlled operations,
local managers may be more readily accepted. In addition, local managers may
cost less than expatriates, both because local wages may be lower than in the
headquarters country and because relocation costs can be avoided.
B. Reasons for Using Expatriates
Although expatriate managers comprise only a minority of total managers within
MNEs, firms use expatriates because of their competence, their need to gain
foreign experience, their need to refine their business skills and their ability to
manage operations according to corporate preferences. To some extent, a
country’s level of economic development determines the availability of qualified
local candidates; another factor is a firm’s need to transfer technologies abroad
that require trained personnel. Although foreign assignments are, in principle,
valuable educational experiences that prepare managers for greater corporate
responsibility, many firms have been slow to reward people who have
international experience with top-level corporate positions. Rotating home- and
host-country nationals through different locations enables a firm to develop a
hybrid type of corporate culture that understands the demands of both global
integration and national responsiveness. People transferred from headquarters to
foreign subsidiaries are more likely to know corporate policies; people transferred
to headquarters are able to learn the corporate way. MNEs may assign upwardly-
mobile candidates to foreign positions to broaden their perspectives and help them
understand the overall corporate system, thereby developing a global management
mindset.
C. Home-Country vs. Third-Country Nationals
Home-country nationals tend to be the most familiar with a firm’s advances in
technology, product and operating procedures. Nonetheless, third-country
nationals may have more compatible and adaptive qualifications in a specific
situation because of (i) their prior process and/or country experience and (ii) their
knowledge of the local language.
D. Some Individual Considerations for Transfers
What criteria should be used to identify the appropriate home-country and foreign
national managers for a country transfer?
1. Technical Competence. Technical competence (usually indicated by
past performance) is a significant determinant of success in foreign
assignments. The foreign subsidiary manager must understand both the
technical necessities of a position and also how to adapt to foreign
conditions, such as scaled-down plant and equipment, varying productivity
standards and less efficient national infrastructure.
2. Adaptiveness. Three types of adaptive characteristics influence an
expatriate’s success when entering a new culture: (i) those needed for self-
maintenance, (ii) those related to the development of satisfactory
relationships with host nationals and (iii) cognitive skills and sensitivities
that help one accurately perceive what is happening within the host
society. The adaptation of a manager’s family is also crucial to the success
of an overseas assignment.
3. Local Acceptance. Expatriates may encounter acceptance problems

regardless of who they are or where they come from. Most such problems
are cultural rather than legal in nature—some are insurmountable.
Expatriates commonly make unpopular local decisions in order to meet
corporate objectives. To minimize such conflicts, it is important that firms
select well-qualified people, specify a clear title and job position and
disseminate information about the person’s qualifications. It is also
important that the expatriate manager develop appropriate coping skills.
4. Securing a Successful Foreign Assessment. Firms generally expect
people to prove themselves domestically before considering them for
foreign assignment. Therefore, a good work record (plus language fluency
and relevant education and experience) is a critical prerequisite for
becoming an expatriate.
E. Post-Expatriate Situations
Nearly a third of returning expatriates leave their firms within one year of
repatriation and nearly half are gone within two years of returning home.
Repatriation problems arise in three general areas: (i) personal finances, (ii)
readjustment to the home-country work environment and (iii) readjustment to
home-country social life. Effective human resource practices for soothing re-entry
includes placement in jobs that build on foreign experiences, a reorientation
program and a corporate mentor who looks after expatriates’ interests while
they’re abroad.
F. Expatriate Compensation [See Table 21.1]
The amount and type of compensation needed to entice an individual to accept a
foreign assignment may vary widely by person and locale. Company practices
also vary in terms of compensation for differences.
1. Cost of Living. Many expatriates encounter a cost-of-living increase
when posted abroad, simply because their accustomed way of living is
expensive to replicate in a foreign country. The ultimate objective of a
cost-of-living adjustment is to ensure an expatriate’s after-tax income (and
job motivation) will not decline as the result of a foreign assignment. Most
firms raise salaries (aka a goods-and-services differential) to offset the
higher costs. Firms also compare their expatriate compensation packages
to those offered by other firms.
2. Foreign-Service Premiums and Hardship Allowances. Living
conditions in certain settings pose particularly severe hardships (such as
harsh climatic conditions, a loss in total family income, or civil unrest).
Historically, firms tended to give expatriates premiums simply for
accepting a foreign assignment. Although that practice is fading
somewhat, firms still need to compensate expatriate managers and their
families in ways that reflect local environments.
3. Remote Areas. Many international projects are in areas so remote that
firms would get few people to transfer there if they did not find ways to
improve their quality of life. MNEs may have to provide additional
benefits to get employees to sign on in remote areas.
4. Complications of Nationality Differences. As firms employ expatriates

from home and third countries, compensation issues grow more
complicated. Salaries for similar jobs vary substantially across countries,
as do the relationships of salaries within the corporate hierarchy. There is
no general consensus as to how to deal with such issues.
IV. MANAGEMENT RECRUITMENT AND SELECTION

To the extent firms have detailed records, they can compare employees to gauge which
may be best suited to foreign assignment. However, firms typically know more about
their employees’ technical capabilities than their adaptive ones. Foreign personnel are not
easily encompassed in information inventories because foreign operations may not be
wholly-owned. To avoid certain problems, a firm may choose to acquire a foreign
company and, hence, its personnel; it may also choose to form a joint venture with a
foreign partner. However, such actions may simply shift the problem, rather than truly
solve it.
V. THE INTERNATIONAL DEVELOPMENT OF MANAGERS

[See Figure 21.5]
Firms need people with a variety of specialized skills to carry out specialized
international assignments. Therefore, programs to develop such managers must be
tailored, to some degree at least, to specific individuals and situations. Ultimately,
development programs should cultivate employees who exhibit the following
characteristics:
 Top executives must have a global mindset free of national prejudices—they
must understand the global environment in such a way that they can provide the
leadership needed to achieve a global mission.
 Managers with direct international responsibility must be able to balance the
well-being of corporate and national operations.
 Managers without direct international responsibility must understand the
importance of international competition to the firm’s performance.
Figure 21.5 identifies four types of expatriate managers according to their level of
allegiance to the parent firm and their level of allegiance to local operations: (i) the free
agent, who either puts his/her career above both corporate and local operations and/or
whose career has plateaued at home; (ii) the going native type, who learns and accepts
the local way of living and doing business and wants to stay in that location; (iii)
the heart-at-home type, who is overly ethnocentric and eager to return home; and (iv)
the dual citizen, who has a clear understanding of global needs, why he or she is needed
at the foreign subsidiary and local realities that may necessitate national responsiveness.
Some of the weaknesses of the first three types may be counterbalanced with support and
training.
VI. LABOR-MARKET DIFFERENCES
As a firm moves into foreign production, it must consider how to staff, motivate,
compensate and retain its foreign workforce. The norms in these human resource
activities vary substantially from one country to another. In addition, labor-saving
devices that are economical at home may be more costly than labor-intensive types of
production in a foreign country. The firm may also find it beneficial to simplify tasks and
use equipment that might be considered obsolete in an industrial economy.
VII. INTERNATIONAL LABOR MOBILITY

People try hard to emigrate from countries with high unemployment and low wages to
countries with labor shortages and high wages. Further, the incentive to hire immigrant
labor is straightforward: immigrants work for significantly lower wages than domestic
workers with comparable skills. (Critics accuse firms of behaving unethically when they
hire foreign workers under such conditions.) However, firms are less certain of a labor
supply when they depend on foreign workers because national guest worker policies
fluctuate and vary.
VIII. LABOR COMPENSATION DIFFERENCES

Firms may gain a competitive advantage by establishing production facilities where labor
rates are lower than those their competitors pay.
A. Reasons for Country Differences in Labor Compensation
Both the amount and the method of compensating workers reflect a country’s
culture. The level of compensation firms pay their workers depends on their
contributions to the business, the supply and/or demand for particular skills in the
region, the cost of living, government policies, labor laws and the collective
bargaining process. Their method of payment (salaries, wages, commissions,
bonuses and fringe benefits) depends on local customs, issues of security, taxes
and government requirements. In general, MNEs tend to pay slightly higher
wages than their local counterparts (but less than the rate in higher-wage
countries), in part to entice local workers from their local jobs, in part because of
their management philosophies and structures.
B. Differing Costs of Benefits
Fringe benefits differ radically from one country to another (e.g., in many
countries, it is nearly impossible to lay off or fire employees). As a result, direct-
compensation figures do not accurately reflect the amount a firm must pay for a
given job in a given country. Thus, it is labor productivity that is the critical
measure. Firms must constantly reassess productivity rates in light of national
labor rates changes and exchange rate fluctuations.
IX. COMPARATIVE LABOR RELATIONS
In each country where an MNE operates, it must deal with groups of workers whose
approach to the workplace reflects the sociopolitical environment of that country. This
environment affects whether they join labor unions, how they bargain and what they want
from businesses.
A. Sociopolitical Environment
There are striking international differences in terms of how labor and

management view each other. When there is little mobility between the two
groups, a marked class difference exists—labor may even perceive itself to be in a
class struggle. Approaches to reconcile labor-management differences vary by
country. Union membership as a portion of the total workforce has been falling in
most countries. Reasons for this decline include the increase in white-collar
workers as a percentage of total workers, the increase in the service to
manufacturing employment ratio, the rising proportion of women in the
workforce, the rising proportion of part-time and temporary workers, the trend
toward smaller average plant size and the decline in the belief in collectivism
among younger workers.
B. Union Structure
Firms in a given country may deal with one or several unions that, depending
upon the situation, represent workers in many industries, in many firms within the
same industry, or in only one company. If it represents only a single company, the
union may either represent all plants, or just one. Although variations exist within
countries, one type of relationship typically predominates within most countries.
C. Protection from Closures and Redundancy
The level to which workers are protected from plant closures and layoffs varies
from country to country. In some nations, workers violently protest layoffs,
whereas in other nations layoffs are rare and lifetime employment is widely
practiced.
D. Co-determination
Co-determination represents the process in which both labor and management
actually participate in the management of a firm. Procedurally, labor is
represented on the board of directors, either with or without veto power and
cooperative (as opposed to adversarial) decision-making is emphasized.
X. TEAM EFFORTS
In certain countries, firms emphasize work teams to foster group cohesiveness and
involve workers in multiple tasks. Rotating jobs within work groups can both improve
worker motivation and develop critical replacement skills. Nonetheless, the effectiveness
of team efforts in improving labor relations has varied across cultures.
XI. INTERNATIONAL PRESSURES ON NATIONAL PRACTICES
The International Labor Organization (ILO) was founded on the premise that the failure
of any one country to adopt humane labor conditions impedes other countries’ efforts to
improve their own conditions; it monitors labor conditions throughout the world. Several
associations of unions from different countries also support the ILO’s ideals and efforts.
Further, various codes of conduct regarding industrial relations, such as those issued by
the OECD, the ILO and the EU, also serve to influence MNE labor practices.
XII. MULTINATIONAL OWNERSHIP AND COLLECTIVE BARGAINING
An unresolved debate is whether the presence of MNEs and the nature of their operations
systematically weaken labor unions and collective bargaining procedures.
A. MNE Advantages
Critics argue MNEs weaken labor because their product and resource flows let
them hold out longer before settling a strike, their multiple operations permit them
to switch production to other locations and their size and complexity prevent
unions from determining their capacity to meet labor’s demands.
1. Product and Resource Flows. MNEs appear to gain advantages from
international diversification when confronted with collective bargaining
situations, but only in limited circumstances. Operationally, MNEs can
continue to supply customers in a strike-afflicted country only if they have
excess capacity and produce an identical product in more than one
country. Further, they may also confront limitations in the form of legal
restrictions and tariff and transportation costs.
2. Production Switching. Although MNEs sometimes threaten to move
production to foreign countries in order to extract concessions from their
workers (thus pressing unions to demand less compensation in favor of
more job security), actually switching often entails the abandonment of
valuable fixed assets in one country and the expensive process of building
new facilities elsewhere.
3. Size and Complexity of MNEs. Critics argue that when the ultimate
decision-makers are far removed from the bargaining location, arbitrary
management decisions are more likely, even though MNEs generally
delegate labor relations to subsidiary management. While unions regularly
examine MNEs’ financial data to determine their ability to meet labor’s
demands, interpreting the data is often difficult because of disparities
among managerial, tax and disclosure requirements between home and
host countries. Nonetheless, financial statements prepared for local
authorities should be no more difficult to interpret than those of a purely
local firm.
B. Labor Initiatives
Unions engage in several tactics to counter the power of MNEs. Internationally
they can share information, assist bargaining units in other countries and deal
simultaneously with MNEs. Nationally they can exert pressure for legislation that
restricts the methods and mobility of MNEs.
1. Information Sharing. The most common form of international
cooperation among unions is exchanging information, which serves to
refute company claims and identify precedents from other countries
pertaining to bargaining issues.
2. Assistance of Foreign Bargaining Units. Labor groups in one country
may choose to support their counterparts in other countries by refusing to
work overtime, disrupting work in their own countries and/or sending
financial aid to workers on strike.
3. Simultaneous Actions. In order to increase the impact on an MNE,

workers may invite unions in other countries to join in simultaneous
negotiations and/or strikes.
4. National Approaches. Unions’ efforts to counter MNEs’ power have
occurred primarily on a national basis. Worker representation on boards of
directors, the regulated entry of foreign workers and the limitation of
imports and foreign investment outflows are most often the result of labor
initiatives.
ETHICAL DILEMMA:
What Are Fair Labor Practices Anyway?
Ethical dilemmas frequently arise regarding labor issues when MNEs expand their operations to
developing countries. While capital-intensive production methods can increase both productivity
and quality, they may also lead to wide-scale unemployment. In addition, when labor is
substituted for capital, its comparatively lower productivity rate condemns workers to lower
wage rates. MNEs are disparaged for the low-wage rates and the poor working conditions of
their labor forces, given the high prices of their products and the amounts they pay to celebrities
to endorse them. MNEs are also criticized for intentionally employing women in countries where
they are legally paid less than men and for hiring children as young as 5 years of age. Although
firms, unions and human rights groups have attempted to develop a voluntary code of conduct,
they have been unable to agree on what constitutes acceptable working conditions. Nearly 250
million children between ages 5 and 17 work; often their choice is not one of work at the expense
of education, because in many countries, the poor have little access to education. Even UNICEF
concedes the unfortunate need for children to work in poverty-stricken nations, but it urges
eliminating hazardous or exploitative child labor.

Which Countries Will Have the Jobs of the Future?
As capital, technology and information become more mobile among companies and countries, it
will become increasingly difficult for firms and nations to retain highly skilled, highly valued
employees. Thus, human resource development will become an increasingly important
component of firm and national competitiveness. Population trends in many industrialized
countries suggest in the future there will be fewer people to do the productive work. At the same
time, the continual push toward the adoption of robotics and other labor-saving devices will
escalate the need for higher-skilled workers. As a result, the gaps between the have-nots will
widen within industrialized nations just as surely as between industrialized and developing
countries. Suggested solutions to these problems include increased emigration from developing
to industrialized countries on the one hand, and the promotion of policies that discourage brain
drain and encourage re-circulation on the other. Governments in industrialized countries will
then face the challenge of dealing with under-qualified workers who face deteriorating job
prospects, as their citizens blame government policies and foreign workers for their plight.
WEB CONNECTION

_________________________
CLOSING CASE: Tel-Comm-Tek (TCT) [See Map 21.2]
1. Which candidate should the committee nominate for the assignment? Why?
2. What challenges might each candidate encounter in the position?
Tom Wallace:
Pros: Cons:
-4.5 years from retirement -Wallace and his wife know
-experienced in the technical and only English
sales aspects of the job -He is not a management star
-managing a plant of similar size —may be resented by local
-expressed interest in foreign management
assignment
-performance rated proficient
-grown children living in U.S.
-age and experience may be valued
Brett Harrison:
Pros: Cons:
-rated highly competent -Harrison may not view position as a
-poised to move to upper-level promotion
management -teenage children
-experience in Asian regional office -wife has career—unable to relocate
-acquainted with Bangalore expatriates
-well-acquainted with India
Atasi Das:
Pros: Cons:
-rated excellent and upwardly mobile
-experienced in both staff and line
positions
-expressed goal of foreign assignment
-speaks Hindi
-single; no children
-sees international experience as an
essential career step
Ravi Desai:
Pros: Cons:
-assistant managing director in
larger Asian operation
-citizen of India
-speaks English and Hindi
-married with four young children
Jalan Bukit Seng:

Pros: Cons:
-managing director of TCT’s assembly
operations in Malaysia
-performance rating positive-excellent
-single
-citizen of Singapore
Saumita Chaka:
Pros: Cons:
-no moving or adjustment problems -only 27
-performance rated competent -lacks line experience
-single
-excels in employee relations
-personal connections with prominent
families and local officials
-speaks Kannada, Hindi and English
3. How might TCT go about minimizing these challenges facing each candidate?
Tom Wallace:
 Offer orientation and language-training for Wallace and his wife.
 Provide training visits to similar operations elsewhere.
 Offer extra encouragement so Wallace feels valued.
Brett Harrison:
 Offer special commuting arrangements so his wife can maintain her career.
 Offer fixed-term assignment.
 Provide assistance in selecting and settling the children into schools.
Atasi Das:
 Offer advanced work with local management.
Ravi Desai:
 Offer advanced work with local management.
Jalan Bukit Seng:

 Offer orientation and language training.
 Provide training visits to similar operations elsewhere.
Saumita Chaka:
 Provide staff assistance from headquarters.
 Provide technical training and development at headquarters.
4. Should all candidates receive the same compensation package? If not, what factors
should influence each package?
There is a good deal of variation among firms with respect to the ways they compensate
managers abroad. In this instance, TCT needs to consider the base salary each employee
is earning, as well as the cost-of-living adjustment necessary to relocate the employee to
Bangalore. Housing allowances and tax differential compensation may also be in order.
5. What recommendations can you offer to help a company facing this sort of decision that
will enable it to balance professional and personal concerns?
In order to balance professional and personal concerns, a firm might do the following:
 Rank applicants according to some criteria, such as experience in company,
technical competence (including managerial), language skills, area(s) of expertise,
age, stability of marital relations, personal preferences, personality attributes and
career plans.
 Check applicants for adaptiveness, sensitivity and flexibility.
 Check applicants for awareness levels.
 Administer formal orientation programs that include concentrated training and
briefing processes. Include family members in the language and culture courses.
 Effectively deal with the issue of security.
Additional Exercises: Human Resource Management
Exercise 21.1. Ask students to discuss the human resource implications for an MNE that
pursues (a) a multidomestic strategy, (b) a global strategy and (c) a transnational
strategy. Then ask them to follow that discussion by examining the relationship among
the human resource function and the sourcing/manufacturing and the marketing functions
of MNEs that pursue each of those strategies.
Exercise 21.2. Research suggests many expatriate employees encounter problems that
limit both their effectiveness in foreign assignments and their contributions to the firm
once they return home. Ask students to discuss the primary causes and consequences of
these problems. What can a firm do to reduce the occurrence of such problems?
Exercise 21.3. A key issue in international labor relations is the degree to which
organized labor can limit a firm’s ability to pursue a global or a transnational strategy.
Ask students to identify MNEs whose operations reflect each of those management
strategies. Then ask them to discuss the ways in which organized labor can possibly
affect (or has affected) their pursuit of those strategies. What, if anything, can MNEs do
to counter those efforts?

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Chapter 1

International Business: An Overview

I. INTRODUCTION TO THE FIELD OF INTERNATIONAL BUSINESS

III. EXTERNAL INFLUENCES ON INTERNATIONAL BUSINESS

IV. EVOLUTION OF STRATEGY IN THE INTERNATIONALIZATION PROCESS

ETHICAL DILEMMAS AND SOCIAL RESPONSIBILITY:

LOOKING TO THE FUTURE:

Teaching Tip: Visit www.prenhall.com/daniels for additional information and links

CLOSING CASE: Disney Theme Parks [See Map 1.1]

Exercise 1.2. Explore the impact of standardization, containerization and

II. CULTURAL AWARENESS

III. IDENTIFICATION AND DYNAMICS OF CULTURES

IV. BEHAVIORAL PRACTICES AFFECTING BUSINESS

1. Materialism and Leisure. People are motivated to work for various

V. STRATEGIES FOR DEALING WITH CULTURAL DIFFERENCES

LOOKING TO THE FUTURE:

Teaching Tip: Visit www.prenhall.com/daniels for additional information and links

CLOSING CASE: John Higgins [See Map 2.5]

2. What are the major reasons for the differences in attitude?

II. THE POLITICAL ENVIRONMENT

III. BASIC POLITICAL IDEOLOGIES

IV. THE IMPACT OF THE POLITICAL SYSTEM ON MANAGEMENT

V. FORMULATING AND IMPLEMENTING POLITICAL STRATEGIES

LOOKING TO THE FUTURE:

Teaching Tip: Visit www.prenhall.com/daniels for additional information and links

CLOSING CASE: Newmont Mining in Indonesia

OPENING CASE: McDonald’s Corporation in Emerging Markets

II. AN ECONOMIC DESCRIPTION OF COUNTRIES

III. KEY MACROECONOMIC ISSUES AFFECTING BUSINESS

IV. TRANSITION TO A MARKET ECONOMY

ETHICAL DILEMMAS AND SOCIAL RESPONSIBILITY:

Teaching Tip: Visit www.prenhall.com/daniels for additional information

4. What risks does GM face in taking over Daewoo Motor?

Exercise 4.3. In a day of global recession, many wonder if it is necessary or

III. ABSOLUTE ADVANTAGE

IV. COMPARATIVE ADVANTAGE

V. SOME ASSUMPTIONS AND LIMITATIONS OF THE THEORIES OF

The world is comprised of multiple countries and multiple commodities.

VI. THE THEORY OF COUNTRY SIZE

The Heckscher-Ohlin theory of factor endowment is useful in extending the concept

VIII. THE PRODUCT LIFE CYCLE THEORY OF TRADE

XII. WHY COMPANIES TRADE INTERNATIONALLY

XIII. COMPANIES’ ROLE IN TRADE

LOOKING TO THE FUTURE:

Teaching Tip: Visit www.prenhall.com/daniels for additional information and links

Government Influence on Trade

II. CONFLICTING RESULTS OF TRADE POLICIES

1. Use of Surplus Workers. Surplus workers can more easily be used to

2. Comparable Access, or “Fairness.” Economic theory supports the idea

IV. NONECONOMIC RATIONALES FOR GOVERNMENT INTERVENTION

V. INSTRUMENTS OF TRADE CONTROL [See Figure 6.3]

A tariff (also called a duty) is a tax levied on internationally traded

1. Quotas. A quota represents a numerical limit on the quantity of a product

b. Professional Standards. Governments may limit foreign entry

VI. THE WORLD TRADE ORGANIZATION (WTO)

VII. DEALING WITH GOVERNMENT TRADE INFLUENCES

LOOKING TO THE FUTURE:

Teaching Tip: Visit www.prenhall.com/daniels for additional information and links

Additional Exercises: Government Influence on Trade