Professional Documents
Culture Documents
Bbng3103 Bi
Bbng3103 Bi
BBNG3103
International Business
BBNG3103
INTERNATIONAL
BUSINESS
Dr Abdul Jumaat Mahar
Mohd Shah Kassin
Mohd Sobri Don
Jannatul Firdaus
Ahmad Bashawir Haji Abd Ghani
Dr Teo Boon Chui
Project Directors: Prof Dr Mansor Fadzil
Prof Dr Wardah Mohamad
Open University Malaysia
Answers 207
References 233
COURSE GUIDE
COURSE GUIDE " xi
INTRODUCTION
BBNG3103 International Business is one of the courses offered by Faculty of
Business and Management at Open University Malaysia (OUM). This course is
worth three credit hours and should be covered over 8 to 15 weeks.
COURSE AUDIENCE
This course is offered to all students taking the Bachelor of Business
Administration programme. This module aims to impart the basic foundation on
the understanding of international business environment and its influence on the
role of the business manager. Relevant to all learners is the Âreal-worldÊ feel that
conveys the complexity yet excitement of cross-border business.
STUDY SCHEDULE
It is a standard OUM practice that learners accumulate 40 study hours for every
credit hour. As such, for a three-credit hour course, you are expected to spend
120 study hours. Table 1 gives an estimation of how the 120 study hours could be
accumulated.
STUDY
STUDY ACTIVITIES
HOURS
Briefly go through the course content and participate in initial 3
discussions
Study the module 60
Attend three to five tutorial sessions 10
Online Participation 12
Revision 15
Assignment(s), Test(s) and Examination(s) 20
TOTAL STUDY HOURS ACCUMULATED 120
COURSE OUTCOMES
By the end of this course, you should be able to:
COURSE SYNOPSIS
This course is divided into 10 topics. The synopsis for each topic is listed as
follows:
Topic 3 deals with the issues on the cultural environment facing firms in terms of
cultural risk, cultural elements and strategies to cope with cultural differences
when entering foreign markets.
Topic 4 discusses the political and legal environment that firms encounter in
international business.
Topic 6 describes the underlying traditional and new international trade theories
to explain why and how international trade occurs.
Topic 8 discusses the international monetary and exchange rate system in which
international business transaction operates.
Topic 9 examines where and how multinational firms select locations to operate
the business and the modes of entry into the foreign markets.
Topic 10 deals with strategies to manage marketing efforts in the global business
environment.
xiv ! COURSE GUIDE
Learning Outcomes: This section refers to what you should achieve after you
have completely covered a topic. As you go through each topic, you should
frequently refer to these learning outcomes. By doing this, you can continuously
gauge your understanding of the topic.
Summary: You will find this component at the end of each topic. This component
helps you to recap the whole topic. By going through the summary, you should
be able to gauge your knowledge retention level. Should you find points in the
summary that you do not fully understand, it would be a good idea for you to
revisit the details in the module.
Key Terms: This component can be found at the end of each topic. You should go
through this component to remind yourself of important terms or jargon used
throughout the module. Should you find terms here that you are not able to
explain, you should look for the terms in the module.
COURSE GUIDE " xv
PRIOR KNOWLEDGE
Learners of this course are required to pass BBPP1103 Principle of Management
course.
ASSESSMENT METHOD
Please refer to myVLE.
REFERENCES
Balcerowicz, L. (1994). Economic transition in Eastern and Central Europe:
Comparisons and lessons. The Australian Economic Review, 27(1), pp. 47–59.
Bartlett, C. A., & Ghoshal, S. (1989). Managing across borders: The transnational
solution. Boston, MA: Harvard Business School Press.
Economist, T. (2007). Over the hill? Foreign investment in Eastern Europe may be
at a peak. Retrieved from http://www.economist. com/node/9392733
Kotabe, M., & Helsen, K. (2011). Global marketing management (5th ed.).
New Jersey: John Wiley & Sons (Asia) Pte Ltd.
Maher, M., & Christiansen, H. (2001). New horizons and policy challenges
for foreign direct investment in the 21st century. OECD Paper. Paper
presented at the Global Forum on International Investment, Mexico City.
Moran, T. H. (2003). FDI and development: What is the role of international rules
and regulations? Transnational Corporations, 12(2), pp. 1–44.
Ouchi, W. G. (1981). Theory Z: How American business can meet the Japanese
Challenge. New York: Avon Books.
Shenkar, O., & Luo, Y. (2004). International business. New Jersey: John Wiley &
Sons, In.
! INTRODUCTION
The first part of Topic 1 summarises the meaning of international business, why
we study international business, the activities involved in international business
and the types of multinational firms. In the latter part of this topic, we will
be looking at the evolution of international business, which includes the
development of international business from the early era until the present. At the
end of this topic, we will discuss the factors contributing to the development of
international business and external influences of international business activities,
and also common terminologies used in international business.
1.1 BACKGROUND
Let us first start our lesson by looking at the meaning of international business.
For example, international business includes buying raw materials from one
country and then transporting them to another country for processing, exporting
products to other countries to be sold and building a factory at a foreign country to
get cheap labour. The parties which handle international transactions consist of
individuals, private companies and corporations as well as government agencies.
ACTIVITY 1.1
Raw Each country is endowed with different For domestic business, the
Materials raw materials due to differences in production of a product depends
climatic and land conditions. Most on the availability of raw
advanced countries invest in developing materials that can be easily
countries to obtain the cheap and sourced in the country.
abundant raw materials not available in
their own country.
Basically, the skills and knowledge required to achieve success are the same as
transactions done either domestically or internationally. However, other risks
and uncertainties tend to make international business more difficult to operate
and manage. Those involved in international business should understand the
culture, legal system, political situation and social background which are
different amongst countries. They have to consider the buying of raw materials
and market conditions in order to gain optimum outcome.
ACTIVITY 1.2
Take a moment to reflect on how the knowledge of international
business can help someone who is involved in business. Discuss with
your coursemates.
SELF-CHECK 1.1
Each subsidiary has its own planning and focuses towards customer needs.
This requires the company to make use of strategies that combine global
effectiveness and local requirement. The management system of a
transnational company is more complex with regards to the way
coordination and two-way communication between headquarters and
subsidiaries are practised. Typically, this type of company uses a
centralised decision-making process especially for its production and
development department which requires parallelism in its activities.
6 ! TOPIC 1 INTRODUCTION TO INTERNATIONAL BUSINESS
ACTIVITY 1.3
Provide two examples of organisations in Malaysia that implement the
following approaches:
Foreign direct investments have also shown an increasing trend. In 1967, the
overall share of foreign direct investment received by other countries is about
$105 billion, but the figure doubled in 1973 and again in 1980. The development
of trade and international investment portrays economic power, politics and
technology as drivers of the global market and industry.
In the 1950s, American Motors (now part of Chrysler), Chrysler, Ford and
General Motors were successful in selling all their cars. General Electric and RCA
became renowned electronic producers. Companies like US Steel and Bethlehem
Steel did not face any competition. Boeing, McDonnel Douglas and Lockheed
dominated the market for commercial flights.
The US army also influenced the foreign economy during that period. For
example, during the conflict in Korea, the US funded many supply operations in
Japan. This helped in capital emergence, employment and technology in Japan.
Most industrial countries like France, Italy and Japan received full support from
the US either directly or indirectly. At the end of the 1950s, the process of re-
building the infrastructure in the European countries and Japan was completed.
8 ! TOPIC 1 INTRODUCTION TO INTERNATIONAL BUSINESS
For example, in 1958, Nissan Motor exported their cars to the US under the
brand, Datsun. Nissan Motor was incorporated in Los Angeles in 1960 and a
factory was built in Mexico in 1961. In the same year, a Canadian company,
Alcan Aluminium, built its first foreign factory in the US. In 1962, Fuji
collaborated with Xerox to produce photocopy machines. The effort by the
companies from Europe and Asia was the basis for the present growth of a more
sophisticated and greater competition faced by present companies.
In the 1970s, a few events weakened the position of the US in the world economy.
Such events included greater competition and uncertain conditions of the world.
Japan, who had concentrated on quality and cost, was more ready to compete
compared to the US.
Another economic shock which occurred in the 1970s was the hike in oil price
and raw materials. At that time, the oil exporting countries had established a
cartel known as OPEC (Organisation of Petroleum Exporting Countries). OPEC
controlled the production of oil and increased its price sharply. Such actions by
OPEC had provided a negative impact on other countries and companies all
around the world and had transferred the wealth from oil consuming countries
to oil producing countries.
Similarly in the 1970s, the structure of world market had changed. For example,
Japan had conquered the market share for the industry of steel and electronics.
Europe and Japan had captured the automobile industry and replaced General
Motors, Ford and Chrysler in the medium-priced and low-priced automobile
markets.
US companies also realised that they could not totally follow the business practices
of Japanese companies because they needed to maintain their own organisational
and business culture. Hence US companies only followed the business practices of
their competitors in specific areas. For example, Ford and Chrysler followed
Honda and Toyota in terms of product quality enhancement. Electronic companies
such as Motorola and Texas Instruments followed Hitachi and Toshiba in research
and development as well as cost control.
When multinational companies in Europe and Japan developed in terms of size and
wealth, they also increased direct investment in the US. Such investments enabled
these companies to operate in the US market and increased their property values. In
the early 1990s, the worldÊs economy was controlled by industrial nations of the US,
the European Union and Japan (also known as the Triads).
10 ! TOPIC 1 INTRODUCTION TO INTERNATIONAL BUSINESS
ACTIVITY 1.4
What are the policies of the Malaysian government that could
encourage and contribute towards international business? Discuss with
your coursemates in myVLE.
(c) Licensing
Licensing happens when a company in a country (licensor) leases licenses
to enable a company from other countries (licensee) to use their intellectual
property such as patent, trading mark, brand, technology copyrights or
trading secret in return for a royalty. For example, Walt Disney Company
allows other companies to display the picture of Mickey Mouse on their
clothes and thus, gain payment from the sale of the clothes.
(d) Franchise
The two parties that are involved in franchising are franchisor and
franchisee. The franchisor allows the franchisee to use their products in
their brand, logo as well as operational techniques of a product or services.
The franchisee will then pay royalties to the franchisor. For example,
McDonalds sells its franchised restaurants all over the world.
EXERCISE 1.1
1. Explain the term „international business‰ and identify the parties
involved in the international transaction. Provide examples.
2. Briefly describe the following international business activities:
(a) Licensing; and
(b) Franchising.
1.7 INTERNATIONALISATION
Internationalisation happens when an organisation gets involved in commercial
activities outside its border through foreign direct investment. The purpose is to
own and control the operation, to enhance the production value and eventually
gain optimum profit. For example, an organisation engaged in
internationalisation activities is a multinational company (MNC) involved
extensively in international business.
(iii) At the same time, it also allows the subsidiaries to operate according to
local situations.
TOPIC 1 INTRODUCTION TO INTERNATIONAL BUSINESS " 15
ACTIVITY 1.5
ACTIVITY 1.6
Think of a few examples of the changes or adaptations by companies
that are made on foreign products in order to suit our Malaysian
culture. Discuss this issue with your coursemates.
TOPIC 1 INTRODUCTION TO INTERNATIONAL BUSINESS " 17
EXERCISE 1.2
Now, try the following questions to check your understanding of the topic.
18 ! TOPIC 1 INTRODUCTION TO INTERNATIONAL BUSINESS
EXERCISE 1.3
B. legal system
C. culture
D. raw materials
E. advanced countries
B. Licensing
C. Franchising
D. Management contract
E. Export
E. market development.
TOPIC 1 INTRODUCTION TO INTERNATIONAL BUSINESS " 19
A. Internationalisation
B. Multidomestic firm
C. Transnational firm
D. Global firm
E. Local firm
" Companies with an increasing participation in the global market will enhance
their business income, widen their market, obtain raw materials easily as well
as human resources and other cheap production factors from foreign
countries.
" International business begins with domestic business in the home market and
expands across borders from multidomestic business to global and
transnational business.
" The contributing factors that have led to the growth of international business
are market development, resource seeking, competition pressures,
technological changes, social changes, and changes in government trade
investment policy.
20 ! TOPIC 1 INTRODUCTION TO INTERNATIONAL BUSINESS
" The external influences that have a direct impact on international business
consist of cultural, law and political and geographical factors as well as
economic forces.
! INTRODUCTION
In this topic, we will discuss the different ways of categorising the economy of a
country according to geographical regions and classifying the economic systems
into market economy, command economy and mixed economy. We will also
discuss the main macroeconomic issues that affect business strategies, AsiaÊs
economic crisis and the current global financial meltdown. Besides that, we will
look at problems in economic growth which include inflation, balance of
payment surplus and deficit and internal debts. This topic also covers the
transition process of the economic system in Russia, China and East Europe and
we will see the differences found in countries that practise democracy and
socialism. We will then look at the importance of using the privatisation policy in
the development of the economy of developing countries.
22 ! TOPIC 2 ECONOMIC ENVIRONMENT AND SYSTEMS
ACTIVITY 2.1
2.1 BACKGROUND
Understanding the economic environment of the foreign market will help
managers predict the direction and forces that can affect the future performance
of the company. A multinational company would have to consider the following
questions when developing their business ventures in a foreign country for the
first time:
(a) What type of economic system would the company be operating under?
(b) What is the market size, potential growth and market stability?
(d) If the company is in the public sector, will the government allow
competition from the private sector?
(e) If the company is in the private sector, will it move towards public
ownership?
(f) Does the government look at foreign capital as a competition or public and
private collaboration?
(g) How does the government control the situation and development of private
business?
(h) How much contribution is expected from the private sector in helping the
government in the economic environment?
Although the questions above seem simple, the answers are complicated because
of the political situation and economic complexities that economies face today.
For example, foreign investors are not interested to invest in Hong Kong after it
was handed over to China in 1997. The economic system in China is different
from the British system. Is China going to continue with the freedom of a market
economy as practised in Hong Kong while under British authority? Doubts
towards such situations may cause many businessmen to transfer their
businesses to other countries like Singapore.
TOPIC 2 ECONOMIC ENVIRONMENT AND SYSTEMS " 23
ACTIVITY 2.2
Physical and societal factors influence economic stability, the existence and
influence of market capital, market size, and infrastructure such as public
transportation and communication. A manager should understand the economic
condition of the worldÊs economy when making decisions. A manager also
should obtain the latest information regarding national income of the country
and the economic system practised by a foreign country. The economic growth,
inflation as well as surplus and deficit influence the decisions made on the use of
resources and dynamic capabilities of a multinational business. Figure 2.1
summarises how physical and societal factors influence the international
business.
climate, water availability, access to raw materials such as steel and agricultural
production as well as transportation of products from one market to another, and
finally knowledge through research and development implemented by the
company and government must be considered.
On the other hand, a country with low per capita GNP and low population is a
favourite of advanced countries to invest in. For example, China has a low GNP
per capita due to its high population, however its market size and demand is
huge and this has attracted many MNCs to invest to gain market share in the
Chinese market.
It is also the total value of finished goods of the market and the services
produced by the factors of production at home and abroad. The alternative to
gross national product is gross domestic product (GDP). GDP is the total
production value of goods and services produced in the country whether it is
produced by a local or foreign company.
SELF-CHECK 2.1
Why must we use the gross national product to explain the economic
growth of a country?
TOPIC 2 ECONOMIC ENVIRONMENT AND SYSTEMS " 25
The World Bank consists of 184 member countries which use the gross national
income (previously referred to as Gross National Product) as the basis for
releasing loans. The World Bank was founded in 1944 at Bretton Woods
Monetary Conference. Its objective is to provide loan and economic advising
assistance to middle-income and low-income countries. It uses the Gross
National Income per capita to determine which country has the most need for the
loans. Its programmes also include:
The main focus of the World Bank is to improve the social development of
people as well as other development institutions as the main element to eradicate
poverty. The activities of the World Bank are important to multinational
businesses because they help develop the infrastructure and enhance the growth
and stability of the economy, quantity and also quality of demands
Source: http://www.worldbank.org
26 ! TOPIC 2 ECONOMIC ENVIRONMENT AND SYSTEMS
The World Bank classifies low and middle income countries as developing
countries, (now also called emerging economies) although it is identified that
developing countries are not all the same and not all are at the same stage of
development. Developing countries are also known as enhancing countries. Such
a term is also used to explain the capital market (debts and equity market) of the
country which is different from the capital market of advanced countries. The
World Bank does not state that high income countries have reached the peak of
development. High income countries are known as advanced countries or
industrial countries. The term „industrial country‰ exists because the percentage
of production and gross national income is high. At present, the percentage of the
gross national income is focused on services and no longer on industry.
However, the term industrial country is still used.
Each year, the Heritage Foundation and Wall Street Journal publish the economic
freedom index. The index is for a country to evaluate another countryÊs economic
freedom based on principles of economic freedom such as individual
empowerment, equitable treatment and the promotion of competition. The index
is determined using 10 indicators:
Research such as this helps in identifying how far is the involvement of the
government in controlling the economic activities. The 2010 Index of Economic
Freedom classifies economic freedom of countries based on economic openness,
regulatory efficiency, rule of law and competitiveness. Table 2.2 shows some
examples of country classification by economic freedom index.
Category Country
Free Hong Kong, Singapore, US
Mostly free Czech Republic, Japan, Germany
Mostly not free Zambia, Indonesia, China
Not free at all Zimbabwe, Cuba, North Korea
Source: http://www.heritage.org/index
ACTIVITY 2.3
The government owns and controls all the countryÊs resources. The government
also sets the goals of each business effort in the country, the total production and
distribution. Under this economy, the government assumes that they are more
qualified in determining the distribution of resources compared to the people or
businessmen.
Countries like Western Europe, Asia, Latin America and South Africa are
examples of mixed economy. To further stimulate their economy, some countries
like Malaysia, Britain, Spain and France embarked on privatisation programmes.
In this programme, government owned companies were sold to private
corporations.
EXERCISE 2.1
2.9.2 Inflation
Another indicator that we should look into is inflation. What do you understand
by inflation?
Consumer price index (CPI) or in some countries it is called Retail Price Index is
often used to measure the rate of inflation. CPI measures consumer prices based
on a basket of goods. Inflation affects:
(a) The first reason is that the interest rate should be higher than the inflation
rate so that investments on money asset will continue to enjoy the actual
profit.
(b) Second, the financial authority, such as the Federal Reserve Bank in the
USA, would raise interest rate to reduce inflation. When the interest rate is
high, companies and consumers will be reluctant to borrow money due to
the high cost of borrowings. High interest rates have deflationary effects on
the economy and in the long run weakens the economic growth.
32 ! TOPIC 2 ECONOMIC ENVIRONMENT AND SYSTEMS
Inflation influences a countryÊs exchange rate. When there is inflation, the value
of currency falls. In other words, the purchasing power of currency is reduced.
Generally, a country with low inflation rate will have a relatively stable and
strong currency. MNCs prefer to invest in economies with low and stable
inflation rate which are conducive for economic growth while high inflation
indicates economic instability, rising costs and poor control of the economy by
the government. Goods produced in the country will be expensive and this leads
to high export prices. This may have a negative impact on FDI.
EXERCISE 2.2
ACTIVITY 2.4
ACTIVITY 2.5
Compare the transitions in the three regions that you have just read
about. State the strengths and weaknesses for each transition. Then,
choose the type of transition which you think is suitable to be
implemented in Malaysia.
TOPIC 2 ECONOMIC ENVIRONMENT AND SYSTEMS " 35
Similarly, Vietnam has charted much success since economic reforms in 1986. It is
one of the fastest emerging countries in ASEAN attracting FDI inflows because of
its openness to trade, high GDP growth, market size and infrastructure
development (Hoang, 2006).
However, FDI to Central and Eastern Europe have declined since its peak in
2006. Poland, Russia and Romania are the top three FDI locations. FDI inflows
were the result of large privatisation sales, investments in commodities, and
property boom (The Economist, 2007).
It is unpredictable and its impact has effects on demand and supply throughout
the global market (Investopedia, 2012).
Now, let us move on to the next section which explains about the Asian Financial
Crisis in 1997/1998.
The currency crisis led to a sharp rise in interest rates and this caused the share
market to collapse. The contagion effect of the crisis led to Indonesia having to
devalue its Rupiah by 90% against the US dollar causing major collapse in its
financial market and political system.
These economic shocks were felt throughout the world notably countries like
Russia and Eastern Europe, and it spread to China and Japan. Competition from
cheap exports from ASEAN countries after large devaluation of currencies were
the main reasons. However, US and European economies were less affected.
Even though the International Monetary Fund (IMF) intervened to provide tight
financial reforms in Thailand and Indonesia, this did not mitigate the contagion
effect rather caused those countries' economy to shrink further as a result of its
tight monetary and fiscal policies.
The contagion effects of this crisis are still being felt today and the problems are
not over. Both economic shocks have brought about tremendous negative impact
on the global business. Some negative impacts of economic shocks are:
(a) Falling exchange rates of important currencies such as the US dollar affect
profits;
(b) Falling world demand for goods and services affects countryÊs exports;
(d) Decline in the global FDI leads to general slowdown in world growth with
developing economies most affected; and
ACTIVITY 2.6
Explain how economic shocks such as the Asian financial crisis and the
global financial meltdown affect international business. You can visit
the following websites for further information:
EXERCISE 2.3
A. abolish poverty
B. abolish bribery
A. advanced countries
B. developing countries
D. socialism countries
E. geographical area
40 ! TOPIC 2 ECONOMIC ENVIRONMENT AND SYSTEMS
" Understanding the economic environments of the foreign markets can help a
manager to predict the direction of the company.
" Countries in the world economy are classified according to income or GNP
per capita, geography by regions and the economic systems such as the
market, command and mixed systems that exist.
" In market economy, the private sector controls and owns the resources,
whereas in a command economy, the government owns and controls the
resources. Mixed economy is a hybrid of market and command economic
systems.
" The economic transformation of China and Russia affected the pattern and
development of international business.
" Financial crisis can bring about economic shocks and adversely impact
international business.
! INTRODUCTION
In this topic, we address the concept of culture and what constitute cultural
elements. The importance of culture to international business is discussed as well
as the risks that culture can pose in international business encounters. It cannot
be denied that today, developing an appreciation of, and sensitivity for, cultural
differences have become imperative for any manager, even more in cross-cultural
boundaries. Different cultural environments are characterised by foreign
languages and different beliefs and values. Hence, global managers need to
develop understanding and skills in dealing with other cultures to avoid cultural
blunders and mistakes. The influence of culture on international business is
discussed together with ways to overcome these cultural challenges.
42 ! TOPIC 3 CULTURAL ENVIRONMENT
The working definition of culture used throughout this topic is by Whitely and
England (1977) who described culture as „the knowledge, beliefs, art, law,
morals, customs and other capabilities of one group distinguishing it from the
other groups.‰
Despite the different definitions, culture has four common features, as shown in
Figure 3.1.
Now let us have a look at the explanation of each feature in Table 3.1.
No Features Explanation
1 Culture is learned It is a learned behaviour and transmitted through
the process of learning and interacting with oneÊs
environment and not inherited.
2 Culture is intangible It is not about „things‰ such as products or values. It is
concerned about meanings which are intangible or not
visible in nature and must be inferred.
3 Culture is shared It does not belong to an individual but is shared by
individuals who are members of a group or society.
Culture is identified with a nation, firm or society.
4 Culture is interrelated It consists of different parts that are interrelated. For
example, a personÊs culture such as language or
religion has an impact on another part.
The impact of culture at the business level ranges from strategy formulation and
communication to foreign investment operations and organisational structure.
Effective cross-cultural management of the firmÊs resources and operations is a
critical source of competitive advantage. Culture can impact managerial tasks in
various ways such as:
(b) FDI strategies such as communicating and interacting with foreign business
partners, screening and selecting foreign distributors and other partners,
negotiating and structuring international business ventures;
(c) Business practices such as interacting with current and potential customers
from abroad;
ACTIVITY 3.1
3.3.1 Language
Let us continue our discussion by looking at the first cultural element which is
language. Language is one of the key dimensions of culture. Language is
construed as the „mirror‰ of culture and provides insights into culture. It is
essential for communication and basic socialisation in which values and norms
are expressed and communicated. Language is both a unifying and dividing
force. There exists diversity in language across and within national boundaries.
At present, the world has nearly 7,000 active languages. India alone has more
than 200 spoken languages. Table 3.2 highlights the major languages of the
world.
Number of Speakers
Language Family Principal Locations
(estimated in millions)
Chinese Sino-Tibetan China 885
English Indo-European North America, Great 450
(Germanic group) Britain, Australia, South
Africa
Hindi- Indo-European India, Pakistan 333
Urdu (Indo-Iranian group)
Spanish Indo-European South America, Spain 266
(Romance group)
Portuguese Indo-European Brazil, Portugal 175
(Romance group)
Bengali Indo-European Bangladesh, India 162
(Indo-Iranian group)
Russian Indo-European Former Soviet Union 153
(Slavic group)
Arabic Afro-Asiatic North Africa, Middle 150
East
Japanese Altaic Japan 126
French Indo-European France, Canada, 122
(Romance group) Belgium, Switzerland,
West and North Africa
German Indo-European Germany, Austria, 118
(Germanic group) Switzerland
Source: alis.isoc.org/languages/grandes.en.htm
46 ! TOPIC 3 CULTURAL ENVIRONMENT
Because of differences between language structure and in the use of slang and
dialects, language blunders are common in business settings. Translation,
meaning and expressions differ across the language spectrum. The concept and
meaning of a word are not universal, even though the word can be translated
into another language. Language mistakes and blunders are embarrassing and
often unnecessary, for example, careless translation in advertising slogans or
products labels. The following examples of language mistakes in cross-cultural
marketing illustrate how crucial language is in international business.
(a) Marketing executives were disappointed to learn that the brand name of
the cooking oil they were promoting in a Latin American country translated
into Spanish as „Jackass Oil‰.
(b) In Chinese, the Kentucky Fried Chicken slogan „finger-lickinÊ good‰ came
out as „eat your fingers off.‰
(c) In Taiwan, the translation of the Pepsi slogan „Come alive with the Pepsi
Generation‰ came out as „Pepsi will bring your ancestors back from the
dead.‰
(d) In Italy, a campaign for Schweppes Tonic Water translated the name into
„Schweppes Toilet Water.‰
As a communication medium, language has two parts: verbal (spoken) and non-
verbal (silent language such as space, facial expressions and gestures). Linguistic
proficiency is a great asset in international business because it facilitates cross-
cultural understanding especially in business negotiation. For example, it is
important for investors to be proficient in Mandarin Chinese and it will be of
great advantage to know the native Chinese language while doing business in
China. For non-verbal language, facial expressions and hand gestures can have
different interpretations in different cultures and often complicate international
communication. Not only may the person you are dealing with be
unintentionally sending non-verbal signals that you do not comprehend or you
misunderstand, you may be unconsciously sending your own signals. Some
examples of silent language blunders and lack of cultural awareness are as
below:
(a) One company printed the „OK‰ finger sign on each page of its catalogue. In
many parts of Latin America this is considered an obscene gesture. The
entire catalogue had to be re-printed.
(b) An American executive refused an offer of a cup of coffee from a Saudi
businessman. Such a rejection is considered very rude and the business
negotiations were terminated.
TOPIC 3 CULTURAL ENVIRONMENT " 47
EXERCISE 3.1
Why is silent (non-verbal) language important for international
business?
Provide several examples of how it differs across cultures.
3.3.2 Religion
Our next discussion will be on religion.
Source: www.infoplease.com
48 ! TOPIC 3 CULTURAL ENVIRONMENT
(b) The case of Nike Air brings back another classic example of cultural
blunder. In 1998, Nike Air Bakin made national headlines when Arab-
American groups thought that the way „Air‰ was written on the shoe
looked too similar to „Allah‰ written in Arabic. Nike recalled thousands of
shoes, covered the logos with patches and the shoes made their way to the
outlets. Unfortunately for Nike, there were hundreds of thousands of shoes
fresh out of the factories that had the same logo (Nicekicks, 2012).
(c) In the Islamic market, Nokia launched a mobile phone that shows Muslims
the direction towards Mecca, IslamÊs holiest site. Heineken, the Dutch
brewing giant, rolled out the non-alcoholic malt drink, Fayrouz.
(d) Major holidays in many countries are tied to religion. Almost 90 percent of
Brazilians are Catholic, making Brazil the largest Catholic population in the
world. Catholic holidays, consequently, affect Brazilian work schedules and
are widely celebrated. MNCs operating there must keep this in mind when
planning marketing events, scheduling meetings or operating in local
offices.
SELF-CHECK 3.1
Social structure affects business decisions ranging from production site selection,
negotiation and marketing to the costs of doing business in a country. One
important dimension of social structure that differs across cultures is social group
interaction.
(i) Nuclear family which comprises parents and children and is found
mainly in Western countries; and
The way in which families are structured present interesting situations for
business people who are unfamiliar with the culture. For example, in
extended family cultures, managers and other employees often try to find
jobs for relatives inside their own companies. This can pose a challenge for
human resource management. In some cultures, business is owned with
family and relatives. Owners and managers buy supplies and materials
only from companies owned by relatives or in which someone from the
extended family works. In cultures where extended families are the norm,
major purchase decisions are influenced by members of an extended family.
50 ! TOPIC 3 CULTURAL ENVIRONMENT
1. Do your homework to know about the Chinese market before making any
concrete move. China is a huge country with diverse cultures and peoples. Each
region possesses unique demographics and consumer preferences that are crucial
to any business plan. What works in one city may not necessarily work in another
city.
2. Do your communications in Chinese. Hire a Chinese-speaking employee to
handle communications in China or use the services of an interpreter for the job.
The Chinese place a premium on good relationships (guanxi).
3. Do your best to locate a good local partner. Existing Chinese laws prohibit foreign
representative offices from signing contracts directly in China. Use a reliable local
agent to sign all sales contracts and send billing statements to customers when
needed. A good local partner is also in the best position to sell and distribute your
products in China.
4. Do not sign contracts without first seeking legal advice. Do not sacrifice short-
term profits for so-called long-term gains. The economic climate in China is
always changing and may be unpredictable.
5. Do not use unsecured channels for payment. Make it a policy to receive or make
payments using only established banking institutions and by asking for Letters of
Credit and other financial instruments.
6. Protect your intellectual property rights. Profitable or well-known brands usually
become the subject of copyright infringement or piracy.
Source: www.chineseewhispers.com
TOPIC 3 CULTURAL ENVIRONMENT " 51
EXERCISE 3.2
3.3.4 Aesthetics
We will now continue with another element, which is aesthetics. What do you
understand by the word „aesthetics‰?
Aesthetics refer to sense and perception of beauty and good taste of a culture.
" Avoid Hand Gestures in Graphic Symbols – In some countries, icons using the
thumbs up, „V‰ for victory or „OK‰ sign would indicate that something is good
but these can be vulgar gestures in other countries.
" Avoid Animals in Graphic Symbols – Owls symbolise wisdom in the United
States but they symbolise stupidity in some Asian countries. Other animals could
cause offence because of their religious significance. For example, dogs and pigs
to Muslims, cows to Hindus, elephants to Thais.
" Avoid Text Requiring Translation in Graphic Symbols – Words or even single
letters will likely not be universal because of the translation required.
" Avoid Humour and Slang in Graphic Symbols – Humour cannot always be
translated.
" Avoid Culturally Sensitive Topics in Graphic Symbols – Examples are
race/ethnicity, politics, religion and sex/gender.
" Avoid Region-Specific Elements in Graphic Symbols – Currency, time/date, and
flags (i.e. in website language selectors) will not share universal meaning across
borders.
Source: www.globalization-group.com
TOPIC 3 CULTURAL ENVIRONMENT " 53
ACTIVITY 3.2
Find out what the following colours symbolise in the countries stated
below.
Examples of countries with high PD are Japan, India, Brazil and Malaysia
while United States, Denmark, and Sweden exhibit low PD. Societies with
high PD tend to tolerate and accept relatively high social inequalities. Status
symbols play an important role. Organisations with high PD are more
centralised, with more layered and hierarchical structure with more
supervisory personnel and larger wage differentials. In societies with low
PD, the gaps between the powerful and weak are minimal and status
symbols are less emphasised. Organisations with low PD are characterised
by flatter structure and less centralisation.
They are emphasised against female values like caring, people orientation,
quality of life and nurturing. Typical examples of masculine cultures are
Australia, Japan and Italy while Thailand, Sweden and Finland are low in
the masculinity trait. MNCs from feminine cultures tend to minimise
gender roles with more women in more qualified jobs. Such organisations
tend to value social rewards and benefits to employees.
TOPIC 3 CULTURAL ENVIRONMENT " 55
Source: http://geert-hofstede.com
56 ! TOPIC 3 CULTURAL ENVIRONMENT
ACTIVITY 3.3
Let us move on by looking at Table 3.7. Table 3.7 provides a summary of the
characteristics of HofstedeÊs cultural dimension and tips to deal with each value
orientation.
Low " A woman can do anything a man " Avoid an „old boysÊ club‰
MAS can do. mentality.
" Powerful and successful women " Ensure job design and practices are
are admired and respected. not discriminatory to either
gender.
" Treat men and women equally.
High " Very formal business conduct " Be clear and concise about your
UAI with lots of rules and policies. expectations and parameters.
" Need and expect structure. " Plan and prepare, communicate
" Sense of nervousness spurns high often and early, provide detailed
levels of emotion and expression. plans and focus on the tactical
aspects of a job or project.
" Differences are avoided.
" Express your emotions through
hands gestures and raised voices.
Low " Informal business attitude. " Do not impose rules or structure
UAI " More concerned with long-term unnecessarily.
strategy than what is happening " Minimise your emotional response
on a daily basis. by being calm and contemplating
" Accepting of change and risk. situations before speaking.
" Express curiosity when you
discover differences.
Source: www.mindtools.com
Form Description
Personal Understanding and valuing yourself such as self-awareness, self-
literacy renewal, and having strong values, being flexible enough to know
that people from other cultures have different values and ethics.
Social Engaging and challenging other people such as learning what gets
literacy said is non-verbal, and learning to read environments, contexts and
circumstances.
Business Learning and building new things, building and rebuilding, tearing
literacy down what donÊt work, engaging in problem solving, navigating
through chaos and leading people through change.
Cultural Valuing and leveraging cultural differences, understanding own
literacy cultural heritage, recognising own strengths and shortcomings and
building bridges across cultures. Cultural literacy in marketing, work
attitudes, expatriates and gender are important.
SELF-CHECK 3.2
Visit Executive Planet website for guidelines on business culture and
etiquette when meeting with business associates from other cultures, at
www.executiveplanet.com/
EXERCISE 3.3
1. _________ consists of people with shared beliefs, values and
attitudes.
A. Moral
B. Culture
C. Identity
D. Self-concept
A. Christianity
B. Buddhism
C. Islam
D. Hinduism
A. Geocentrism
B. Polycentrism
C. Ethnocentrism
D. Regiocentrism
A. High individualism
B. High collectivism
C. High masculinity
TOPIC 3 CULTURAL ENVIRONMENT " 61
A. Career choice
B. Aesthetics
D. Religion
A. Quality of life
B. Assertiveness
C. Achievement
D. Status
" Lack of cultural understanding and sensitivity towards foreign cultures when
doing cross-border business can lead to cultural blunders.
" Language and religion are two major cultural elements that exert a direct
impact on international business operations and strategies.
" Hofstede classified national culture into four major cultural value
dimensions: power distance, individualism-collectivism, uncertainty avoidance
and masculinity-femininity.
" The family unit and gender are two components of social group interactions
that influence cultural behaviour in particular situations.
" Key cultural challenges facing MNCs include cultural bias, ethnocentrism,
cultural stereotypes and cross-cultural miscommunication.
62 ! TOPIC 3 CULTURAL ENVIRONMENT
" Cultural literacy which forms part of understanding the business culture and
practices of local markets is key to MNCsÊ success abroad.
Aesthetics Individualism
Business practices Masculinity
Collectivism Non-verbal language
Colour symbol Power distance
Cultural awareness Religion
Cultural bias Social group interaction
Cultural literacy Social structure
Culture Uncertainty avoidance
Ethnocentrism Value orientation
Femininity Verbal language
Topic! ! Political and
Legal
4 Environment
LEARNING OUTCOMES
By the end of this topic, you should be able to:
1. Discuss the functions of a political system;
2. Compare between three political ideologies and how each of them
influences government policy decisions on investments;
3. Explain political risks and how companies formulate and
implement political strategies to overcome such risks; and
4. Examine three types of legal systems in international business.
! INTRODUCTION
Welcome to Topic 4 on International Business. Before we proceed with the
discussion on the political and legal environment, let us take a moment to think
about political issues in international business. In your opinion, how do political
issues affect international business? Do you think that political issues can
exacerbate economic challenges? Can a company which implements different
business practices from Malaysia operate successfully in China?
You must remember that multinational companies operate in the political and
legal environment of their host countries. Therefore, international business
managers must analyse in detail whether their corporate policies and objectives
are in line with the political environment and legal system of the host country.
If you would like to have better knowledge of the political and legal systems
which managers have to deal with and the factors to consider when operating a
business in a foreign country, read through this topic. Happy reading!
64 ! TOPIC 4 POLITICAL AND LEGAL ENVIRONMENT
SELF-CHECK 4.1
Did you know that most of the major obstacles to the operations of a foreign firm
relate to the political and legal environment? In todayÊs fast-changing political
environment, changes in a countryÊs political system can have dramatic and
widespread impact on businesses, both domestically and internationally. For
example, Malaysian managers may be familiar with a relatively stable political
system but this is sometimes not the case in other countries. For instance, since
2008, Thailand has been experiencing political instability due to anti-government
protests. Civil unrest and riots have affected tourism, consumer spending and
investor confidence not only in Thailand but also in its neighbouring Association
of Southeast Asian Nations (ASEAN) countries (Euromonitor, 2010).
Figure 4.1 shows political and legal factors that form part of the external
environment influencing management decisions.
Examples of political ideologies are the Democratic and Republican parties in the
United States; and the Conservative and Labour parties in the United Kingdom.
A country with a pluralistic society is likely to have many political ideologies.
Most of modern society is pluralistic politically because there is no ideology that
could be fully accepted. Pluralism exists because groups in a country are often
significantly different from each other in terms of language, race and religion (for
example, India).
The main purpose of any political system is to unite the society even with
pressures from various ideologies. The more different the ideas the more difficult
it is for the government to form ideologies that can be accepted by all. In sum,
whatever types of ideology the host government supports, the number of
political parties and the ideology of the main political party in the country are
major concerns of multinational corporations (MNCs). Political instability is the
result of transcending differences in ideas and ideologies. Political instability
makes it difficult for foreign investment and any operation that uses the
resources in a country. A political ideology determines the direction of a host
governmentÊs policy towards foreign direct investment (FDI).
ACTIVITY 4.1
As you can see in Figure 4.3, there are three different political ideologies on
foreign investment.
(a) The radical view, based on Marxism, adopts a hostile stance towards FDI. It
sees MNCs as a tool for exploiting a host country. The host government
restricts foreign investment and is more likely to nationalise MNCs. The
radical view declined due to the collapse of communism in the late 1980s.
(b) The free market view sees MNCs as an important tool for efficient
allocation of resources and production. Based on this view, no restrictions
are placed on FDI and it is allocated to countries where it will be produced
most efficiently.
ACTIVITY 4.2
1. List three approaches of political ideologies which influence
government policies towards MNCs.
Politics that affect international trade and foreign investment can stem from
political changes in the home country, host country or the rest of the world.
Table 4.1 shows a list of countries ranked according to the risk of political
instability.
Note: Rating of 1 = very high political instability risk, rating of 10 = very low political instability
risk
Source: The IMD World Competitiveness Yearbook (2011)
Table 4.2: Three Types of Political Risks that Affect FDI Operations
Types of Political
No Causes Examples
Risk
1 Ownership risks (a) Change in political Change in political
associated with ideology of a country. leadership when China took
change in the (b) Change in political over Hong Kong in 1997 –
structure of foreign leadership. many MNCs which invested
ownership and in Hong Kong had to
(c) Change in opinions of
control of assets and identify new risks
political leaders.
properties. associated with changes in
the political system,
ideology, government
leadership and rules of the
game between the
communist system of the
government of Mainland
China and Hong KongÊs
democratic system.
2 Operational risks (a) Political instability in a " Violent political riots in
occur when there is host country or region Egypt, Libya and
change in the „rules arising from riots, civil neighbouring countries
of the game‰ by the war, terrorism and have a negative impact
government or the natural disaster disrupt on tourism FDI, airline
political climate, MNCÊs local operations. operations and oil
affecting daily (b) Host or home industries.
operations of the government introduce " Venezuelan President
foreign business. changes in rules of Hugo Chavez
investment on FDI and confiscated the oil fields
limit foreign ownership of foreign oil companies
of equity. operating in Venezuela
(c) Host government and made new oil
actions such as contracts.
confiscation,
expropriation (seizure
of property without
compensation) and
nationalisation of
foreign business and
assets interrupt MNCs
daily operations causing
FDI losses, closure and
even exit the country.
70 ! TOPIC 4 POLITICAL AND LEGAL ENVIRONMENT
3 Transfer risks arise (a) Host government During the Asian Financial
from barriers to imposes foreign Crisis, Malaysia and other
transfer of FDI exchange controls on ASEAN countries impose
capital, profits and MNCs that restrict capital controls to protect
human resources by outflow of their FDI their local currency.
MNCs. profits back to their Increasing levels of capital
home country. controls reduce the life-span
(b) Host government of FDI and foreign
restricts placement of investorsÊ willingness to
expatriates in key undertake new investment
positions at foreign (Siddiqui, 2012).
companies.
ACTIVITY 4.3
According to Shenkar and Luo (2004), a few strategies available to managers for
managing political risk are as follows:
(a) Opt for collaboration such as joint venture with a local partner to gain local
acceptance for a foreign investorÊs presence, product and brand.
(d) Build political support at home and in host countries through lobbying,
public relations and implementation of corporate social responsibility.
(h) Minimise outright investment, use leasing or collaborate projects with host
governments.
(i) Use risk management measures to insure and protect properties and
intellectual property.
72 ! TOPIC 4 POLITICAL AND LEGAL ENVIRONMENT
(a) Economic Role – through economic policies, for example, tax, monetary,
price controls and employment (this has been discussed in Topic 2).
(b) Legal Role – through laws and legislations, for example, environmental,
trade and investment policies (this will be discussed further in subtopic 4.7).
MNCs have to establish good relationships with the government in the host
country. The main political objective of MNCs in a host country is to establish
favourable trade and investment conditions. MNCs seek from the host
government for:
ACTIVITY 4.4
Common and civil laws differ. Common law is based on the courtÊs
interpretation of the case, while civil law is based on how the law is applied
based on information. An example of how it is practised in both systems is a
contract. For countries that practise common law, a contract sets out in detail the
terms that govern the contractual relationships between the parties whereas in a
civil law country, contracts are often shorter and have limited legal provisions.
(a) Al-Quran;
(c) Writings of Muslim scholars based on the principles found in the Al-Quran
and Sunnah.
There is a strong relationship between the legal systems and MNCsÊ investment
operations. MNCs have to abide by the legal systems practised by host countries.
MNCs are concerned about legal jurisdiction or legal authority levels that govern
MNC operations. MNCs are subject to a multitude of laws under international
laws, regional laws and national laws of home and host countries and also third
countries.
ACTIVITY 4.5
These include:
(a) Product safety and consumer protection such as product liability laws;
(a) Product liability issues are a major concern and challenge for MNCs.
Different legal systems provide different protection for consumers. One
example is the case of melamine milk contamination in China which
prompted the government to introduce product liability and recall laws.
Civil liability suits can be brought against manufacturers and sellers of
goods, enabling consumers to seek compensation and damages. China also
imposed criminal sanctions on the production and sale of fake, counterfeit
and defective products (CECC, 2009). Following that, the US Food and
Drug Administration Act issued health warnings on infant formula in
China to protect consumers.
(i) Customers must have a choice about what Windows components are
mandatory in any installation of the operating system; and
(c) Intellectual property (IP) refers to creations of the mind: inventions, literary
and artistic works, and symbols, names, images, and designs used in
commerce. MNCs often face the problem of intellectual property theft and
increasing difficulty in protecting their IP in their FDI. Examples of IP laws
administered by the World Intellectual Property organisation (WIPO) are
Patent Law Treaty and Trademark Law Treaty. WIPO is specialised agency
of the United Nations aimed at developing a balanced and accessible IP
system, which rewards creativity, stimulates innovation and contributes to
economic development while safeguarding the public interest (http://
www.wipo.int/). For example, the top five pharmaceutical MNCs – Pfizer,
Bayer, Roche, Schering and Bristol Myers Squibb – have been accused of
violating patent laws with regard to top-selling patented anti-cancer and
hepatitis drugs sold in India (Mukherjee, 2011).
Legal issues are more complex in the context of international business than in
domestic business; hence, MNCs must study, adapt and leverage national and
international differences in product liability, competition, intellectual property
laws as well as labour, marketing and distribution laws.
TOPIC 4 POLITICAL AND LEGAL ENVIRONMENT " 77
SELF-CHECK 4.2
What are some national laws that MNCs must comply with in order to
make FDI in Malaysia?
EXERCISE 4.1
A. privatisation policy
B. inflation
C. war
A. political
B. social
C. economic
D. industrial
E. cultural
A. product liability
C. technology
D. employee recruitment
E. local resources
TOPIC 4 POLITICAL AND LEGAL ENVIRONMENT " 79
" The political ideologies of host governments can impact foreign investments
in many ways.
" The three views of political ideologies which affect government policies
towards foreign investments are radical, free market and pragmatic
nationalism.
" The three types of political risks are operational, ownership and transfer
risks.
" Some of the legal issues facing foreign companies are product liability,
competition and intellectual property laws.
! INTRODUCTION
In Topic 2, we discussed the importance of free trade, investment and capital to
the worldÊs economy. There are fewer obstacles to trade and investment today
than before, however, one of the main developments in the international market
is the increasing economic integration of countries.
Regional economic integration (REI) has greatly altered global economic patterns
and influenced trade activities.
The main concern of REI is the removal of tariff and non-tariff barriers.
TOPIC 5 REGIONAL ECONOMIC INTEGRATION " 81
An example of a free trade area is the European Free Trade Association (EFTA).
EFTA was established in 1960 by West European countries which were not in the
European Community. The main objective of EFTA is to ensure free trade and
market access among its members. Agricultural products, however, are not
included in the agreement and each member is allowed to determine its own
tariff when trading with countries which are not EFTA members. Other examples
of free trade areas are North America Free Trade Area (NAFTA) and ASEAN
Free Trade Area (AFTA). These will be discussed in the last section of this topic.
ACTIVITY 5.1
ACTIVITY 5.2
In sum, one form of economic integration may shift from one level to a higher
level over time provided the participating member countries agree. For example,
the European Union started out as a common market (Single European Market)
and evolved into an economic union and now can be regarded as a partial
political union.
84 ! TOPIC 5 REGIONAL ECONOMIC INTEGRATION
We have discussed the five stages of regional economic integration. Table 5.1
shows the basic features of the different stages of regional economic integration.
EXERCISE 5.1
Generally, economic theory suggests that trade and investment which are free
from obstacles are beneficial to all countries. This condition can be achieved by
forming economic integration areas. Free trade leads a country to specialise in the
production of a product or service which will be produced more efficiently.
Based on the law of comparative advantage, economic efficiency is enhanced.
The result is an increase in regional output and gain in regional welfare.
The member countries not only gain increased market power but also increased
collective bargaining power with non-member countries. They are more
successful in getting better terms of trade for their exports and imports with non-
member countries.
You may visit the World Trade Organisation website at http://www.wto.org for
additional information.
nations having to finance poorer member nations. For example, the 2010–
2011 EuropeÊs financial debt crisis in Greece, Ireland, Portugal and Spain
could have negative domino effects on the European Union. It remains to
be seen how the EU will tackle this debt crisis.
(b) Economists argue that governments fear the loss of decision-making power
and sovereignty. Such fear is caused by close economic cooperation among
member countries and governments lose control and decision making in
some policies. For example, in the UK, some sovereign power is transferred
from London to Brussels as headquarters of the EU.
ACTIVITY 5.3
On the other hand, removal of tariffs protection will expose firms to competition
from other member countries. This results in negative effects on local firms
which are less cost efficient. Economic integration areas are also the preferred
location of investments from advanced countries. These firms invest in such
areas in order to gain entry and market share into the region.
TOPIC 5 REGIONAL ECONOMIC INTEGRATION " 87
In brief,
Assume that before the formation of the European Union, an apple from France
cost $1.00 per kilogramme. Price per kilogramme for the apple in Germany is
$1.20. If, for instance, Germany uses an import tariff of $0.25 per kilogramme on
apples imported from France, those apples from France will be expensive and
could not compete in the Germany market ($1.00 + $0.25 = $1.25 per
kilogramme). When the European Union is formed, this import tariff will be
abolished. „Trade creation‰ will happen because the apple production will move
from a high cost producer (Germany) to a low cost producer (France) within the
European Union territory. However, if Chile can produce apples with a lower
price ($0.85 per kilogramme) compared to France and Germany, then „trade
diversion‰ will happen. Since Chile is not a member of the European Union,
apples from Chile will be imposed import tax by Germany resulting in apples
from Chile to be expensive ($0.85 + $0.25 = $1.10).
Tariff abolition on apples from France will make it cheaper compared to the
apples from Chile. This shows a trade diversion from a low cost producer (apple
farmer from Chile) out of the European Union to a high cost producer (apple
farmer from France) in the European Union. In sum, trade diversion occurs when
cheaper imports of member countries from lower cost countries outside the
formation are replaced by less efficient and higher cost member countries. While
trade creation contributes positively to welfare in the home country, trade
diversion results in a welfare loss (Tangermann, 2002).
88 ! TOPIC 5 REGIONAL ECONOMIC INTEGRATION
EXERCISE 5.2
1. List the reasons that support the formation of regional economic
integration.
(a) Form a basis for a tighter union among European economies; and
(b) Form a common market among the members through abolishment of trade
obstacles.
ACTIVITY 5.4
(a) From the British perspective, what are the strengths and
weaknesses of the euro?
You can discuss the questions above with your friends on myVLE.
ACTIVITY 5.5
Explain the difference between a free trade area and an economic union.
What are the key success factors to the EU as an integration model?
(a) Abolish 99 percent of tariff on trading between the US, Canada and Mexico
in 10 years.
(b) Abolishment of a big part of obstacles on free trade and services in 2000.
ACTIVITY 5.6
During the mid-1980s, the Andean Pact remained a failure. However, things
began to change by the end of the 1980s when the American Latin government
began to accept an open market policy. In 1990, leaders of the five countries had a
meeting and formed the Galapagos Declaration. The Andean Pact countries
agreed to proceed with the Andean Pact initiatives to form free trade areas in
stages by 1992, a customs union by 1994 and a common market by 1995.
Today, the Andean Community integration has strengthened and extended from
purely economic and commercial matters to a wide variety of sectors, such as
social cohesion, job creation, fight against drugs and protection of the
environment (EEAS, n.d.).
5.6.3 Mercosur
In March 1991, Brazil, Paraguay, Argentina and Uruguay signed an agreement
known as the Mercusor Accord. This agreement was aimed at forming a common
market among the four countries with free movement of goods, services, capital
and labour. The common market was fully implemented in 1995 with a common
tariff structure and common external tariff rates. In 2006, Venezuela was accepted
and is in the process of being integrated as a member. In 2009, EU-Mercosur
trade represented nearly as much as EU trade with the rest of Latin America
taken together. In 2008, the EU was Mercosur's first largest trading partner
(EEAS, n.d.).
ACTIVITY 5.7
More recent development saw the formation of the China-Asean Free Trade Area
(ACFTA) in 2010. ACFTA is expected to create an economic region with
1.7 billion consumers, a regional Gross Domestic Product (GDP) of about US$2
trillion and total trade estimated at US$1.23 trillion. This makes it the biggest
FTA in the world in terms of population size (Cordenillo, 2005).
ACTIVITY 5.8
EXERCISE 5.3
1. Agreement between countries in the same geographical area in
order to lessen tariff and non-tariff barriers on trade flow, services
and production factor is known as:
A. regional economic integration
B. cross-cultural economy
C. geography and trade integration
D. less tariff and non-tariff integration
TOPIC 5 REGIONAL ECONOMIC INTEGRATION " 95
B. custom union
C. common market
D. economic union
A. Trade diversion
B. Trade creation
C. Trade modification
D. Trade separation
96 ! TOPIC 5 REGIONAL ECONOMIC INTEGRATION
" Economic integration also has disadvantages such as trade diversion, loss of
sovereignty and flexibility over control of economy and policies.
LEARNING OUTCOMES
By the end of this topic, you should be able to:
1. Identify six main theories of international trade;
2. Explain the benefits of free trade;
3. Apply the various international trade theories to explain world
trade patterns;
4. Differentiate between four foreign direct investment (FDI) theories.
! INTRODUCTION
Welcome to a new topic titled International Trade Theories. In this topic, we will
discuss various international trade theories which have existed since the 19th
century. These theories include Mercantilism Theory, Absolute Advantage
Theory, Comparative Advantage Theory, Heckscher-Ohlin Theory, International
Product Life-Cycle Theory and Competitive Advantage Nations Theory. Then,
the challenges and application of these theories are discussed.
We will also look at free trade briefly to determine its relationship with
international trade theories.
In other words, free trade is hindered when governments impose trade barriers
through tariff, quota, subsidy and other commercial trade instruments, and this
will cause free trade to be restricted. Smith said a governmentÊs trade should not
affect the world commerce trend but it should be determined by market control.
We will also look at other theories such as the Comparative Advantage Theory
by David Ricardo, Heckscher-Ohlin Theory, International Product Life-Cycle
Theory and other international investment theories.
6.2.1 Mercantilism
Mercantilism was the first international commerce theory formulated in England
in the middle of the 16th century. At that time, silver and gold were the source
of wealth for each country and played a major role in international trade
transactions. They were the main currencies used in trading and businesses
among the countries. A country would receive inflow of gold and silver by
exporting their products to other countries, while outflow of gold and silver was
100 ! TOPIC 6 INTERNATIONAL TRADE THEORIES
To gain wealth, the government would be involved in trade to get trade surplus
in the balance of payment account. For this reason, mercantilism theorists
suggest that the application of trade is aimed at maximising export trade
activities and minimising import activities. The import activities could be
decreased by trade restrictions such as tariff and quota, while export activities are
encouraged through subsidies given to the domestic companies. Subsidies would
make the products of the domestic companies more competitive in the foreign
market and hence, increase their export activities. The use of import duty or tax
would make the imported products more expensive and less competitive in the
local market. The high price of the imported products would then lead to a fall in
the demand for imports, resulting in the low volume of imported products.
In 1752, David Hume (Figure 6.2), a classical economist, said that the
mercantilism doctrine was not consistent in explaining the real situation of a
countryÊs balance of payment. For example, if England had trade surplus with
France, this meant the products exported were more than the imported products
and the inflow of gold and silver into England would result in an increase of
money supply in the market. This in turn would cause inflation in England.
Then, France would have insufficient gold and silver because of their import
activities and the price of the products in France would decrease. The price of
exports of England would increase and it becomes less competitive. France
would not import any products from England. In contrast, England would
import products from France because of the low price. As a result, the trade
balance in England would decrease while in France, it would increase. In the
long run, none of the countries would gain from the trade surplus.
However, there are weaknesses in this theory. The main weakness of the
mercantilism view is that trade benefits the country which has trade surplus in
the balance of payment account. The exporter will gain more profit while the
importer will incur losses. The zero sum game situations occur with trade when
one country gains while the other loses.
On the other hand, other trade theories by Adam Smith and David Ricardo have
proven that trade is beneficial and both countries can benefit from exchange of
goods.
SELF-CHECK 6.1
SmithÊs theory was based on the view that each country aims to maximise the
wealth of the people. The mercantilism doctrine is inefficient as it reduces the
wealth of the country as a whole. It is most likely that only certain groups of
people will benefit from it. From SmithÊs observation, mercantilism will prevent
individuals from engaging in free trade. The nation will experience wastage of
resources due to inefficient production.
Smith then suggested that free trade will benefit countries. Free trade would
determine the level of products or services that should be imported or exported
by a country. He propounded the absolute advantage theory. This theory states
that a country should export the products that it is able to produce efficiently
(absolute advantage) and import the products from other countries in which they
can produce more efficiently in their own country. In other words, the country
should specialise in producing products productively and efficiently before
exporting them to other countries. On the other hand, that country would import
products that they cannot produce productively and efficiently. By specialising
and trading, the countries will increase total world output.
If both countries do not trade with each other, each country is assumed to use
half of its resources to produce cocoa and another half to produce rice. Each
country is expected to use all products that have been produced. In this situation,
Ghana will produce 10 tonnes of cocoa and five tonnes of rice, while Malaysia
will produce 10 tonnes of rice and 2.5 tonnes of cocoa. Without trade, the total
amount of cocoa produced by both countries is 12.5 tonnes and 15 tonnes of rice.
If both countries choose to specialise production in accordance to the absolute
advantage theory and trade, this scenario will change. Through specialisation,
Ghana will produce 20 tonnes of cocoa and Malaysia will produce 20 tonnes of
rice. By specialising, the total output for both countries will be 20 tonnes,
increasing from 12.5 tonnes without specialisation. The production of rice will
increase from 15 tonnes to 20 tonnes. Basically, with specialisation in production
based on natural advantage and trade between the two countries, both countries
will gain from an increase of output by 7.5 tonnes of cocoa and five tonnes of rice.
104 ! TOPIC 6 INTERNATIONAL TRADE THEORIES
Both countries benefited from the trading. Assume that both countries agree to
trade on the range of 1:1 (one tonne of rice with one tonne of cocoa). If Ghana
exports six tonnes of cocoa to Malaysia and imports six tonnes of rice from
Malaysia, the amount of cocoa in Ghana will be 14 tonnes while the rice will
increase to six tonnes. Therefore, the total amount of cocoa will be four tonnes
more than the production if Ghana does not practise specialisation. Malaysia will
have 14 tonnes of rice and six tonnes of cocoa. As a result of specialisation and
trading, output will increase and both countries will benefit from a larger output.
In a nutshell, a positive sum game is achieved that will benefit and profit both
countries.
SELF-CHECK 6.2
3. How will the Absolute Advantage Theory help increase trade and
world output?
The theory states that a country will produce and export products or services that
it can produce more efficiently relative to other countries. Both countries would
gain even if one country were more efficient in producing all goods. The
difference between the two theories lies in the concept that the Absolute
Advantage Theory is based on absolute productivity difference while the
Comparative Advantage Theory focuses on the relative productivity difference
between countries. This distinction occurs because Comparative Advantage
Theory uses the opportunity cost concept to identify which products a country
should specialise in.
Again, using the example of Ghana and Malaysia, assume that Ghana has
absolute advantage in producing both products, cocoa and rice, and needs
10 resources to produce one tonne of cocoa and 13.3 resources to produce one
tonne of rice. With 200 resources, Ghana can produce 20 tonnes cocoa without
producing any rice and 15 tonnes rice without producing cocoa or any
combination between the two products according to resource distribution.
Malaysia needs 40 resources to produce one tonne of cocoa and 20 resources to
produce one tonne of rice. Malaysia can produce five tonnes of cocoa without
producing rice, 10 tonnes of rice without producing cocoa or any combination
according to resource distribution. Without trade, each country will use half of its
resources to produce rice and another half to produce cocoa. As a result, Ghana
will produce 10 tonnes of cocoa and 7.5 tonnes of rice, while Malaysia will
produce 2.5 tonnes of cocoa and 5 tonnes of rice (refer to Table 6.2).
Based on the absolute advantage theory, Ghana does not have to trade with
Malaysia. In contrast, the Comparative Advantage Theory shows that that even if
Ghana has absolute advantage in producing both products, it has comparative or
relative advantage in producing cocoa only. Ghana can produce four times more
cocoa than Malaysia but only 1.5 times more rice compared to Malaysia. In
relative terms, Ghana is more efficient in producing cocoa compared to rice.
Without trade, the total amount of cocoa produced by both countries is
12.5 tonnes and the total amount of rice is 12.5 tonnes. The countries are assumed
to use both products they produce. If they trade, both countries will increase the
production of both products and consumers will have more of the products.
106 ! TOPIC 6 INTERNATIONAL TRADE THEORIES
Comparative Advantage Theory shows that the world production potential will
increase if there is no trade barrier. RicardoÊs theory suggests that consumers in
all countries will gain from more output if there is no trade barrier. This takes
place even if a country does not have absolute advantage in any production. The
Comparative Advantage Theory asserts that trade is a positive sum game in
which all countries will benefit from free trade. Therefore, this theory sets a
strong basis towards promoting policies for freer trade.
TOPIC 6 INTERNATIONAL TRADE THEORIES " 107
SELF-CHECK 6.3
What is the difference between Comparative Advantage Theory and
Absolute Advantage Theory?
Two Swedish economists, Eli Heckscher (in 1919) and Bertil Ohlin (in 1933)
explained different perspectives in a countryÊs comparative advantage. You can
see their pictures in Figure 6.5 and Figure 6.6.
will reduce input cost. The Heckscher-Ohlin Theory suggests that a country with
relatively abundant factor endowment will export products that use those
abundant factors and import products that use factor endowments in which the
country does not have in abundance. Unlike Ricardo, Heckscher-Ohlin explains
that the international trade pattern is determined by a countryÊs differences in
factor endowments and not differences in productivity.
ACTIVITY 6.1
Vernon describes the international trade pattern through the Product Life-Cycle
Theory. This theory is different from the earlier theories discussed as it focuses
on the product and not the firmÊs productivity or factor endowment. This theory
which was developed in the mid-1960s suggests that most new products are
initially produced by firms in the United States and other developed countries
and are sold there. Vernon comments that the wealth and market size of
developing countries provide big incentives to firms to develop and produce
new products. Moreover, expensive labour cost has caused firms in the United
States to develop innovation processes to reduce production cost.
The product life-cycle can be divided into three phases as simplified in Figure 6.8.
In this phase, the new product that has been produced is not yet a standard
product. The production process needs the use of skilled workers.
Therefore, the production cost is high. For example, the United States as the
innovating country has the status of monopoly over a new product and
enjoys a high profit margin arising from the monopoly power. In this first
stage, US producers have export monopoly over the new product and will
continue to sell and export with no concern for foreign competition.
110 ! TOPIC 6 INTERNATIONAL TRADE THEORIES
The location for the production of products will be shifted from the
innovating (United States) to other countries that have cheap labour. The
country that acts as the facilitator will enjoy the benefit of trade overflow.
Exports come to an end as the United States becomes an importer of this
no-longer-new product. The Theory of Product Life-Cycle explains clearly
how international trade and foreign direct investment is conducted by
multinational firms.
ACTIVITY 6.2
Porter emphasised that there are four main attributes of a country that can shape
a nationÊs competitive nature. The existence and non-existence of these attributes
will determine whether a country would have competitive advantage. These
attributes are further explained in Table 6.3.
Attribute Description
Factor Conditions Factors of production such as supply for skilled workers,
land, natural resources, capital and the infrastructure needed
to compete in an industry.
Demand Conditions The market conditions of demand towards products or
services that are produced.
Supporting and Related The existence or non-existence of the local industries and
Industries competitive supporting industries at an international level.
Firm Strategy, Local conditions that affect the shaping, structuring of
Structure and Rivalry strategy as well as rivalry.
112 ! TOPIC 6 INTERNATIONAL TRADE THEORIES
Did you know that the Eclectic Model is also known as the OLI paradigm? You
can see this as it is shown in Figure 6.14. All three factors (OLI) are important in
determining the extent and pattern of FDI.
ACTIVITY 6.3
EXERCISE 6.1
A. ethnocentrism
B. capitalism
C. mercantilism
D. natural advantage
A. Absolute Advantage
B. Comparative Advantage
C. Competitive Advantage
D. PorterÊs Diamond
B. economic needs
I. Adam Smith
J. David Ricardo
K. David Hume
L. Raymond Vernon
" Free trade can benefit countries because there is no government intervention
in international trade, whether through tariffs or non-tariffs that will affect
the trade flow.
" The main concept of mercantilism is that a country would incur trade surplus
in the balance of payment account because the trade surplus would result in
inflow of gold and silver, and the country would gain wealth and prestige.
" SmithÊs Theory of Absolute Advantage states that a country should specialise
in the production and export of goods in which it has acquired or natural
advantage.
" Location-specific advantages arise from assets which exist in certain locations
(countries) and usually these advantages are specific elements belonging to
that place.
! INTRODUCTION
Hello and welcome to Topic 7 titled Foreign Direct Investment (FDI). What will
you learn in this topic? We will first discuss the concept of foreign direct
investments (FDI) made by multinational companies (MNC). This will be
followed by a section on the pattern of FDI since the early 1980s to the late 20th
century.
122 ! TOPIC 7 FOREIGN DIRECT INVESTMENT (FDI)
A major part of this topic will focus on the major motives of MNCs in FDI. One of
the major motives is to gain the main resources of a particular country. For
example, Goodyear invested in Malaysia to control the supply of rubber that can
be found in abundance in Malaysia. The company also invested in other foreign
countries to expand its market, which can supplement its small domestic market.
Other motives include low production cost, gaining major sales and market share
to supplement the high cost of research and development, and the short product
life cycle as a result of technological advancement.
The positive and negative aspects of the impact of FDI will also be discussed.
Then, types of foreign direct investments, vertical investment and horizontal
investment, and reasons why MNCs opt for either type of investment are also
discussed.
Lastly, before we end this topic, we will look at International Product Life-Cycle
Theory to better understand FDI activities. Are you ready? Let us start the
journey of FDI!
(a) Outward FDI is outflow of FDI out of a home country where firms
undertake FDI in foreign countries.
ACTIVITY 7.1
Figure 7.1: Top priority host economies for FDI for 2010 to 2012 period
Source: World Prospectus Survey 2010–2012 by United Nations Conference on Trade and
Development (UNCTAD)
ACTIVITY 7.2
2. Can you think of the main reasons why firms undertake foreign
direct investments?
TOPIC 7 FOREIGN DIRECT INVESTMENT (FDI) " 125
Figure 7.2 shows the four major motives of foreign direct investment.
Other new motives for FDI include the rapid advancement in technology which
has forced companies to develop and sell their products faster. New technologies
tend to shorten the life cycle of products in the market. This has also caused
companies to search for new buyers in other countries for their products. In
addition, the increase in research and development costs has compelled these
companies to seek FDI in foreign countries as the main alternative to market their
products.
Host countries who are recipients of foreign direct investment tend to benefit
substantially from FDI. Can you think of what the benefits are?
!
TOPIC 7 FOREIGN DIRECT INVESTMENT (FDI) " 127
(a) FDI brings about creation of new jobs and employment in the host country.
Foreign subsidiaries employ local workers in their domestic operations.
Employment is not only created in the FDI industry by MNCs but also in
upstream and downstream businesses that provide goods and services to
the FDI industry (Sun, 2002). Hence, more employment is created in FDI-
related industries. As FDI-related industries expand, the demand for local
workers also increases and this leads to higher wages.
(b) The host country benefits from transfer of technology. Foreign MNCs with
technology advantage via their FDI result in a positive effect in the form of
technology spillover to domestic firms. The domestic firms are thereby able
to improve their level of technology and become more productive. Such
technology spillovers provide the strongest potential for FDI to enhance
economic growth of the host country (Johnson, 2005).
(c) FDI affects the economic development of the host country. FDI can
contribute to host country development in many ways which enhances the
host countryÊs economic growth and improvement in standard of living of
its people. MNCs via FDI bring in new products, improved quality and
lower prices to consumers in the host country. New resources provided
through FDI such as technology, capital and human resources and
management techniques help raise domestic output (Moran, 2003). All
these benefits add to the competitive advantage of the host country in the
international business arena.
In sum, FDI enhances economic growth in the host country especially among the
developing countries who are the main recipients of FDI from MNCs.
On the other hand, FDI can have a negative impact on a host country. The
possible negative impacts are:
(a) FDI exposes host countries and leads them and their resources to
exploitation by the foreign company. In some situations, host governments
fear the FDI can lead to loss of sovereignty and control over domestic
policies. The risks of overdependency on FDI remain an issue of debate
among many developing economies. They have tried to restrict and resist
FDI because of national sentiments over foreign economic and political
influence (Economy Watch, 2010).
128 ! TOPIC 7 FOREIGN DIRECT INVESTMENT (FDI)
(b) There is a risk of FDI firms leaving the host country when other emerging
countries become more attractive with location advantages. Hence, host
governments fear outflow of FDI can adversely affect the net capital
outflow and unemployment. This happens when MNCs close their
domestic operations when other host governments offer attractive FDI
incentives. Or when during economic recession, when demand declines,
MNCs withdraw FDI from a host country.
SELF-CHECK 7.1
(a) Toyota, a Japanese car maker, has factories in the United States.
(b) Renault has purchase and controlling interest in Nissan, a Japanese car
maker.
TOPIC 7 FOREIGN DIRECT INVESTMENT (FDI) " 129
Note that vertical foreign direct investment is divided into two categories:
Backward FDI happens when a MNC enters an industry to produce inputs to the
production process of the companyÊs products.
Examples of companies that undertake backward vertical FDI are Royal Dutch
Shell, British Petroleum and Alcoa that build or acquire oil refineries to secure
the supply of petroleum. A car manufacturer that acquires a foreign steel or tyre
supplier is another example of backward vertical FDI to ensure supply or lower
cost of raw materials.
Forward vertical FDI occurs when investment is made towards the source of
distribution of a firmÊs output. An MNC decides to buy or build its own
distribution network to secure distributors or sell its finished products.
130 ! TOPIC 7 FOREIGN DIRECT INVESTMENT (FDI)
You can refer to Figure 7.3 which illustrates the types of FDI.
(a) Horizontal FDI is more common than vertical FDI while backward FDI is
more common than forward FDI. According to the economic theory, a
company can control resources such as minerals in foreign countries and it
helps to block other companies from entering the industry. For example, in
the 1930s, Alcoa and Alcan Aluminium Ltd in North America monopolised
a huge bauxite mine in the Caribbean Island of Trinidad. At that time, the
bauxite mine was the only mine that had aluminium material to be
processed and both companies made huge profits because they blocked
their rivals from entering the industry.
(b) Another reason for forward vertical FDI is the difficulty of finding
distributors for a market. This situation influenced Volkswagen to build up
its car selling network while entering the US market. The company thought
the quickest way to enter the US market would be by acquiring a large
number of car dealers.
TOPIC 7 FOREIGN DIRECT INVESTMENT (FDI) " 131
There are also other factors that lead to vertical and horizontal FDI. They are:
SELF-CHECK 7.2
!
132 ! TOPIC 7 FOREIGN DIRECT INVESTMENT (FDI)
Production goes through various stages. Let us look at Table 7.3 for these stages
with their examples.
Before we conclude this topic and move on to the next topic, let us do Exercise 7.1
to enhance our understanding of FDI.
TOPIC 7 FOREIGN DIRECT INVESTMENT (FDI) " 133
EXERCISE 7.1
" Foreign direct investment (FDI) occurs when an entity invests directly in
production or other physical facilities in a foreign country.
" The main motives behind FDI are resource-seeking, market-seeking and cost-
seeking.
" Host countries benefit from FDI in terms of increase in jobs and employment,
transfer of technology and human resource training for the local people as
well as enhancement of economic development. These benefits add to the
economic growth of the host economy.
" Some negative impacts of FDI include the fear that host governments might
lose sovereignty and control over domestic economic policies as well as risks
of overdependency on FDI such as exploitation of resources and adverse
effects when MNCs exit or withdraw FDI out of the country.
" MNCs can enter a foreign market via two forms of FDI: horizontal FDI and
vertical FDI.
" Horizontal FDI allows firms to expand to multiple markets similar to its
operation in the home country. This is often regarded as a safe and fast way
of entering a foreign market.
" Vertical FDI can either be backward towards the source of supply of
resources or forward vertical FDI towards the distribution network.
" The International Product Life-Cycle Theory explains why companies with a
new product become MNCs and engage in FDI via the product stages from
new to growth and standardisation stage and finally, mature stage. FDI is
shifted from the home country where product innovation originated to low-
wage countries where manufacturing plants are set up to gain cost advantage
and access to market their exports.
TOPIC 7 FOREIGN DIRECT INVESTMENT (FDI) " 135
! INTRODUCTION
Welcome to Topic 8 on international financial environment. We start off this
topic by defining the functions and conditions that influence foreign exchange
markets. This is followed by a discussion on the evolution of international
monetary systems such as the Gold Standard (1876–1914), Bretton Woods System
(1944–1971) to present day fixed and floating exchange rate regimes.
Lastly, we will look at the money markets such as the capital, bond and equity
markets. These are also the key components of the international financial system.
Therefore, it is important to understand their roles and functions in the world of
financial market. Are you ready? Let us start the topic.
TOPIC 8 INTERNATIONAL FINANCIAL ENVIRONMENT " 137
The exchange rate is simply the price of a currency. It measures the rate at
which one currency is converted into another currency.
Let us look at Table 8.1 which shows you the exchange rates of major currencies.
USD 1 0.7411 0.6208 100.216 0.9149 1.0447 1.0669 1.1992 7.7537 1.2464
EUR 1.34907 1 0.83723 135.197 1.23432 1.4094 1.4394 1.6179 10.4604 1.6813
GBP 1.61138 1.1944 1 161.4865 1.4743 1.6834 1.7193 1.9325 12.4945 2.0082
JPY 0.01 0.7395 0.0062 1 0.9129 1.0422 0.0107 0.012 0.0774 0.0124
CHF 1.093 0.8101 0.6783 109.538 1 1.1416 1.1662 1.3105 8.4745 1.362
CAD 0.9572 0.7095 0.5942 95.9275 0.8757 1 1.0219 1.148 7.4223 1.193
AUD 0.93715 0.6947 0.5816 93.923 0.8575 0.9791 1 1.124 7.267 1.1681
NZD 0.8337 0.618 0.5174 83.552 0.7628 0.871 0.8895 1 6.4645 1.039
HKD 0.129 0.0956 0.08 12.925 11.7995 0.1347 0.1376 0.1547 1 0.1607
SGD 0.8023 0.5947 0.498 80.415 0.734 0.8388 0.8563 0.9623 6.2216 1
Source: http://www.fxstreet.com/rates-charts/exchange-rates/
138 ! TOPIC 8 INTERNATIONAL FINANCIAL ENVIRONMENT
ACTIVITY 8.1
List the major currencies of other countries that are used to facilitate
trade in the world market.
Hedging facilities insure against potential losses arising from the transfer of
exchange risk to another party who is willing to carry the risk.
TOPIC 8 INTERNATIONAL FINANCIAL ENVIRONMENT " 139
Lastly, have you ever heard about arbitrage? Arbitrage is the simultaneous
purchase and sale of a currency is undertaken in different markets for a
profit.
SELF-CHECK 8.1
Features Description
Whole world is It is the largest financial market in the world. It is primarily an over-
its market the-counter market which means that transactions occur through
online exchanges and via electronic means (by phone or Internet) and
not on the trading floor of an exchange.
Leverage Leverage foreign exchange trading takes place at the market.
trading Leverage refers to trading on margin. In other words, in leverage
trading, a small amount of funds can be used to gain control of a
bigger amount. The funds are the source of credit for speculative
activity in the foreign exchange market with the risk of making
profits or losses.
Large trading The whole world is its market. Large sums of money are traded daily
volume on the currency market. Global foreign exchange market turnover
totalled US$4 trillion in 2010 (taken from www.goforex.net).
The American dollar is the most traded currency, followed by Yen
and the Euro.
Trading opens Currencies in the foreign exchange market are traded 24 hours a day,
24 hours a day five days a week in most financial markets.
!
140 ! TOPIC 8 INTERNATIONAL FINANCIAL ENVIRONMENT
These four features of foreign exchange market are simplified in Figure 8.1.
Let us look at an example. The price of Malaysian Ringgit (MYR) against the US
dollar ($) is quoted as MYR3.2000/$.
Foreign exchange rates follow specific quoting conventions. Since most of the
foreign exchange rate transactions are done in US dollars, the exchange rate
quotes are in US Dollar prices. There are several pairs of quotations used in
foreign exchange businesses, two of which are as follows:
Forward rate is the exchange rate for a transaction that requires delivery of
a foreign exchange at a specified future date.
For example, the MYR is quoted against U.S$, a single spot rate and two
different forward rates are:
ACTIVITY 8.2
What are the exchange rates for Malaysian Ringgit to other foreign
currencies such as the US dollar, Singapore dollar and Indonesian
rupiah?
Now, let us look at further descriptions of these four major market players.
(a) Central banks – The role of a central bank in the foreign exchange market is
not over the profitability of currency trading but to support the value of
their own currencies. It ensures adequate trading conditions and intervenes
in economic or financial imbalance in the foreign exchange market. In
Malaysia, we have Bank Negara that act as Malaysia's central bank.
(b) Banks – Commercial and investment banks are natural players in foreign
exchange. All other foreign exchange trading players must deal with them.
Major banks also known as market makers invest in currencies for a return
or keep currencies as their inventories. As market makers, they can
influence exchange rate quotations. As for medium-sized banks, they
participate in currency markets to facilitate international trade on behalf of
their customers. Some examples include Bank Islam, Bank Rakyat and
Maybank.
As stated before, political stability plays an important role as one of the major
factors influencing foreign exchange market volatility. Any political disruption in
one country may affect the neighbouring countriesÊ currency exchange rates. For
example, political crisis such as civil war can cause loss of confidence in a
currency and it may subsequently fall in currency value.
(a) The Asian financial crisis of 1997–98 found changes in the Thai baht
exchange rate which had an impact on prices, trading activities and fund
liquidity. This in turn triggered contagious effects and caused volatility of
exchange rates of Asian and even in Western countries.
(b) The recent global financial meltdown of 2008–2009 and current European
Debt Crisis too had tremendous impact on exchange rates of almost all
countries in the world.
Lastly, let us look at market psychology. Market psychology factors influence the
foreign exchange market in a variety of ways. Any destabilising international
events or crisis can change market expectations and perceptions including trader
and investor perceptions. This can lead to flight-to-quality and investors seeking
safe options. As a result there will be greater demand, hence a higher price, for
perceived currencies.
144 ! TOPIC 8 INTERNATIONAL FINANCIAL ENVIRONMENT
In sum, many situational factors can cause currency movements. For instance, the
US budget deficits, Japanese recession, the rise of China as the new super
economic powerhouse and the debt crisis in Greece have an effect on the price of
currencies. Everyone can feel the impact of currency price movements directly or
indirectly. Do you agree with that?
SELF-CHECK 8.2
Please visit these websites for additional information on the Asian Financial
Crisis:
(a) www.ifg.org/imf_asia.html
(b) www.imf.org/external/np/exr/facts/asia.HTM
This system comprises currencies from individual countries and exchange rate
systems adopted by countries. The foreign exchange rate market forms the
primary institution for determining exchange rates based on the demand and
supply of any two currencies. There are three monetary systems that determine
exchange rates:
(a) Fixed exchange rate system in which the government of a country regulates
the rate at which a local currency is exchanged for other currencies.
(c) Floating or flexible exchange rate system in which the government does not
interfere in the valuation of its currency.
Next, we are going to look at a brief review of the evolution and history of the
international monetary system. This can give you a better understanding of the
present monetary system.
The government of each country agrees to buy or sell gold on demand at its own
fixed parity rate. Under this system, it is necessary for governments to maintain
sufficient supply of gold reserves to back up its currencyÊs value. The gold
standard operated until the outbreak of WW1 when movement of trade and gold
were restricted and it was then suspended.
146 ! TOPIC 8 INTERNATIONAL FINANCIAL ENVIRONMENT
Figure 8.3: Global trade and the currency market: The big picture matters
Source: www.fxstreet.com
ACTIVITY 8.3
Can you find out the primary roles of the IMF and World Bank?
148 ! TOPIC 8 INTERNATIONAL FINANCIAL ENVIRONMENT
Under the flexible exchange rate system, governments can intervene directly and
take part in the currency market by buying and selling their own currency using
their reserves to stabilise their exchange rate. Capital inflows can be increased by
raising interest rates. However under such a system, exchange rates have become
more volatile and less predictable than the fixed exchange rate system. Floating
exchange rates can increase exposure to speculative activities that may result in
currency devaluation.
The 1985 Plaza Accord, an agreement among G-5 countries (United States,
France, Germany, Japan, and the United Kingdom), was set up to work together
to deliberately weaken the US dollar's exchange rate. The objective of this
strategy was to help the United States improve its huge trade deficit (especially
against Japan) and to spur its economy to climb out of the 1980sÊ long recession.
The Louvre Accord of February 1987 was agreed by the G-6 nations (West
Germany, France, Great Britain, Japan, Canada and the United States) to stop the
United StatesÊ dollar depreciation.
Under the revived Bretton Woods II system which started in 2003 and lasted
until 2007, the new international system involves interdependency between
states with generally high savings in Asia (lending and exporting) to Western
states with generally high spending. This system was in response to the 1997
Asian financial crisis.
TOPIC 8 INTERNATIONAL FINANCIAL ENVIRONMENT " 149
Although most major currencies float in value against one another, some of the
developing countries pegged (fixed) their exchange rates to one of the major
currencies or to a basket of currencies. For example, the European UnionÊs Euro
under the European Monetary System (EMS) is pegged to a basket of chosen
currency mix and the Chinese currency (yuan) has been pegged to the US dollar
for a decade. Hence, todayÊs global economy is increasingly dominated by
currency blocs especially by the US dollar, EUÊs Euro and the Japanese Yen.
Have you ever heard of the European Monetary System (EMS)? Launched in
1979, it was the forerunner of the Economic and Monetary Union (EMU) which
led to the establishment of the Euro. It created an area of currency stability
throughout the European community by encouraging countries to co-ordinate
their monetary policies. It used an Exchange Rate Mechanism (ERM) to create
stable exchange rates in order to improve trade between EU member states and
thus help the development of the single market. The Euro was introduced in
practice in 2001 (Civitas, 2011).
For example, Sony and Hitachi borrowed US dollars from several banks in Tokyo
to finance their worldwide operations. Capital markets provide long-term debt
and equity finance for the government and corporate sector. Multinational
companies (MNCs) occasionally source foreign capital from international money
markets to finance global operations at a lower cost than is possible domestically.
For example, in London, the Euro currency market is a market for bank deposits
and loans denominated in dollars, yen, franc, marks and any other currency
except British pounds. The main instruments used in this market are certificate of
deposits (CDs), time deposits and bank loans.
International bond markets are a place where company stocks are listed and
traded on foreign stock exchanges.
For example, some recent issuers of bonds are Google and Apple. Tencent
Holdings, China's largest Internet company by revenue, became the first Asian
borrower from the sector to issue global bonds. Can you define bonds?
The approximate worth of bond markets worldwide is more than $45,000 billion,
of which the US bond market, comprises a significant portion of the total value
(finance.mapsofworld.com). The Euro bond market is a long-term market for
bonds denominated in any currency outside the country in whose currency the
bond is denominated. A foreign bond is sold outside a borrowerÊs country and
denominated in the currency of the country in which it is sold.
For example, Google of the United States issued stocks on the New York Stock
Exchange. These markets provide financing for global operations but can also
improve organisational recognition and portfolio performance. MNCs that are in
need of financing use foreign stock markets as their additional sources of funds.
The Euro equity market issues US dollar-denominated stocks on non-US
exchanges for distribution among foreign markets. The stocks are underwritten by
investment banks and purchased by institutional investors in several countries.
SELF-CHECK 8.3
The average world inflation rate grew to 5.5% in 2008, the highest since
1999. How does rising inflation affect exchange rate and international
business?
ACTIVITY 8.4
Before we conclude this topic, let us complete the following exercise. Good luck!
EXERCISE 8.1
A. swapping
B. crawling
C. profit
D. arbitrage
5. Between two major currencies, the spot exchange rate is the rate
__________ and the forward exchange rate is the rate ___________.
B. Japan
C. Europe
B. Jamaican Agreement
" The foreign exchange market is a market to convert the currency of one
country to another country.
" Exchange rate is the rate at which one currency can be converted into other
currencies.
" The three main functions of foreign exchange markets are: currency
conversion, provision of credit for foreign trade and insurance for foreign
exchange risk.
" Political conditions, economic factors and market psychology are factors that
can influence the foreign exchange market.
" There are five international monetary systems that determine exchange rates.
They are the gold standard, interwar years, Bretton Woods System, floating
exchange rate system and contemporary exchange rate system.
" There are three international money markets that borrow and invest
internationally in money market instruments – international capital market,
international bond market and international equity market.
! INTRODUCTION
In this era of globalisation, we can feel how small the world can be. You can
travel easily to another country for a lot of reasons. Sometimes the reason can be
about business. But how do we make business with another country? This topic
will give the answers to such questions as we are going to learn about country
selection and entry strategies.
Companies are faced with several important decisions when entering a foreign
market. One major decision that companies should consider during international
expansion is the entry strategies. International entry strategies concern two major
decisions:
This topic deals with how foreign companies allocate their scarce resources
among different countries when selecting where they might operate. The focus is
on major variables to consider when evaluating and comparing countries based
on opportunities and risk factors. This is followed by a discussion on how to
collect and analyse data. After that, you will learn how to use two comparison
tools on selecting potential countries to enter. Lastly, three modes of entry
strategies will be explained so that you know how companies decide which entry
mode to use for specific markets. Let us begin our lesson!
Did you know that the factors to consider in the selection of production and
marketing locations are usually interdependent? Production sites are often
located close to the market when transportation costs are high or when host
government regulations require local production. For example, in service
industries, they need to be close to their customers.
The process of determining the overall location strategy must be flexible due to
the ever-changing situation in certain countries. A good strategy must enable a
company to respond to new opportunities in alternative locations. Hence, a
company must take into account existing factors in the foreign environment, such
as future cost, price, rivalsÊ reaction and technology.
Figure 9.1 demonstrates what managers should consider when making decisions
on market and production location.
158 ! TOPIC 9 COUNTRY SELECTION AND ENTRY STRATEGIES
SELF-CHECK 9.1
There are four factors that need to be considered when assessing opportunities:
(d) Bureaucracy.
160 ! TOPIC 9 COUNTRY SELECTION AND ENTRY STRATEGIES
Figure 9.2 simplifies these opportunities in a diagram. Note that these factors also
affect both the market location and production decisions.
(d) Bureaucracy
Companies usually compare the level of bureaucracy that is needed to
operate in certain countries as this can increase their operating costs.
Bureaucracy includes the administrative work in getting a licence to
operate, produce and sell certain products, bringing in expatriates and
abiding by host government policies such as taxes, labour laws, working
conditions and environmental rules.
ACTIVITY 9.1
If the expected return is the same, most decision makers prefer a certain
gain than an uncertain one. In order to estimate the ROI, a company will
count the different average return for an investment. Table 9.1 shows you
two same lines of ROI but they have clear differences in terms of
achievement and possibilities. In Table 9.1, at the 10 percent level of
certainty, the ROI lines are higher for investment B compared to investment
A (40% to 30%). Next, the 10% of customersÊ possibilities are also higher for
B (.40 +.30 = .70 or 70%) compared to A (.30 +.20 = .65 or 65%). Experience
shows that most (not all) investors will prefer alternative B as compared to
alternative A. Moreover, when doubt increases, investors will need a higher
estimation of ROI.
Investment A Investment B
Weighted Weighted
ROI as Percentage Possibilities Possibilities
Value Value
0 0.15 0 0 0
5 0.20 1.0 0.30 1.5
10 0.30 3.0 0.40 4.0
15 0.20 3.0 0.30 4.5
20 0.15 3.0 0 0.0
Estimation of ROI 10.0% 10.0%
ACTIVITY 9.2
If two projects have a similar ROI (7%), does that mean that both
projects have an equal risk and opportunity to be successful?
Companies can also form a strategy by searching for countries which do not
have any apparent competition. For example, you might be familiar with
Kao. Kao is a manufacturer of goods for household cleaners and bath
toiletries. The company has already focused its international expansion in
South East Asia because its market is expanding and also lack of
competition from America and Europe.
However, there are also cases where a company can benefit if it operates in
places where there are competitors. Companies that operate in a cluster
location can gain better information about the latest development and
technologies.
„L
Liquidity preference‰ is a theory whereby investors usually require part
of their investment in liquid asset.
If the fund is not convertible, the seller has to spend the fund in the host
country. Another concern that worries most of the foreign investors is the
ability and cost to convert overseas operation profits. Investors are more
willing to receive a lower ROI in a country that has a stable currency as
compared to those with unstable exchange rates.
There are two variables that affect the financial risk of operating in a foreign
country: capital control and exchange rate stability. Changes in exchange
rates may decrease investment liquidity and increase financial risk. A
countryÊs balance of trade, savings, interest rates, inflation and government
budget are other useful indicators to predict the financial situation of a
particular country.
There are three methods that a manager can use to predict a countryÊs
political risks. These are:
(iii) Inspection of social and economic situation which may lead to such
risks.
TOPIC 9 COUNTRY SELECTION AND ENTRY STRATEGIES " 167
SELF-CHECK 9.2
1. What are the types of risks that may directly affect business
investment in a foreign environment?
(c) Service firms that provide services to international clients such as banks,
accounting firms, rating agencies publish reports on subjects such as
taxation and legislation;
(f) Trade associations that publish trade journals that provide industry
information related to product lines with technical and competitive factors;
(g) Information service companies that manage and sell online databases from
multiple sources. Companies can obtain such computerised data from
library sources; and
(h) The Internet which provides a host of current information via World Wide
Web. However care must be taken to ensure reliability of information.
TOPIC 9 COUNTRY SELECTION AND ENTRY STRATEGIES " 169
EXERCISE 9.1
9.5.1 Grids
A firm can use grids to make comparisons between countries based on factors
that they deem important. Values and weights are assigned to each country-
related variable in order to rank each country according to factors identified as
important. Table 9.2 shows you how grid analysis is done based on information
which is divided into three categories: equity, income and risk.
170 ! TOPIC 9 COUNTRY SELECTION AND ENTRY STRATEGIES
Table 9.2: Simple Grid for Comparison of Countries for Penetration of Market
Country
Variables Leverage
I II III IV V
1. Accepted factor (A), unaccepted (U)
1.0 Allow 100% equity hold – U A A A A
2.0 Allow licensing to subsidiaries – A A A A A
which are owned by majority
2. Income (higher score = higher
choice)
1.0 Size of investment needed 0–5 – 4 3 3 3
2.0 Direct cost 0–3 – 3 1 2 2
3.0 Tax rate 0–2 – 2 1 2 2
4.0 Market size, current 0–4 – 3 2 4 1
5.0 Market size, 3–10 coming years 0–3 – 2 1 3 1
6.0 Market share, in a short time, 0–2 – 2 1 2 1
0–2 years
7.0 Market share, 3–10 future years 0–2 – 2 1 2 0
Total 18 10 18 10
3. Risk (lower score, higher choice)
(a) Loss of market, 3–10 coming 0–4 – 2 1 3 2
years
(b) Problem of foreign exchange 0–3 – 0 0 3 3
(c) Potential political problem 0–3 – 0 1 2 3
(d) Business law, current 0–4 – 1 0 4 3
(e) Business law, 3–10 coming 0–2 – 0 1 2 2
years
Total 3 3 14 13
Companies can ignore non-potential countries based on the first category (U).
They will determine the weight or value for each variable according to
importance. High income will be assigned a high score, while high risk will be
assigned a low score.
TOPIC 9 COUNTRY SELECTION AND ENTRY STRATEGIES " 171
In this example (Table 9.2), country II is seen as a country that has high income
and low risk (total of income = 18, total of risk = 3), country III has low income
and low risk (total of income = 10, total of risk = 3), country IV is a country that
has high income and high risk (total of income = 18, total of risk = 14) and
country V with low income and high risk (total of income = 10, total of risk = 13).
Both variables and weights differ between product and company, and it depends
on the companyÊs situation and objective. Grid technique is not only useful for
comparisons across countries, but it can also help to analyse if a company needs
to add further investment or deeper analysis into feasibility research after
fulfilling the minimal criteria of the company. However, grids tend to become
cumbersome and limited as the number of variables for comparison increases.
SELF-CHECK 9.3
What are the advantages and disadvantages of using the grid technique
to determine investment across countries?
9.5.2 Matrices
Now, let us look at the second instrument of comparison tools – matrices. In
general, there are two types of matrices that managers can use when comparing
countries. They are:
How are the scores determined using this matrix? First, the factors that are
considered as good indicators of companiesÊ risk and opportunity are
determined and then we weigh them to reflect their importance. For
example, in risk axis, a company can determine 40 percent (0.4) for takeover
risk, 25 percent (0.25) for foreign exchange control, 20 percent (0.2) for riot
and 15 percent (0.15) for exchange rate. The total is 100 percent. The
company will then assess every country based on a scale of 1 until 10 for
every variable (by giving 10 as the best and 1 as the worst) and multiply
every variable with weights that has been determined.
TOPIC 9 COUNTRY SELECTION AND ENTRY STRATEGIES " 173
For example, the company may give 8 marks to takeover risk for country A
and multiply 8 with 0.4 to get 3.2. The company will total up all of the risk
variablesÊ scores at the risk axis. The same method is used to determine the
position in the opportunity axis. When the scores for each country are
determined, the management can determine the average risk and
opportunity scores among the countries and divide the matrix into four
quadrants.
Based on Figure 9.6, we can see that a company should try to focus on its
activities in countries which are situated in the upper left corner of the
matrix and try to hold onto as many equities as possible. In this situation,
the level of attractiveness of a country and ability to compete are at the
highest level. At the upper right corner, the level of attractiveness is also
high but the ability to compete is weak, probably due to unsuitable
strategy. If the cost is not too high, the company can try to gain advantage
and alter its weakness. If not, it may have to liquidate its investment or try
174 ! TOPIC 9 COUNTRY SELECTION AND ENTRY STRATEGIES
SELF-CHECK 9.4
1. List two tools and their major components that can be used to
analyse and compare information on market location.
(c) Foreign direct investment-related entry modes via joint venture and
wholly-owned subsidiary.
TOPIC 9 COUNTRY SELECTION AND ENTRY STRATEGIES " 175
Figure 9.7 summarises these three types of entry modes and their components.
EXPORTING
Advantages Disadvantages
" Suitable for small firms to sell surplus " Firm is subject to government
production abroad. regulations on exports into a country in
" Low costs involved with low the form of trade barriers such as tariffs
commitment of financial and human and non-tariff barriers.
resources. " Firm is subject to high transportation
" Low risks. costs of bringing goods abroad making
it uneconomical.
" Does not require substantial presence
in foreign countries. " Problems associated with export agent
who carries many brands and types of
" Allows firms to expand new products and firm has no control over
knowledge and experience about marketing activities of export agent.
going overseas.
176 ! TOPIC 9 COUNTRY SELECTION AND ENTRY STRATEGIES
There are three broad options of exporting available to companies that plan to
enter a market. They are:
(b) Direct exporting occurs when a company sets up its own export
organisation and uses a foreign distributor based in a foreign market to
handle its exports.
ACTIVITY 9.3
The licensor does not have to start or build a new operation overseas as the local
licensee is allowed to produce, manufacture and market the licensorÊs product.
For example, Coca Cola Company has a trademark licensing agreement with
Fraser & Neave Holdings Berhad (F&N) Malaysia giving F&N rights to bottle
and distribute cola in Malaysia, Thailand and Brunei. How about the advantages
and disadvantages of licensing? Let us look at Table 9.4 to find out the answers.
!
178 ! TOPIC 9 COUNTRY SELECTION AND ENTRY STRATEGIES
LICENSING
Advantages Disadvantages
" Offers benefits to both parties involved. " The licensor bears the risk of creating
The licensee gets to enjoy products or a new competitor once the licensing
technology that involves development agreement expires as production
cost and high production. technology is already known and
" The licensor gains entry into the exposed to the foreign licensee. For
international market quickly with example, the case in 2008 between
minimal investment, effort or risk New Balance (NB) and HK Yangtian
especially entry into established (former authorised manufacturer of
markets that have been closed or NB) for imitating the package and
restricted by high tariffs. intentionally used the good reputation
of „NB‰ to mislead consumers and to
" The licensor can expand its limited promote its products after termination
capacity at home to overseas markets of use of trademark.
and develop market outlets for its
products via the licensee. " Cultural clashes between licensor and
licensee due to differences in language
" The licensor is able to prevent possible and political risks may affect and
infringement, imitation or loss of cause termination of licensing
patents or trademarks by granting agreement.
licensing rights.
" The licensor has little or no control
" Considered a globalisation strategy over the manufacture, quality and
that allows multinational companies to marketing of its goods in the foreign
grow and build their core business for country. For example in 2007, Mattel
example license agreements between which license its brands to toy
mass merchandisers and licensors for manufacturers in China had to recall
toys, games, and children's apparel Barbie dolls due high lead paint.
such as Barbie, Mickey Mouse, Harry
Potter and many others.
Franchising is widely used in the fast food and hotel/motel industries. The
franchising concept can be easily adapted to fulfil the needs of the local market
and produce high profits to the company. Can you think of any examples? Fast
food companies such as KFC, McDonaldÊs and Burger King use franchising to
widen their markets. In the hotel industry, Holiday Inn is among the
international franchise businesses which have been effective and successful.
FRANCHISING
Advantages Disadvantages
" Offers a fast and easy opportunity for " More difficult to execute at the
the franchisor to explore international international level as all franchisees use
markets with low cost and risk. the same name, image and product. The
" The franchisee gets to start a business franchisor must ensure uniformity and
using a product and operation system quality in the production process. There
that is already established in the might be conflicts and disagreements
international market. between the franchisor and franchisee
over control of operations and also due
" Involves longer commitments, offers to cultural clashes and differences in
greater control over foreign operations opinion.
and receives more rights and
resources. This may be the reason why " The franchisor bears the risk that the
service MNEs such as KFC and franchisee may damage the companyÊs
McDonalds prefer franchising. image if the franchisee fails to meet
quality standards.
" Franchisees often have access and
assistance from franchisors such as
production equipment, operating
procedures, advertising, management
systems and even financing funds.
180 ! TOPIC 9 COUNTRY SELECTION AND ENTRY STRATEGIES
ACTIVITY 9.4
Through this approach, the entry risk in the international market is low and is
suitable when there is lack of local skills to manage the project or when a host
government restricts other entry methods.
In return, the investor is guaranteed periodic payments for the project. The
turnkey investment is also called Build-Operate-Transfer (BOT) which is useful
especially for large scale and long-term infrastructure projects, usually for
government agencies such as building airports, highways and rail transportation.
The main advantage of the turnkey method is that the host government and local
companies gain the technology transfer as well as training and expertise from the
foreign investor that has agreed to complete and manage the entire project. BOT
allows the foreign investor to enter the market easily. The method involves low
risk as the foreign investor normally gets support from the host government to
complete the entire project. However, the main disadvantage of turnkey
operation is that the foreign investor can become a leading competitor in the
future after the BOT.
ACTIVITY 9.5
For example, ChinaÊs law requires a foreign venture partner to contribute at least
25% of capital to the EJV. While there is no upper limit on the foreign partnerÊs
contributions (maximum 99%), however, host governments may limit majority
ownership for foreign JV partners in restricted sectors. The main factor behind a
successful international joint ventures is by choosing a suitable partner.
What are the advantages and disadvantages of EJV? Let us look at the answers in
Table 9.6.
There are two strategies of setting up a new entity in the host country:
Before we come to the end, can you think of the advantages and disadvantages of
a wholly-owned subsidiary? Let us look at Table 9.7 to find out the answers.
ACTIVITY 9.6
As a conclusion, let us look at Table 9.8 which shows a comparison between the
foreign market entry modes.
Conditions Favouring
Mode Advantages Disadvantages
this Mode
Exporting " Limited sales " Minimises risk " Trade barriers and
potential in target and investment. tariffs add to costs.
country; little " Speed of entry. " Transport costs.
product
adaptation " Maximises scale; " Limits access to
required. uses existing local information.
facilities. " Company viewed
" Distribution
channels close to as an outsider.
plants.
" High target
country
production costs.
" Liberal import
policies.
" High political risk.
Licensing " Import and " Minimises risk " Lack of control
investment and investment. over use of assets.
barriers. " Speed of entry. " Licensee may
" Legal protection " Able to become
possible in target circumvent trade competitor.
environment. barriers. " Knowledge
" Low sales " High ROI. spillovers.
potential in target " License period is
country. limited.
" Large cultural
distance.
" Licensee lacks
ability to become a
competitor.
186 ! TOPIC 9 COUNTRY SELECTION AND ENTRY STRATEGIES
Source: http://www.quickmba.com
Before we move on to the next topic, let us do Exercise 9.2 to enhance our
knowledge about this topic.
TOPIC 9 COUNTRY SELECTION AND ENTRY STRATEGIES " 187
EXERCISE 9.2
2. Generally, which are the two types of matrix that are usually used
by managers when making comparisons between countries?
A. SWOT matrix and environmentÊs observation matrix
B. Subsidy matrix
C. Opportunity-risk matrix and countryÊs attractiveness-
companyÊs strength matrix
D. Industrial-non industrial company matrix and companyÊs
strength matrix
A. Automobile dealerships
B. Banking services
C. Food services
" There are two important decisions that should be made by a manager:
determine the best country/market to be selected to locate production site
and the mode of entry into the market.
" There are a few techniques that can be used to help the manager in making
country selection and evaluation decision. The techniques are the
environmental scanning technique, ranking technique, published data and
using professional expertise of consultants.
" The most important factors in country selection should take into account
initiatives that maximise the companyÊs profit and opportunities and
minimise cost and risks simultaneously.
" There are two tools used in determining a global location strategy: grids and
matrices.
" The two types of matrix used for country comparison are opportunity-risk
matrix and countryÊs attractiveness-companyÊs strength matrix.
" Opportunity-risk matrix studies the opportunity to invest and risk that will
be faced in a particular situation.
" If a firm has a low level of competition and high level of countryÊs
attractiveness, the domination of liquidation or collaboration can be
conducted.
" However, if the strength to compete is high and the countryÊs attractiveness is
also high, an investment strategy can be considered.
" There are three available entry modes to invest in a foreign country: trade-
related, transfer-related and foreign direct investment-related.
" FDI-related entry modes involve higher commitment and risks such as joint
ventures and wholly-owned subsidiaries.
! INTRODUCTION
Hello and welcome to the last topic of International Business. In this last topic,
we will discuss how to manage the global marketing environment as global
markets offer vast potential opportunities and threats for companies to market
their products or services abroad.
In the next section, we will talk about global products and brands in multiple
markets. This is followed by an explanation on how to promote the products and
brands globally. As the promotion has been set, how about the pricing? You will
find the answer on how to set the global pricing in the following section.
!
Can you think of what is the first thing a company should do before deciding to
operate internationally? Well, before deciding to operate internationally, a
company must understand the global marketing environment.
Did you know that adaptation has other names? Adaptation is also called
customisation or localisation. It involves firms in multidomestic industries who
make minor alterations of their product offerings or marketing programmes.
MNCs such as McDonaldÊs, Coca Cola and Pepsi do standardising where they
can, which means they need to engage in adaptation to meet local responsiveness
of each foreign market.
194 ! TOPIC 10 MANAGING THE GLOBAL MARKETING ENVIRONMENT
Standardisation Adaptation
Involves global integration and is suitable Involves local responsiveness and it is
among MNCs. suitable in multidomestic industries.
Undertaken when: Undertaken when there are:
" Similar market segments exist across " Niche or small market segments
countries " Customers who have national
" Customers have similar preferences preferences
" Products have universal specifications " Distinct laws and regulations
" Regional market agreements " Different cultural needs
" Gains from economies of scale " Different living standards
Country Modification
Saudi Arabia " Halal menus
" Separate floors: first floor conventional, second floor family section
" All Muslim employees
Hong Kong " Curry potato pie
" Sake fries
" Red bean sundae
Malaysia " Halal menus
" Porridge
" Fried chicken
India " Lamb burger
" Vegetarian burgers
" Veggie McNuggets
Japan " Teriyaki burger
There are three strategies available to marketers for adapting products to a global
market. Do you have any ideas what these are? They are explained in Table 10.3.
scale in which costs can be spread over large volumes of products. In addition, it
creates brand awareness and brand loyalty as global brands are more visible than
local brands. Global branding enhances the companyÊs competitive advantage in
the global market and enable charging of premium prices. Consumers prefer
products that are global brands as it provides a sense of status, quality and trust
in their purchase decision. Table 10.4 shows you top global brands by region.
How about you? Do you prefer global brands or local ones?
Source: www.interbrand.com/
TOPIC 10 MANAGING THE GLOBAL MARKETING ENVIRONMENT " 197
SELF-CHECK 10.1
(b) Company enjoys consistent brand image and identity thereby creating
brand awareness and a similar positioning theme worldwide.
(c) Serve and target global consumer segments that are similar across markets.
This enables an integrated and standardised approach. Thus, this creates a
global village that is culturally binding with similar taste, convergence in
advertising and media.
(a) Cultural differences which can persist for many product categories such as
language and religion.
(c) Level of market maturity differs across countries and may require
advertising to create brand awareness or educate consumers by giving
product information.
ACTIVITY 10.1
Pricing the product too low! –! Customers see the low price of the product as a
signal for low quality.!
As for pricing strategies, there are three pricing strategies that a company may
choose when establishing a price for a product in the global market. They are:
SELF-CHECK 10.2
Global distribution is defined as the design and management of a system that directs
and controls the flows of materials into, through and out of the firm across national
boundaries. It aims to achieve its corporate objectives at a minimum total cost. !
Materials management refers to the inflow of raw material, parts and supplies
through the firm.
Did you know that today many companies have adopted international sourcing?
These are the reasons for that:
ACTIVITY 10.2
Visit the IKEA website at www.ikea.com and find out how the
companyÊs competitive advantage is developed in its global logistics
and sourcing strategies.
As a potential market for global expansion, Asia is an attractive region for the
global retail industry expansion growing at a rate of 9% per year. The Asian retail
industry is worth $1 trillion USD (Farfan, 2012). Retailers have grown into some
of the worldÊs largest international businesses. The list showing the top 10
countries for global retail expansion in 2011 based on A.T. Kearney Global Retail
Development Index is summarised in Table 10.5:
TOPIC 10 MANAGING THE GLOBAL MARKETING ENVIRONMENT " 203
Rank Country
1 Brazil
2 Uruguay
3 Chile
4 India
5 Kuwait
6 China
7 Saudi Arabia
8 Peru
9 U.A.E.
10 Turkey
Table 10.6 lists the top five global retailers in 2011. Are you familiar with some of
the names?
!
Table 10.6: Top Five Global Retailers in 2011
Countries of Revenue
Rank World Country Format
Operation (USD billion)
1 Wal-Mart Stores USA Discount store 16 404
2 Carrefour France Hypermarket 36 122
3 Metro AG Germany Diversified 33 91
4 Tesco UK Supermarket/ 13 90.43
hypermarket
5 Schwarz Germany Hypermarket 25 77.22
Unternehmens
Treuhand KG
Source: http://ecobuildertoday.com
204 ! TOPIC 10 MANAGING THE GLOBAL MARKETING ENVIRONMENT
(a) Branding strategy with the use of private labels or store brands. These
brands appeal to price-conscious customers and are attractive to MNCs
facing strong local competition. The share of store brands is increasing
globally and is particularly attractive to MNCs competing with local
brands.
(b) Entry strategy using company resources to open a store on a green field site
(for example Carrefour Hypermarket in Malaysia) or chain acquisition of a
company with multiple existing outlets in a foreign country (for example,
Dairy Farm from Hong Kong acquired GiantÊs hypermarket chain) or joint
venture in markets that are culturally distant and difficult-to-enter (for
example, TescoÊs joint venture with Sime Darby).
ACTIVITY 10.3
Did you know that the top three trends in the world on retail marketing
are mobile marketing, mobile service and green products? Visit the
website www.deloitte.com to find out the global powers of retailing.
TOPIC 10 MANAGING THE GLOBAL MARKETING ENVIRONMENT " 205
Before we conclude this module, let us do some revision by doing this exercise.
All the best!
EXERCISE 10.1
" Before the new century, companies in the United States gave more attention
to the international trade.
" The environmental factors that influence global marketing are determined by
market size, market growth, cost of operation, level of competitiveness and
risks.
" The main concern faced by global marketers is the ability to determine the
need as well as the degree to adapt or standardise marketing strategies.
" When establishing a price for its products in the global market, companies
can opt for ethnocentric, polycentric or geocentric pricing policy.
Answers
TOPIC 1: INTRODUCTION TO INTERNATIONAL
BUSINESS
Activity 1.1
A few organisations that implement international business include:
" Malaysian MNCs: Petronas, Genting Group, Maybank, Axiata
" Foreign MNCs: Intel, IKEA, McDonalds, HSBC
Activity 1.2
Knowledge of international business can assist an individual involved in
business through the following:
" Providing information on the real-world perspective to meet the current
challenges in the global business arena;
" Gaining learning benefits from the participants involved in international
business;
" Enhancing careers and enabling effective interaction between managers and
subsidiaries; and
" Learning and understanding the cultures of other countries.
Self-Check 1.1
Four differences between international business and domestic business:
(a) Use of currency;
(b) Legal systems;
(c) Economic and political systems; and
(d) Cultural differences.
Activity 1.3
Examples of organisations in Malaysia that implement:
Activity 1.4
Policies of the Malaysian Government that could encourage and contribute
towards international business include:
Exercise 1.1
1. International business is cross-border commercial/business transactions
between individuals and businesses. Examples are Samsung, Toyota and
Subway Sandwich.
Activity 1.5
Examples of multinational organisations:
Activity 1.6
Examples of the changes or adaptations by companies that are made on foreign
products in order to suit our Malaysian culture:
" McDonalds adapted its menu to meet halal food standards and to suit
Malaysian taste and culture; and
" Coca-Cola adapted its advertising strategy using local language and local
theme to target the Malaysian youth market.
Exercise 1.2
The external influences in international business include:
" Legal influences: change in FDI policies, taxation, and international trade
rules and treaties.
Exercise 1.3
1. E
2. A
3. E
4. B
5. A
210 ! ANSWERS
Activity 2.2
A global company must understand the need to constantly adapt to changing
economic conditions to keep abreast of the latest economic developments as
businesses change with times or it can become extinct.
Self-Check 2.1
We use the gross national product to explain the economic growth of a country
because GNP measures the market value of output produced by residents of a
country. In addition, GNP per capita is used to measure economic growth of a
country as it reflects productive potential output that a country can produce.
Activity 2.3
The countries classified according to economic activities include:
Exercise 2.1
The features of these economies:
Exercise 2.2
1. Inflation affects FDI decision as FDI decision not to invest somewhere is
affected by rising cost of production and exports in the country due to
inflation in the host country. Inflation causes an increase in cost of
production and increase pressure on domestic prices. This will cause price
of exports to rise and make country exports less competitive.
Activity 2.4
The economic transition of economies such as China and Russia has transformed
these economies into big emerging markets:
" From command economy to open market economy driven by exports and
consumption; and
Activity 2.5
China used a step-by-step approach to carry out its economic transition by
started restructuring in rural areas and slowly introducing it to urban cities
Russia used shock therapy or rapid transition. Transition of eastern Germany
was quick and easily merged with a more stable western Germany.
The weaknesses of ChinaÊs and RussiaÊs economic transition are the relatively
weak regulatory systems and corruption.
Activity 2.6
Economics shocks especially financial crises have affected the socio-economic
and political changes in many countries. Financial crises have brought about a
slowdown of the world economy as many countries experience a fall in
consumption, investment and trade.
Exercise 2.3
1. A
2. B
3. A
4. D
5. E
Self-Check 3.1
The dominant religion in each of these countries:
Exercise 3.2
Social structure refers to a societyÊs basic social organisation. Social group
interaction can influence international business decisions as it is a cultural
element. It refers to how people of different cultures associate themselves and
interacts with one another, such as the structure of the family unit and role of
gender in society.
Activity 3.2
What the following colours symbolise in different countries:
Exercise 3.3
1. B
2. B
3. C
4. C
5. B
6. B
7. A
8. A
Activity 4.1
Malaysia is moving towards a more pragmatic nationalism approach where the
government views FDI as having both benefits and costs. Hence the Malaysian
government is open to FDI and implements policies that aggressively attract
foreign investments that aim to maximise benefits and minimise costs of FDI.
ANSWERS " 215
Activity 4.2
1. Three approaches of political ideologies influencing government policy
towards MNCs:
Activity 4.3
Major sources of political risks that can bring about ownership, transfer and
operation risks are:
Activity 4.4
If I was a manager in a multinational organisation, my organisation would prefer
an individualistic paradigm as this system is more open to trade and business.
There is more economic freedom with little government intervention to restrict
trade.
Activity 4.5
Some banks in Malaysia that implement Islamic banking are Maybank, CIMB,
HSBC Amanah and AmBank.
Self-Check 4.2
Some national laws that MNCs must comply with in order to make FDI in
Malaysia:
Exercise 4.1
1. C or E
2. A
3. C
4. A
5. A
ANSWERS " 217
" An independent monetary policy run by the European Central Bank; and
Exercise 5.1
1. The meaning of regional economic integration: it is a formal agreement
among member countries in a particular region to foster economic and
political cooperation. Main objective is to abolish barriers to trade.
Activity 5.3
Disadvantages of REI:
Exercise 5.2
1. The reasons that support the formation of regional economic integration:
" Boosts higher share of trade in world trade and enhance economic
growth in the region from increased intraregional trade; and
" Political cooperations ensure stability, safety and security in the region.
(a) Trade creation: production shifts from a high cost producer to a low
cost producer within the economic integration leading to increased
economic efficiency.
(b) Trade diversion: production transfers from low cost to higher cost
producer through REI.
Activity 5.5
The difference between a free trade area and an economic union:
" Free trade area: economic agreement to abolish trade obstacles (tariff and
nontariff barriers) between member countries but each member country is
allowed to establish its own external tariff policy with non members.
" Economic union: economic agreement at the high level which involves free
trade among member countries, common external tariff policy, common
market agreements such as free movement of capital and labour as well as
common monetary and fiscal policies.
Activity 5.7
The common challenges faced by economic integration across many regions:
" Political differences: internal political instability and security;
" Cultural differences;
" Barriers to coordination and harmonisation of regulations; and
" Problems in integrating regulations on investment rules and domestic
industrial policy.
Activity 5.8
The economic benefits of the ACFTA to ASEAN:
" Enlarged market size, trade and production base;
" Access to wider consumer base and choice of products;
" Removal of trade barriers, specialisation and enhanced economic efficiency;
and
" Improved FDI prospects.
Exercise 5.3
1. A
2. B
3. A
4. D
5. B
220 ! ANSWERS
Self-Check 6.2
1. The limitations of the Absolute Advantage Theory:
" The theory fails to explain the situation when a country has absolute
advantage in producing all products;
" It assumes that resources (labour) are perfectly mobile and easily
interchangeable between productions.
Self-Check 6.3
A country has absolute advantage over another in a particular good when it can
produce that good at a lower cost resulting in the country having greater output.
Activity 6.1
Heckscher-Ohlin Model of Comparative Advantage explains how trade occurs
based on differences in factor endowment while Ricardian Comparative
Advantage theory focuses on the natural advantages of production and trade at
different levels of productivity.
Activity 6.2
International Product Life-Cycle Theory seeks to explain how a company will
begin by exporting its products and eventually undertake FDI as the product
moves through its life cycle. A countryÊs export could eventually become its
import.
Activity 6.3
1. Reasons why some organisations fail at the international level:
" Lack of research and analysis on the nature of the international market;
" Late entry and the too competitive nature of the international market.
(c) Competition at the global level is inevitable for firms making FDI.
222 ! ANSWERS
Exercise 6.1
1. C
2. A
3. A
4. A
5. D
" Inward FDI: inflow of foreign capital into local resource or into host countries
from MNCs.
MNCs that have FDI in Malaysia – Dell, Toyota, National Panasonic, Samsung, Intel.
Activity 7.2
1. FDI pattern in major economies have changed in terms of:
" FDI growth via mergers and acquisitions, joint venture and strategic
alliances; and
Reasons why a large proportion of the worldÊs FDI is found in the "Triad"
region:
Self-Check 7.1
The likely positive and negative impact of FDI on host countries:
Self-Check 7.2
Difference between horizontal FDI and vertical FDI:
" Horizontal FDI refers to investment in the same industry as the parent
company in the home country.
" Vertical FDI occurs when MNC operates in a foreign country at different
stages of production. It can be backward or forward vertical integration.
224 ! ANSWERS
Exercise 7.1
1. A
2. B
3. D
Self-Check 8.1
The major functions of a foreign exchange market include:
Activity 8.2
The exchange rates for Malaysian Ringgit to other foreign currencies such as the
U.S. dollar, Singapore dollar and Indonesia rupiah:
" Exchange rate for RM/ Singapore dollar; 1 MYR = 0.400031161 SGD
" Exchange rate for RM/ Indonesian rupiah; 1 MYR = 2970.1515 IDR
ANSWERS " 225
Self-Check 8.2
1. Yes, major disruptions caused by political disasters have major impact and
repercussions on almost all economies in the world. The impact can be
seen when changes or fluctuations in major foreign exchange rates cause
foreign exchange markets to be active.
Activity 8.3
The primary roles of the IMF and World Bank:
Primary Role
IMF World Bank
IMFÊs main focus is to encourage countries World Bank provides development loans,
to correct macroeconomic imbalances, grants and aids for specific projects, such
reduce inflation, and undertake key trade, as the building of dams, roads, harbours
exchange, and other market reforms and so on which are considered necessary
needed to improve efficiency and support for „economic growth‰ in a developing
sustained economic growth. country.
226 ! ANSWERS
Self-Check 8.3
Inflation causes an increase in the general price level of a domestic economy. This
in turn causes production costs to rise and hence raise price of exports. Increase
in export prices reduces export competitiveness and demand for countryÊs
exports. Reduced demand for exports leads to a fall or depreciation in the
countryÊs exchange rate.
Exercise 8.1
1. A
2. D
3. A
4. D
5. D
6. D
7. A
" Access to other resources. Example, labour, raw materials and facilities.
Activity 9.2
ROI is just the expected net income that a firm can earn from a project that it
invested in. Risk and opportunity to be successful for a project depends on
financial, political and economic conditions in the market and these risks vary
across markets in which the project is undertaken.
ANSWERS " 227
Self-Check 9.2
1. Financial risk, political risk, legal risk and economic risk.
" Inspect and scan the social and economic situation which may lead to
such risk.
Exercise 9.1
1. Decide on important and potential country variables – market opportunity
versus risks and assign weights to determine the importance of each
variable to the company.
Self-Check 9.3
Advantage: Grid technique is useful for comparisons across countries and
helps a company to analyse if it needs to add further
investment or deeper analysis into feasibility research after
fulfilling the minimal criteria of the company.
Self-Check 9.4
1. Two tools and their major components that can be used to analyse and
compare information on market location:
Activity 9.3
Companies export to sell surplus production abroad, and exporting allows low
cost and low risk method of entry into a foreign market.
Potential pitfalls in exporting are: exporting company has to face trade barriers,
high transportation costs of bringing goods abroad making it uneconomical, face
problems associated with export agent who carries many brands and types of
products and firm has no control over marketing activities of export agent.
Activity 9.4
1. The main differences between international licensing and international
franchising include:
Activity 9.5
1. Express Rail Link in Kuala Lumpur and Kuala Lumpur International
Airport Express.
" Host government and local companies must gain the technological
transfer as well as training and expertise from the foreign investor that
has agreed to complete and manage the entire project;
" Hiring a reliable outside contractor to handle the entire project as full
responsibility for the project rests upon the contractor; and
Activity 9.6
1. Some of the criteria in selecting suitable joint venture partners:
Exercise 9.2
1. A
2. C
3. D
4. C
5. C
Which strategy is the best? The best strategy depends on the companyÊs goals
and objectives, the intended market to enter and the nature of the product.
Self-Check 10.2
The factors that affect pricing of products in a global market include:
" Standardising or adapting pricing policy: which pricing strategy to use –
ethnocentric, polycentric or geocentric;
" Price sensitivities of consumers in various markets; and
" Competitive pricing from the competitors in the markets.
ANSWERS " 231
Exercise 10.1
Threats Opportunities
" Rising costs of raw materials and " Large market size
wages " Rise of emerging markets
" Large and increasing global " Rising income per capita
competition
" Rising spending power of middle
" Political risks class consumers
" Cultural differences " Technological advancement
" Economic shocks
" Open and deregulated economy = " Technical and IT skills of Indian
government relaxed controls on labour
foreign ownership and taxation
" Target market: local consumer tastes and demands differ from foreign
target markets due to cultural differences and levels of sophistication.
" Entry strategy: how to enter foreign market via exporting or wholly
owned subsidiary or collaboration strategies such as joint ventures and
licensing.
232 ! ANSWERS
" Strategies for 4Ps differ between foreign and domestic market; need for
standardisation or adaptation of 4Ps in foreign market.
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OR
Thank you.