International Business Case Study

i
Advanced Diploma in Business Management

INTERNATIONAL BUSINESS CASE STUDY
Contents
Unit Title Page
Introduction to the Manual iii
Syllabus vii
1 The Importance and Nature of International Business 1
Introduction 2
The Importance and Growth of International Business 2
International and Domestic Business 7
Types of International Business Involvement 9
2 Understanding the World Trading Environment 17
Introduction 18
The Changing World Trading Environment 18
The Big Three The Triad 22
Classifying the World 23
A New Focus Global Convergence 26
3 Understanding International Trade 29
Introduction 30
The Reasons for International Trade 30
Trade Barriers 34
World Trade Bodies and Institutions 36
World Regional Groups or Trading Blocs 39
4 Understanding the International Business Environment 43
Introduction 45
Social/Cultural Factors 45
Legal Factors 50
Economic Factors 52
Political Factors 54
Technological Factors 55
The C Factors 57
The Use of Slept and C Factors in International Business Planning 59
Social Responsibility and International Business 62
International Buyer Behaviour 63
International Business Research 67
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Unit Title Page
5 International Business Strategy 73
Introduction 74
Business Planning 74
Strategy Development 79
Strategy and Company Factors 82
Strategy and Competition 86
Strategy and Level of Economic Development 90
Strategy and Finance 93
6 Organisational Structures, Cultures and Capabilities 95
Introduction 96
Organisational Structures 96
Organisational Culture 102
Staffing and the International Business 104
7 International Strategy: Standardisation, Adaptation and Globalisation 107
Introduction 108
Standardisation 108
Adaptation 111
Globalisation 113
8 Entry Strategies 119
Introduction 120
Choice of Entry 120
Selection of Entry Routes 124
The Entry Decision 128
9 International Marketing 131
Introduction 133
Product Management 133
Pricing Strategies and International Pricing Policies 141
International Promotion Policy 150
International Distribution and Logistics 156
The Extended Marketing Mix 172
10 International Manufacturing 181
Introduction 182
Manufacturing Management 182
Manufacturing Location 183
Make or Buy 185
Co-ordination of International Manufacturing 187
11 International Human Resource Management 189
Introduction 190
The Strategic Role of International HRM 190
Staffing 191
Developing the Global Approach 196
Labour Relations 198
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Unit Title Page
12 Implementation, Evaluation and Control 201
Introduction 202
Individual Country Annual Plans 202
Managing the Implementation Process 206
Performance Evaluation and Control 207
Planning for the Future 213
13 Finance and International Business 217
Introduction 218
Finance and the Development of International Business 218
Financing International Trade 222
Finance and the Multinational Company 229
International Investment Decisions 237
14 Risk and the International Business 241
Introduction 242
Risk and International Trade/Finance 243
Managing Political Risk 244
Internal Methods of Managing Exchange Rate Risk and Exposure 248
External Methods of Managing Exchange Rate Risk and Exposure 250
15 The International Business Case Study Guidance 259
Introduction 260
Initial Reading 261
Detailed Analysis 263
The Examination 267
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v
Introduction to the Study Manual
Welcome to this study manual for International Business Case Study.
The manual has been specially written to assist you in your studies for the ABE Advanced
Diploma in Business Management and is designed to meet the learning outcomes specified
for this module in the syllabus. As such, it provides the basis for your study of each subject
area, guiding you through the various topics which you will need to understand. However, at
this level, it is most important that you do not rely solely on the manual as the only source of
information in studying the module. It is essential that you read more widely around each
topic, and we set out below some guidance on additional resources which you should use to
help in preparing for the examination.
The syllabus for the module is set out on the following pages and you should read this
carefully so that you understand the scope of the module and what you will be required to
know for the examination. Also included in the syllabus are details of the method of
assessment the examination and the books recommended as additional reading.
The main study material then follows in the form of a number of study units as shown in the
contents. Each of these units is concerned with one topic area and introduces you to the key
concepts, themes and issues of that area. They are, though, designed to be a starting point
at this level, and provide a framework for developing your knowledge and understanding
through your own learning, rather than everything you need to know for the examination.
You need to think critically about what you read and develop it by further reading and relating
it to your own experience and understanding of applications in the real world.
Note that the examiners for all the modules at the Advanced Diploma level have stated
clearly that it is not sufficient to learn the material in this manual and repeat it in the
examination. You must demonstrate depth to your understanding by having read and
thought more widely about the topics under discussion.
Additional resources
ABE website www.abeuk.com. You should ensure that you refer to the Members
Area of the website from time to time for advice and guidance on studying and
preparing for the examination. We shall be publishing articles which provide general
guidance to all students and, where appropriate, also give specific information about
particular modules, including updates to the recommended reading and to the study
units themselves.
Additional reading As noted above, it is most important you do not rely solely on this
manual to gain the information needed for the examination on this module. You should,
therefore, study some other books to help develop your understanding of the topics
under consideration. The main books recommended to support this manual are
included in the syllabus which follows, but you should also refer to the ABE website for
further details of additional reading which may be published from time to time.
Newspapers You should get into the habit of reading a good quality newspaper on a
regular basis to ensure that you keep up to date with any developments which may be
relevant to the subjects in this module.
Your college tutor If you are studying through a college, you should use your tutors to
help with any areas of the syllabus with which you are having difficulty. That is what
they are there for! Do not be afraid to approach your tutor for this module to seek
clarification on any issue, as they will want you to succeed as much as you want to.
Discussion with other students If you can, you should consolidate and test your
knowledge and understanding in discussion with others. This can add an important
dimension to your studies at this level by explaining and justifying your understanding,
or challenging the understanding of others.
vi
Your own personal experience The ABE examinations are not just about learning lots
of facts, concepts and ideas from the study manual and other books. They are also
about how these are applied in the real world and you should always think how the
topics under consideration relate to your own work and to the situation at your own
workplace and others with which you are familiar. Using your own experience in this
way should help to develop your understanding by appreciating the practical
application and significance of what you read, and make your studies relevant to your
personal development at work. It should also provide you with examples which can be
used in your examination answers.
And finally
We hope you enjoy your studies and find them useful not just for preparing for the
examination, but also in understanding the modern world of business and in your own
personal and work development. We wish you every success in your studies and in the
examination for this module.
The Association of Business Executives
September 2008
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IBCS
4. Evaluate and recommend organisational structures outside the
domestic situation

4.1 Explain how cultural values play a major role in shaping
customs and practice in the organisation
4.2 Describe the body of knowledge on cultural diversity and explain
its effect on organisational practices and customers
4.3 Identify and describe the various methods and approaches to
international organisational structures and make
recommendations relevant to the needs of the organisation and
the environment
4.4 Describe and explain the linkages between corporate
headquarters and the regional and local subsidiaries

5. Critically evaluate a vision, providing leadership for the
organisation

5.1 Explain the issues underpinning motivational change and the
creation of readiness for this change
5.2 Evaluate the strategic role of leadership in developing
international expansion, particularly the creation of a vision and
the communion of this to a diverse audience
5.3 Explain the role played by planning in the shaping of the future
direction for the organisation
5.4 Assess the significance of team building as a change agent
internationally and its contribution to sustaining momentum

6. Evaluate the regulatory, ethical and social responsibilities of the
international firm

6.1 Describe how, as a result of globalisation, companies operate
within different political systems, from collectivism, individualism
and democracy to authoritarianism
6.2 Explain how countries are at different stages of economic
development and how business solutions will reflect this
6.3 Explain the growing role and significance of ethical
responsibilities
6.4 Examine the growing importance of corporate social
responsibility (CSR) and the impact of consumer movements so
that the organisation strikes the appropriate balance in its
international development
6.5 Describe the legal systems in terms of protection of
employment, property rights and intellectual capital together with
product safety and product liability

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ABE, ABE Study Manual International Business Case Study, ABE
1
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Study Unit 1
The Importance and Nature of International Business
Contents Page
Introduction 2
A. The Importance and Growth of International Business 2
The Changing Nature of the International Business Environment 3
Reasons for Going International 5
B. International and Domestic Business 7
Similarities 7
Differences 8
C. Types of International Business Involvement 9
Different Orientations, Different Management Culture 9
The Stages Approach 10
2 The Importance and Nature of International Business
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INTRODUCTION
Fewer and fewer companies these days can focus only on their domestic markets.
Increasingly, businesses need to understand, consider and plan for international business
activities. The growth of international business, in all its facets, represents probably one of
the most significant commercial developments in recent years. Specifically, international
markets represent one of the most significant sources of business opportunities (and
threats).
Just consider for a moment some of the following facts:
Initial forecasts of world trade in the year 2000 suggest that the total value of goods
and services traded will reach nearly $7 trillion.
China alone represents a total potential market of some 6 billion people.
In excess of $1 trillion crosses national boundaries each and every day.
The worlds largest 500 companies derive on average approximately 70% of their sales
and profits from international markets.
Small wonder then that international business opens up such major profit and sales
opportunities to companies. Moreover, virtually every available measure indicates that
international, as opposed to purely domestic, business has for many years now been the
fastest growing area of commercial and trading activity and that, if anything, this growth is set
to accelerate into the future.
The bald statistics on the importance and growth of international business, impressive though
they may be, do not of themselves tell us about the following issues:
The reasons for this growth.
The nature and variety of international business activities.
How, if at all, international business differs over and above purely domestic business.
Related to the above, the implication of any differences for the financial, marketing and
operations managers and in particular what additional skills and techniques are
required when planning international business strategies.
The key trends and developments in the scope and nature of international business
and the way that international markets and business are likely to develop in the future.
As a prelude to understanding how to analyse international markets and to develop and
implement business strategies for them, we need first to understand some of the background
to the nature, growth and scope of international business. This first study unit is designed to
do this.
A. THE IMPORTANCE AND GROWTH OF INTERNATIONAL
BUSINESS
As already indicated in the introduction, international markets represent one of the largest
and fastest growing areas of commercial and marketing activity. As such, they represent one
of the most significant areas of business opportunities for the organisation. A number of
factors serve to underpin the size and growth of international activities, some of the most
important of which are considered below.
The Importance and Nature of International Business 3
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The Changing Nature of the International Business Environment
As in all business situations, opportunities and threats stem from changes in the
environment. In environments which are not dynamic and changing, few such opportunities
and threats arise. There is little doubt that the international environment is one of the most
dynamic. It is this dynamic nature which gives rise to major opportunities for international
business.
Examples of some of the major changes in the international business environment in recent
years include the following:
The growth of whole new trading blocs and major changes to existing ones, e.g. the
expansion of the European Union (EU), the formation of the Association of South East
Asian Nations (ASEAN) and the Andean Common Market (ANCOM).
Newly emerging markets with significant growth potential, e.g. the Chinese Economic
Area, Indonesia, India, South Korea and Mexico.
Fundamental changes to the economic systems in some countries/regions of the world,
for example the collapse of the former Eastern European Communist Bloc.
Diminishing barriers to international trade and consequent significantly increased
competition across national boundaries and often, as we shall see later, on a global
basis.
The growth of the multinational and transnational organisation.
The development and impact of communications technology including the Internet
These, and other changes, are in fact considered in more depth in this and later study units,
but at this stage it is sufficient to note that it is the particularly dynamic nature of the
international environment that provides the source of major business opportunities. The
following list describes some of the key factors effecting growth.
The continued liberalisation of international trade
This particular aspect of the international environment is of particular importance when
considering the growth of international business. As already indicated, there has been
a continuing trend towards the liberalisation of international trade. Starting after the
Second World War, under the auspices of GATT (latterly the World Trade Organisation)
agreements have been reached to gradually remove trade barriers such as tariffs and
quotas. Imperfect though these agreements have sometimes been, there is no doubt
that these have helped the growth of world trade and the rising importance of
international business. Patterns of world trade and understanding the world trading
environment are so important to international business that we consider them in more
depth again in Study Unit 3, together with the social, legal, economic, political,
technological and competitive forces which underpin them and which are considered in
Study Unit 4.
Cosmopolitan customers
A second factor in the growth in importance of international business is the changing
nature of customers and demand, and in particular, the increasingly cosmopolitan
nature of todays customers.
Todays consumer is much more widely travelled compared to even a decade ago.
Combined with an increasingly global media network, todays consumer is exposed to
global lifestyles, products and brands. Increased affluence and education on the part
of customers have also served to reinforce much more cosmopolitan attitudes and
lifestyles. At the turn of the twentieth century, our grandparents were mainly exposed
to domestic products and services. Furthermore, they werent particularly interested in
buying foreign products. Todays consumer, however, travels widely and wants to
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purchase the best value and most innovatory products and services, regardless of their
country of origin. Clearly, consumers and their needs change, together with their
buying habits and the influences on these.
Understanding the consumer and their needs lies at the heart of business strategy and
planning. This is no different in international business indeed, if anything, one might
argue that the need to understand or at least analyse customer behaviour is
heightened when considering consumers across international frontiers. For this
reason, therefore, we consider the importance of understanding customer behaviour in
Study Unit 4.
Improved communications
Helping to facilitate the emergence of the more cosmopolitan international consumer
have been the huge improvements in international communication. Indeed, the
increase in international travel just referred to has partly come about because of these.
So, for example, it now costs considerably less than 25% in real terms of what it did
some 20 years ago to fly the Atlantic. Of particular importance in this area, of course,
has been the growth of new communication technologies such as satellite TV and more
recently the growth of the Internet, which is rapidly becoming ubiquitous and is giving
ready access to consumers to international trends and markets.
Strategic networking and the international supply chain
It is not only final consumers that have become more cosmopolitan in their lifestyles
and purchasing habits, but so too have organisational customers formed from:
(i) Strategic networking is the formation of alliances and agreements between
companies. Such alliances and agreements may involve, for example, licensing,
franchising and even mergers and acquisitions. Strategic networking is an
attempt to combine two or more companies skills and resources so as to be able
to compete better.
(ii) International supply chains refers to the increasingly international nature of
supply in as much as companies often purchase components, raw materials,
services, etc. from very diverse parts of the world
Increasingly, organisational buyers, whether in manufacturing, services or retailing,
have turned towards non-domestic suppliers to provide their raw materials,
components and finished products. A good example is that of the United Kingdom
retailer, Marks & Spencer. At one time, Marks & Spencer made a feature out of
sourcing from only UK suppliers wherever possible. However, in recent years this
company, facing increasingly aggressive competition, has begun to purchase from
whichever supplier can best serve their needs with regard to factors such as price,
design, delivery and so on, irrespective of their geographical location in the world.
Some of the same factors underpinning the emergence of the more cosmopolitan
consumer, such as improved communication and so on, apply equally to the
organisational customer. In addition, however, companies are increasingly developing
strategic networks with suppliers that are based on international supply chains. So, for
example, a car that is ultimately sold in the United Kingdom may have had its engine
built in Spain, its transmission in Japan, its gearbox and steering in Korea and its trim in
Brazil, with assembly in Germany.
A number of factors underpin this growth of strategic networking and international
supply chains. So, for example, increasingly, even the largest companies can no
longer afford to develop new products on their own, but must share the risk by
developing strategic alliances with other companies, often in different parts of the
world. Similarly, sometimes a company will be unable to gain access to an overseas
market without the help of a local company and so again, strategic alliances or joint
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ventures of some kind are increasingly the order of the day. One of the most significant
developments promoting the growth of the international supply chain has been the
recognition that managing supply effectively through value chain activities can be one
of the most important sources of competitive advantage. There is no doubt that
strategic networking and the international supply chain management which is
associated with this, will continue to facilitate the growth of international business in the
future.
Growth of global companies multinationals and transnationals
Factors already discussed which have served to underpin the growth of importance of
international business have in turn led to the emergence of the global company.
The global company thinks, plans and operates on a truly global basis; in other words,
it transcends international boundaries. The 1980s and 1990s have seen the
emergence of the multinational and, more recently, transnational company; while the
emergence of the global company has in turn, helped fuel further growth in
international business. At this stage, we should note that one factor in particular linking
the global company with the growth of international business itself has been the growth
of the global brands that such companies have promoted.
Global brands
A combination of increasingly cosmopolitan consumers and lifestyles, together with the
growth of global companies, has led to the growth of the global brand. Global brands
transcend international boundaries and include brands such as Coca Cola, Ford,
Mercedes, IBM and Rolex, to name just a few examples. Global brands reduce the
risks for customers of buying brands produced in other countries. They also help
facilitate a feeling of belonging on the part of customers throughout the world with
shared lifestyles, values, aspirations, etc.
These, then, are just some of the key factors that underpin the growth in, and importance of,
international business. Again, remember that we will be considering many of these factors
again in more depth in later study units. Here, we are simply concerned to establish the
importance of international business and the fact that the dynamic environment which
surrounds this area of business means that this is an area of significant opportunities.
Needless to say, to recognise and appraise these opportunities is a key part of the
international businesss task. In addition to understanding the nature of the international
environment and the factors which underpin this, including competitor and customer aspects,
the international business also needs to understand and be able to apply the tools of
international business research together with the concepts and techniques of competitive,
absolute and comparative analysis. These two aspects of appraising international business
opportunities, therefore, form the focus of Study Units 4 and 5 respectively. But what
prompts companies to consider going international in the first place? What are some of the
key motives and incentives?
Reasons for Going International
All business is ultimately about identifying opportunities in markets and developing
programmes to take advantage of these. We have already discussed some of the reasons
for the growth of international business, which has served to illustrate how dynamic this area
is and therefore how it gives rise to significant opportunities. In broad terms, going
international offers several potential advantages over and above purely domestic markets.
For example, we have already seen that international markets and trade have tended to grow
faster than more domestic economies.
Furthermore, there is substantial evidence to suggest that international markets and business
are more profitable i.e. the companies that operate in these markets achieve higher rates of
return than their purely domestic counterparts of a similar size. It is not difficult to think of
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reasons for these higher rates of return. For example, international markets often give more
scope for economies of scale or similarly, may allow the business to source components and
raw materials, etc. more cost-effectively. Additionally, the international business may, through
effective global branding, simply be able to command a price premium or gain leverage for
shelf space in the retail outlet compared to the purely domestic counterpart.
There are all sorts of reasons, therefore, why international business may represent
opportunities for increased profits but there are many reasons that may underpin a decision
for a company to go international. Examples of some of these reasons are shown below.
Saturated domestic markets the international product lifecycle
Very often, the motive for going international by a company will be that its own
domestic markets are saturated, with no potential for future growth. The business may
therefore be prompted to look for other international markets where this potential still
exists.
There may be several reasons why a market may be saturated at home and yet offer
potential for growth in other markets, but one reason is the product lifecycle. You know,
of course, that the product lifecycle concept illustrates the fact that products pass
through a number of stages in their lives from introduction through growth to eventual
saturation and decline. We can also see that a product may often be at different stages
in different countries. So, for example, the microwave oven was entering maturity in
the United States whilst at the same time only being at the introduction stage in the
United Kingdom. Very often, in fact, there is a pecking order to the international
product lifecycle with products and services first reaching maturity and decline in
developed economies while still being at the growth or even introductory stage in
developing economies. The point is that by carefully identifying the next growth
market, a business can achieve a fresh impetus to growth when domestic markets
have become saturated.
Two further examples of products that are at different stages of their lifecycle in
different parts of the world are shown in the following table:
Table 1.1. Product Current Lifecycle Stages.
Product Current stage UK Stage of lifecycle elsewhere
Cable TV Growth Maturity (US)
Disposable nappies Maturity Growth (Poland)
Intense/increased international competition in home markets
Another factor that may prompt a company to go international is where it faces intense
and/or increased competition in its domestic markets, particularly from non-domestic
competitors. Sometimes the business may seek to avoid such intense competition by
looking for non-domestic markets to maintain and expand sales and profits. The
danger here, of course, is that competition will simply follow you into your new markets.
An opportunity to exploit a real competitive advantage
A much more positive reason for going international than avoiding increased
competition in the domestic market is where a company has a genuine competitive
advantage which it wishes to exploit on an international basis. So, for example, a
company with an innovatory new product that is, say, patent protected may feel that it
wishes to gain the maximum value by expanding its sales of the product into other
countries.
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Economies of scale
We have already mentioned the fact that international expansion through expanding
the potential market often enables a company to achieve economies of scale. At one
time, these economies of scale were linked to decreases in average cost in the
production and research and development areas of the business, but increasingly,
companies are also being driven by economies of scale in the marketing area and
particularly in the areas of branding and advertising where going international can help
reduce the average costs in this increasingly expensive area of the business.
Merger and acquisition activity
Sometimes companies find themselves in the international arena through their merger
and acquisition activities. Clearly, where the reason for the merger/acquisition is to,
say, gain access to an overseas market, then obviously this is a conscious policy
decision to go international. Sometimes, however, a company can find itself operating
in international markets where the major reason for the merger/acquisition was perhaps
to simply protect the domestic market or to acquire a valuable distribution structure. In
doing so, however, the company may acquire/merge with a company that is already
involved in international markets and so goes international by default.
Clearly, there are many reasons why companies go international, but it is important to stress
that all the evidence suggests that where a company goes international for positive reasons it
is much more likely to be successful. So, for example, a company that is experiencing
difficulties in its domestic markets, such as decreasing sales, increased competition, etc. will
often struggle if it attempts to move into international markets from this weak base.
This again highlights the importance of analysing and assessing international markets for
genuine market opportunities and matching these opportunities to company competences
and strengths. This aspect of identifying and appraising opportunities in international
markets is again, I would stress, no different to purely domestic business. But if this aspect
is no different, it raises the issue of what is involved in international business and it is to this
area that we shall now turn our attention.
B. INTERNATIONAL AND DOMESTIC BUSINESS
Before considering the differences it might be useful, however, to consider what is similar in
international and domestic business.
Similarities
The main similarities between international and domestic business are:
The centrality of the business strategy concept
You will, of course, be familiar with the notion of the business strategy concept, namely
that effective business is based around identifying and satisfying various stakeholders
needs and wants. The importance of this concept is no different when considering
international or domestic business activities.
Management processes
The key processes of business management, too, are no different in international
compared to domestic markets. Successful practice is still built upon the elements of
analysis, planning, implementation and control.
Management tools and techniques
All the tools and techniques pertinent to, and used in, domestic business activities are
also relevant in the international context. For example, the tools and techniques of
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marketing research, market segmentation and targeting, forecasting and so on are just
the same.
Key decision areas/planning frameworks
Finally, the planning frameworks and key decision areas for international business are
similar to those for domestic. So in marketing, for example, the business must
establish objectives, select target markets and positioning strategies, develop
marketing strategies encompassing the marketing mix and implement these and finally
evaluate and control marketing activities.
There will however, be some differences in application. For example, the business
must decide the mode of entry into international markets a decision obviously not
found in purely domestic business, but again the principles and key areas of decisions
are just the same in international, compared with domestic business.
Differences
With so many similarities between international and domestic business, what, if anything, is
different? The deceptively simple answer to this question (i.e. the key difference between
international and domestic business) is the following:
International business takes place across national boundaries.
At first sight, this would not appear to be a major difference but the very fact that international
business is carried on across national boundaries is the reason for a range of major
differences and applications of business concepts and techniques:
Different environment, culture and language
Operating across national boundaries means that the business encounters a range of
problems and issues not encountered when operating exclusively in domestic markets.
Again, this deceptively simple statement masks the complexities and problems that this
can cause. So, for example, the business must deal with a different set of
environmental factors. Perhaps most significant of all, the business is dealing with a
set of customers from a different culture and language.
So, for example, in marketing, research involves considering language and respondent
differences, and businesses must consider the extent to which marketing activities, and
particularly the marketing mix, can be standardised across national boundaries.
Customers
In advanced countries, the wide range of available goods and services leaves few
unsatisfied market areas. Buyers can be very fickle about whether or not to buy, and
businesses therefore must be clear about identifying and satisfying customer needs.
In lesser-developed countries, many customers have insufficient money to buy
products. In other words, there is no effective demand. However, people in these
countries are often aware of the most up-to-date products through television and the
cinema. Businesses in these countries face additional problems with regard to making
products available that customers can afford.
Business information and forecasting
International markets often exhibit very different rates of growth which, combined often
with a paucity of information, makes it very difficult to develop reliable estimates of
market size and sales forecasts.
Competition
Businesses entering international markets, as already indicated, generally face much
fiercer competition. Furthermore, this competition is now composed of perhaps
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unknown competitors from other countries. Admittedly, the purely domestic marketer
can face international competition from both domestic and international competitors,
but generally speaking, international business moves competitive pressures up to a
new level.
Environmental turbulence
Compared to domestic environments, the international environment within which
businesses must operate is much more dynamic and unpredictable. Changes in the
international environment can be very rapid indeed, such as the much-discussed
withdrawal of the UK and Italy from the Exchange Rate Mechanism of the European
Union in September 1992. Even changes that have been expected for many years can
be difficult to predict with regard to their impact and implications for business, for
example the handing back to China of Hong Kong. Environmental factors such as
inflation rates, disposable incomes and technological and legislative changes can all
change very rapidly in international markets, making it much more difficult for business.
On the other hand, as we shall see, this very dynamism in international markets also
gives rise to major business opportunities.
C. TYPES OF INTERNATIONAL BUSINESS INVOLVEMENT
There are a number of different types of involvement in international business. At one
extreme, some companies have a few sporadic foreign orders that they process as and when
they arrive. At the other extreme, there are companies, such as Coca-Cola, Unilever,
General Motors and Sony, with significant investments in plant, machinery and staff in other
countries and with detailed marketing, planning and implementation in a large number of
countries.
The degree of involvement can be measured by the percentage of sales revenue or profit
contribution attributable to domestic and non-domestic sales. The amount of investment in
non-domestic markets is another indicator. Other measures are the percentage of staff
working on international markets and the relative planning importance given to international
business.
The ways in which companies move from very little to intense international business have
been explained in a number of different ways. In such a varied situation of companies,
countries and interests, any one explanation is unlikely to be complete. Here we shall
consider two such approaches.
Different Orientations, Different Management Culture
A widely used classification was developed by Howard Perlmutter to identify four different
types of attitude or orientation that influence internationalisation. The orientations are as
follows:
Table 1.2. International Orientations
Orientation Focus
Ethnocentric Home/domestic country
Polycentric Host country
Regiocentric Regional market groups, e.g. ASEAN
Geocentric World/global
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The ethnocentric orientation is one where the attitudes and approaches of
managements are based upon their own domestic market. Little or no consideration is
given to the different needs of non-domestic customers.
The polycentric orientation is associated with multi-national enterprises with
subsidiaries strongly based in host countries. This orientation is sometimes called
multi-domestic because the company operates with an almost domestic approach to a
number of different markets.
Regiocentric orientation has become more prevalent as regional market groupings
have developed. In Europe we are seeing an increased interest in tackling European
markets.
Geocentric orientation is becoming increasingly important. It is sometimes
mistakenly thought that the geocentric approach is only for very large companies. It is
increasingly likely that all but the small companies will need to consider a geocentric
orientation. Medium-sized companies might not compete in many markets around the
world, but they need to be aware of emerging world trends in buying behaviour, in cost
levels and in technologies. Without this global vision the company will not be able to
adapt to our fast-changing world.
The Stages Approach
The following table illustrates the different stages a company may go through in developing
from a purely domestic business to one that is fully international.
Table 1.3: The stages of international involvement
Stages in Process Degree of International
Involvement
International Business Approach
Domestic None None
Export selling Reactive, very limited,
experimental
None
Proactive exporting Active involvement Increasing knowledge and the
development of planning
approaches. Approaches are
usually more tactical than strategic.
International Committed involvement The key here is that the company
has some investment in at least
one other country. Planning is
used extensively, but usually on a
multi-domestic basis.
Global Committed strategic
approach
Treats the world as an opportunity.
The equidistant approach would be
an ideal.
Note that the international business approach becomes more comprehensive, strategic and
sophisticated the closer to the global stage the company has reached.
The difference between simply exporting and international business arises from the fact that
exporting is the physical movement of a product produced in one country to another country.
Profits are made from the sales revenue (less variable and indirect costs) gained from the
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non-domestic country customer. In international and global business, profits will be earned in
a variety of ways:
Net profits remitted by subsidiary companies;
Net profits remitted from joint ventures;
Licence fees earned by allowing non-domestic users to use your patented processes;
Fees earned from the sales of know-how;
In addition, there will usually be sales revenues earned from exporting.
In general, international business is a more sophisticated process than exporting. It is
usually closer to the final customer. Global business is a much more recent phenomenon.
Whereas exporting and international business look for profitable opportunities, almost
wherever they exist, global business seeks systematically to exploit opportunities around the
world. For the global company the markets of Europe, North America and Japan, sometimes
called the Triad, usually represent over 75% of the world market and are therefore of crucial
importance. The Triad is likely to contain most of the world market and most of the world
competition.
Most companies develop their first steps in international business through reacting to export
orders. These orders could come from anywhere in the world. Once the company becomes
more interested, it will become more proactive. It will try to make things happen. It usually
does this in markets that do not seem to be too difficult quite often markets that it perceives
to be like its domestic market.
The less difficult markets are those that are either geographically close (sometimes called
geographical proximity) or psychologically close (sometimes called psychological proximity):
Geographical proximity Many US companies gain their export experience by
exporting to the bordering countries of Canada and Mexico. A similar pattern will occur
in most parts of the world.
Psychological proximity Sometimes countries that are geographically distant will
seem to be very familiar. This usually happens because of a common language and a
similar culture for example, it is quite common for a UK company to export to
Australia or New Zealand, or a Spanish company might feel closer to some of the
South American countries than, say, Central Europe.
Until quite recently, many countries in continental Europe, although geographically
close, have seemed psychologically distant to UK companies. The result of this was
that UK companies developed markets based on Commonwealth countries. It is only
since Britain joined EFTA (European Free Trade Association) and then the European
Community that UK companies have learned more about other European countries. As
knowledge increases, the psychological distance begins to diminish. The process has,
of course, been helped by the abolition of tariff barriers within the EC (now called the
European Union (EU) since the formal approval of the Maastricht Treaty in 1993) and
large amounts of information from the European Commission and the Department of
Trade and Industry (DTI).
Consider the case of a US food manufacturer seeking new markets. Geographical and
psychological proximity suggest that Canada and the UK would be appropriate. The
similarities in terms of a common language and similar cultural patterns serve to reduce the
apparent risks of entering new markets. On the other hand, there are differences. Canada
has two official languages, French and English, and packaging will need to be adapted to
carry both languages. Similar adaptations will be necessary to take account of the fact that
UK English has some differences from US English. Further, the evolution of the US food
market might be in advance of the UK and Canada. Thus, not all US food products will be
successful in these markets and some might need considerable adaptation.
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The early experience in international business gained from expanding into proximate markets
can be used as a way of preparing for markets that are more different.
The different stages in more detail:
Export selling
The export selling stage is the typical starting point in international business. As its title
implies, this is not a focused international approach and the company orientation will be
ethnocentric.
The initial reactive approach to unsolicited orders received is likely to change to one
where the company seeks to sell, but the company will seek to sell its domestic
offering. There will be little or no modification to customer requirements.
The differences in approach between its domestic and its export business will be driven
by legal and administrative requirements. So, for example, the marketing mix
changes:
(i) Product This will be modified only to meet legal and technical standards within
the country exported to.
(ii) Price This will be dictated by currency conversion, by the extra physical
distribution management (PDM) costs, by distribution channel cost margin
requirements and by local tax requirements.
(iii) Distribution This will have to change as new distribution channel members
have to be found and PDM decisions are made to transport the product, hold
inventory (stock), invoice, insure, provide customs documentation, etc.
(iv) Promotion The only element that is usually used is selling, so sales literature
might be changed and translated, but sales promotion, publicity and advertising
are rarely used.
The export selling approach is essentially casual and does not involve anything more
than minimal interaction with the international market. It does not, therefore, integrate
the marketing concept into its business activities having little knowledge of its
customers and not considering the overall business environment, and making only
minimal attempts to adjust its marketing mix offering to customer requirements.
However, this approach can be profitable. Because of low costs of adjustment and
adaptation and a limited use of extra marketing mix resources (i.e. little or no spending
on marketing research or on the promotional mix, with the exception of selling) the
company incurs few extra costs. Those costs are usually direct costs and are included
in the price quoted. At a tactical level, export selling can provide a useful profit addition
to the company. The difficulty with this approach is that it is essentially short-term.
This approach is more likely to be followed by smaller companies. It restricts their
risks, allowing them flexibility to drop in or drop out of markets.
Proactive exporting
At this level the company is beginning to undertake business and marketing planning
for various markets. It is, by definition, taking account of customer needs and wants. It
will make various adaptations to customer requirements, seek out market opportunities
and develop appropriate marketing mix solutions in an attempt to achieve profitable
sales.
Various types of company will undertake proactive exporting:
(i) Small and medium-sized enterprises (SMEs) export to various countries.
(ii) Multi-national enterprises (MNEs) have various subsidiaries in different countries
and some subsidiaries will export to smaller or more risky markets.
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A frequently quoted criticism of UK exporters is a tendency to spread their efforts too
thinly around too many export markets. As long ago as 1976, the BETRO Report,
entitled Concentration on Key Markets, recommended that UK exporters should select
a few markets to concentrate on. Such a market concentration (sometimes called the
key market) approach involves identifying important markets, becoming knowledgeable
about them and devoting sufficient resources to implement an effective marketing plan
in each country selected. In this way the company can build a worthwhile market share
and gain long-term profitability.
It is useful to balance the key markets or market concentration approach with the
opposite approach of market spreading, under which the aim is to sell to markets in
many different countries. The market spreading argument, based partly on the
justification developed under export selling, is that of low cost, low commitment but a
useful profit return. The company has to spread its resources thinly and does not learn
much in terms of in-depth information about each countrys market. Its sales are small
in each country, but equally its costs are low. Another part of the argument is to do with
the wisdom of spreading risk. A key market approach that had all its eggs in the
market basket of Kuwait and Iraq in 1990 would have suffered catastrophic losses with
the invasion of Kuwait and the subsequent breakdown in trading.
Many companies find a compromise as the best solution. They identify a number of
key markets, usually less than 10 countries, and concentrate long-term efforts on these
markets. However, in addition they will export to a number of other countries following
the market spreading principles of low cost, low risks, but some profit return.
International business
To fall into this category, a company needs to have made investments in sales offices,
distribution systems or production units in other countries. These investment decisions
imply greater access to resources and are therefore more likely to be undertaken by
larger companies.
You will note that the way in which we have defined international business is very
similar to definitions of multinational enterprises. MNEs are organisations that have
companies operating in different countries, but are controlled by a headquarters in one
given country (invariably the domestic nation of the original company). In practice, they
are often thought to be the large blue chip companies, for example, Gillette, IBM or ICI.
Until recently, most MNEs followed approaches that were more multi-domestic than
one that segmented international markets in a strategic way. The multi-domestic idea
is captured in the polycentric orientation, the management culture became centred on
the host country and they became expert in each host country. The end result was a
series of adaptations to each country, such as the following in respect of the marketing
mix:
(i) Product This is usually standardised, along with brand names.
(ii) Price This is adapted according to local costs, competition and customer
demand.
(iii) Distribution This is adapted to the distribution channels of each country.
(iv) Promotion Selling is fully adapted to the requirements of the particular country,
with sales promotion and publicity being mostly adapted, but advertising will be
based on certain standardised creative themes and TV commercials, although
media selection is adapted to the host country media.
The connection between MNEs and polycentric orientation is very strong. It results in
the various subsidiary companies to be strongly influenced in their strategic planning by
the country in which they are based. As a consequence, MNEs had a tendency, as
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they expanded into more and more countries, to lose a certain amount of control, with
the central headquarters often concentrating on the achievement of financial targets.
This type of approach was very powerful when its main competition was on a country-
by-country basis. In the 1980s and 1990s, though, competitive forces developed which
operate on a world region (e.g. the EU) or on a global scale. These competitors were
initially Japanese companies, but other Southeast Asian companies are becoming
significant (Korean, Malaysian and companies from Taiwan, Hong Kong and
Singapore). The new aggressors were able to benefit from economies of scale through
a more standardised approach. They also adopted a more systematic approach to
competition. The companies relying on one market at a time became vulnerable to
companies that used their resources in a co-ordinated way against several markets.
Global business
A global approach needs to cover a substantial part of the world market for the relevant
product or service. This involves identifying global competitive opportunities in order to
anticipate and satisfy customer requirements profitably whilst developing and
implementing plans which are standardised wherever possible.
There are, essentially, two bases upon which this approach can be built.
(i) The global brand In this approach, the brand needs to have widespread
availability in most parts of the world (usually the Triad plus other countries) and
to be presented in a more or less similar approach in each market. It will be
standardised as far as possible so, while adaptations do occur, they are
contained within a standardised approach. Generally speaking, you should avoid
citing Coca-Cola and McDonalds in all your examples, but in this instance they
are two of the best examples.
The global brand aims to have one clear communication of its brand name, its
logo and its complete visual identity. Coca-Cola, for example, puts considerable
emphasis on the legal protection of its trademark. The company takes action
against those thought to be infringing its trademark.
The global brand will have a number of adaptations. These will be confined to
areas of important local difference. There will be differences in distribution
channels, prices will vary, slight modifications might be sanctioned in the product,
and often sales promotions will be localised to the market.
The global brand will try to standardise visual communications and the expensive
elements of the product and TV and cinema advertising. The global brand seeks
widespread global availability.
Note that the standardised global brand is relatively rare. The reasons for this
are the wide variations between different market and cultural conditions,
differences in distribution channels, different availability of advertising media, and
price differences caused by distributor margins and tax levels, etc
(ii) The global strategic approach This approach is different from the global
brand. The global strategic approach looks at the world (global) opportunity. The
approach to standardisation is more flexible. Standardisation will be sought
where it is useful, but regional world market variation is allowed. Unilever is a
company that is moving from a multi-domestic approach through a regiocentric
approach towards a global strategic approach. The end result might be global
co-ordination but with different brands in America, Europe and Asia.
Whichever approach is taken, the global company will be following an approach that is
now described as transnational. This marks a movement from the MNE multi-
domestic way to one that operates over and above country boundaries, they might be
physically similar types of company but the transnational will have a company culture
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and orientation that is geocentric. They often have a strong headquarters influence,
usually based in the country in which the company was founded, for example, Alfa-
Laval (food processing equipment) in Sweden, Benetton in Italy, Philips in the
Netherlands, etc.
The transnational approach has to accommodate country differences, but it looks for
broader market opportunities and solutions. Thus, the response to marketing issues
will be on a global scale but with the flexibility for necessary local adaptation. Further,
as companies move from a position of treating a country as being synonymous with a
market and look at targeting their product offering at consumer segments, it becomes
easier to identify the similarities that exist and therefore can be exploited. For example,
the student population in the UK, the USA and the Far East are likely to be similar in
many ways despite significant cultural differences.
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17
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Study Unit 2
Understanding the World Trading Environment
Contents Page
Introduction 18
A. The Changing World Trading Environment 18
The Growth of Internationalism 18
The Composition of World Trade 19
World Trade Shares 20
A Shrinking World 21
Uncertainties/Turbulence 22
The Internet and the Worldwide Web 22
B. The Big Three The Triad 22
C. Classifying the World 23
Classifying by Gross National Product 23
Classifying by Stage of Economic Development 24
D. A New Focus Global Convergence 26
Drivers of the Global Approach 26
Forces Working to Keep Markets Localised 28
18 Understanding the World Trading Environment
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INTRODUCTION
This second study unit is the first of six successive study units that concentrate on the
analysis of the international business environment. Remember, environmental analysis is a
key task of management irrespective of whether we are considering purely domestic or, as in
our case, international business. This involves analysing those factors that provide the
context for planning effective business strategies, and in particular the analysis of those
factors which give rise to opportunities and threats.
This study unit encompasses some of the broadest aspects of the environment that the
international business needs to understand and assess, namely developments and changes
in the world trading environment. As you will appreciate, it is impossible to describe all of the
developments in this area, and indeed this is not really necessary for our purposes.
However, the scope of this area of the syllabus is such that it necessitates two full study units
to encompass the area so that you should consider this study unit and the one that follows on
Understanding International Trade as essentially one study unit.
In this particular study unit, we shall trace the background to world trade and some of the
important dimensions and changes in this area. In the study unit which follows, we shall
consider many of the economic and political facets of the world trading environment,
including the economic arguments for international trade, trade regulations, world region
groups or trading blocs, and some of the major developments in these. You will appreciate
that a knowledge and understanding of the world trading environment is essential in as much
as it provides the environmental context for developing business strategies and plans. As
any historian will tell you, the key to understanding the present, and to some extent,
forecasting the future, is an understanding of how the present and future have been shaped
by the past and the forces, factors, decisions and developments which have been important
in this shaping. In this particular study unit, we shall therefore be introducing some of these
key forces and factors that have affected the current world trading environment so we can
understand the context in which contemporary international business takes place.
A. THE CHANGING WORLD TRADING ENVIRONMENT
As you would expect, the world trading environment has changed substantially over the
years, and indeed will continue to do so. The international business needs to understand
how different forces and factors have shaped the current world trading environment and how
this environment might change in the future. For our purposes, we shall look at what are
considered to be some of the major developments in the world trading environment since the
end of the Second World War, including the most recent developments in this area. In doing
so, we have concentrated on the key characteristics of the world trading environment which
have particular significance for the international business.
The Growth of Internationalism
Perhaps one of the most significant developments in the world trading environment since
World War II has been the growth of what is often termed internationalism. Quite simply,
individuals, organisations, governments and whole societies have become increasingly open
to the exchange of goods, services, people and ideas, etc. with other parts of the world. We
saw in Study Unit 1 that the growth of international trade and business is in large measure
due to this increased openness to, and acceptance of, internationalism and we also looked at
some of the reasons for this. Factors such as increased travel, international communication
networks and the more cosmopolitan consumers and lifestyles, which were discussed in
Study Unit 1, have all played their part in the growth of internationalism.
Another key factor in this growth, however, has been the increased recognition and
acceptance of the need for, and value of, open and improved international relations between
Understanding the World Trading Environment 19
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countries. For obvious reasons, a major impetus to this recognition and acceptance was the
terrible consequences and effect of the Second World War itself. Immediately after the
Second World War, therefore, international co-operation began to develop, reliant to a
considerable extent on the United States, in an effort to encourage the orderly reconstruction
of the world economy. For a variety of reasons, the United States, backed by the United
Kingdom, took active responsibility for helping the crushed economies of Germany and
Japan to re-emerge. The Marshall Aid Plan and the Bretton Woods Agreement are examples
of early efforts to help the world economy and to promote the growth of international relations
and trade. Admittedly, with many hiccups and problems along the way, this desire to build
international relations and trade has continued over the post-war years and up to the present
day.
In Study Unit 3 we shall be considering some of the specific efforts to promote international
trade through, for example, the removal of trade regulations and barriers, but in addition to
these essentially economic actions to promote internationalism, we have also seen, for
example, an increasing level of co-operation between east and west in a variety of areas
including technology, arms negotiations and even cultural exchanges. The point here is that,
if anything, internationalism as a force underpinning and affecting the world trading
environment, is set to become even more important in the future. As we shall see later in the
study unit, in part, this underpins the growth of a global approach in international business.
The growth of internationalism and the impetus it has given towards the development of
world trade, however, contains some important changes in the nature and composition of
world trade since World War II that we shall now examine.
The Composition of World Trade
We have already noted in Study Unit 1 that world trade has been one of the fastest growing
areas of commercial activity since World War II. This overall growth, however, contains some
significant changes in the composition of this world trade. Some of the more important
changes include the following.
From primary to secondary products
Shortly after the Second World War, a substantial proportion of world trade was
accounted for by trade in primary commodities. So, for example, nations traded their
raw materials with other nations, including, for example, wool, cotton, timber, basic food
commodities such as wheat, rice and so on, and energy commodities such as coal and
oil.
Certainly commodities still represent a large proportion of world trade between
countries, but since the Second World War, trade in manufactured products began to
increase substantially as a proportion of world trade. This increase included trade in
products for manufacturing, such as components and machinery etc., and also
products intended for final consumers ranging from clothing through to electrical
products, cars and so on. By the 1970s and 1980s trade in manufacturing products
had become the major element of world trade.
More recently, this trade has been increasingly accounted for and fuelled by trade in hi-
tech products including, for example, computers and information technology,
biochemical products, genetic engineering and so on. In short, world trade is
increasingly being dominated in terms of manufacture of products by hi-tech industries.
Service trade
Alongside this growth in the trade of manufactured and hi-tech products has been the
growth in the trade of service products. As economies have become more advanced,
so service industries within those economies have become more important, to the
extent that in some highly industrialised countries, such as the United States and the
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United Kingdom, service industries are now economically more important than
manufacturing industries.
Corresponding to this growth in service industries has been a growth in international
trade in services and service products. Admittedly, certain services have always been
traded internationally, for example, the United Kingdoms trade in financial and
insurance services has long been a major part of its trade in world markets.
Increasingly, however, international trade in services has expanded to include, for
example, transport, tourism, telecommunications, consulting and so on. Many service
organisations now operate on a global basis and this growth in the marketing of
services in world trade is set to continue and increase. Later on in the course,
therefore, we shall be looking at the extended marketing mix for services in the context
of marketing internationally.
Not-for-profit organisations
Finally, you should note that the application of business and marketing concepts and
ideas to not-for-profit organisations such as charities, institutions and even political
parties, is now helping to internationalise many of these types of organisations. In the
past, for example, very few charities have operated and certainly marketed, on an
international or global basis, but increasingly these organisations can be expected to
do so, and, therefore, will begin to take a larger share of world trade, albeit that for
obvious reasons this share will never approach the shares accounted for by
manufacturing and service industries.
World Trade Shares
Linked to the changing patterns of trade in manufactured, commodity and service products
are the changing patterns in the composition of world trade which have taken place since
World War II. Shares of world trade can be categorised and analysed in different ways, and
we shall examine these by reference to three criteria, country, geographic area and economic
categories. Each of these provides some useful and interesting insights into the changing
patterns of world trade.
Share by country
Shortly after the Second World War, and despite the devastation of the levels of trade
with the rest of the world wreaked by this, the United Kingdom was still a major player
in world markets. Since the 1950s, however, and needless to say, much to the concern
of interested parties in the United Kingdom, its share of world trade has continuously
fallen. In contrast, the shares of some countries that for long periods of history, and
indeed up to the 1950s, had relatively small shares of world trade have continued to
increase over this period. In fact, as UK shares have fallen, some of these other
countries have been major beneficiaries. So, for example, Japan, Germany and more
recently countries such as South Korea, Hong Kong and Taiwan, have all increased
their shares of world trade.
Admittedly, as we shall see shortly, world trade continues to be dominated by the Big
Three (or Triad as they are often referred to) of the United States, Western Europe
and Japan, but other countries continue to make inroads into the world shares of the
Big Three. Quite simply, over time, patterns of world trade, as measured by shares of
volume and value, evolve and change.
There are numerous and often complex reasons for these changing patterns of share
by country. For example, not surprisingly, shares change as competitive advantages
change between countries. Generally speaking, the more competitive a country is in
the production and marketing of particular products and services, the more likely this
country is to increase its world share in these products and services.
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Interestingly enough, changing patterns of world trade shares are linked to the area
previously discussed of changing patterns of trade in commodities, manufactured
products and services. Remember that the fastest growth in world trade in recent
years has been in manufactured products, and in particular, hi-tech products, followed
more recently by a growth in international services. Obviously, countries that have
concentrated on and/or have an advantage in hi-tech or service industries have
increased their shares of world trade at the expense of countries that have
concentrated on commodity products. In part, this explains the success of Japan in
gaining larger shares of world markets.
Share by economic category
One of the ways of classifying countries is by their stage of economic development.
Hence we can distinguish between:
(i) Lesser-developed countries.
(ii) Newly industrialised countries.
(iii) Highly industrialised countries.
Perhaps as one would expect given our discussion of the growth in trade accounted for
hi-tech and service products, when considering the composition of world trade by
economic category, once again the highly industrialised countries have in fact
increased their share of world trade. Admittedly, there are some notable exceptions to
this, particularly in the case of the newly industrialised category of countries as already
mentioned. Taiwan and North Korea and more recently China and India, have
increased their share of world trade substantially, but overall, these are indeed
exceptions. The lesser-developed countries in particular have lost out with respect to
their share of the rapid growth of world trade, needless to say, adding to their already
often severe economic problems.
Share by region
Regions can also, of course, classify the world. These regional groupings may be by
geographical location, e.g. Western Europe, Africa, North America, Latin America, Asia,
etc, or, for example, by political or economic groupings, such as the European Union
(EU), NATO countries, Latin American Free Trade Area (LAFTA), etc.
Changing patterns in the composition of world trade are more variable and harder to
isolate in this way than when analysed by our previous two categories. So, for
example, Asia as a geographical area has been a major player in the expansion of
international markets and this is reflected in the increased share of world trade in this
region. In comparison, Eastern Europe as a region has tended to lose out in shares of
world trade. One thing we can say is that there is a close relationship between
economic groupings of countries (particularly those which have formed trading bodies)
and their share of world trade, so, for example, countries which belong to the European
Union, the Asian Pacific Economic Co-operation, members of the Association of South
East Asian Nations and so on have, because of the power and concerted planning
associated with such trade bodies and groupings, tended to increase their share of
world trade compared to those countries and regions which have not formed such
bodies.
A Shrinking World
Another set of factors affecting the world trading environment have again already been
referred to in Study Unit 1, namely the speed and ease of travel and the growth of global
communication technologies. These have resulted in what is often referred to as a shrinking
world. This, in turn, has had a number of effects on the pattern and nature of world trade; for
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example, the speed at which transactions can occur between business and customer has
been substantially increased.
Communications, including facets such as purchasing and promotion, are increasingly
electronically based and facilitated. Once again, it is the more developed economies that
have benefited from these developments at the expense of the lesser-developed countries.
Uncertainties/Turbulence
Always an uncertain environment in which to trade compared to domestic marketing, the
world trading environment has become more turbulent and dynamic in recent years. There is
a high degree of political and economic uncertainty when conducting business across
international boundaries. Changes can occur very rapidly. Take, for example, the collapse of
the Soviet Bloc and the removal of the Berlin Wall as a prelude to the reunification of Eastern
and Western Germany.
Both businesses and governments try to remove some of these uncertainties and turbulence
through, for example, trading agreements, political treaties and so on. But the speed at
which social, technological, political and economic changes take place in the world trading
environment has been itself increased by some of the developments already discussed such
as global communications, speed of travel and so on. There is no doubt that the world
trading environment of the future will continue to be uncertain and turbulent for business.
The Internet and the Worldwide Web
This now ubiquitous technological development is already beginning to affect world trading
patterns and practices and we shall return to this area, therefore, at several points during the
course. Global trading on the Internet, although relatively small in comparison with other
methods for facilitating world trade, is growing and is likely to have a major effect on the
nature, patterns and practices of world trade in the future. So much so that no business can
afford to ignore this aspect of the world trading environment.
There are a number of reasons why the Internet and the Worldwide Web is likely to become
an increasingly important aspect of international trade and marketing. In particular, these
technologies and developments facilitate both the ease and speed of conducting transactions
across national boundaries. Increasingly, consumers will buy from whichever companies and
countries can satisfy their needs, doing all this from the comfort of their own homes.
Although the number of people in global terms connected to the Internet and Worldwide Web
is still relatively small, more and more people will purchase in this way as computing power
becomes increasingly cheap and powerful.
B. THE BIG THREE THE TRIAD
As we can see, then, the world has changed over the past few decades. It is worth returning
to the fact that three parts of the world have become economically significant. The United
States of America, a dominant economic force during the 20th century, has been joined by
Japan and Western Europe. To give you some idea of their importance, the United States
accounts for about one third of the worlds annual income, the European Union one third and
Japan one fifth. This leaves 10 15% for all the rest of the world.
Obviously it would be wrong to ignore the importance of countries outside the big three (or
The Triad, as they are called by the well known Japanese writer, Kenichi Ohmae). In some
markets, other countries might be much more important. The main markets for mining
equipment, for example, might be found in Africa and Australia. However, the significance of
the big three should not be ignored. Not only do they represent the big consumer, industrial
and government-influenced markets in the world, but also the biggest companies in most
markets usually have their headquarters in one of the three points of the Triad; for example
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the worlds largest advertising agency, Dentsu, is in Japan and the other main world-size
advertising agencies are based in the US, the UK and France. In addition, the worlds largest
banks and car manufacturers are to be found in the Triad.
The definition of the Triad countries does cause some problems. The definition of Japan is
quite clear, but it is less so for the United States (should we include Canada as well?) and is
much less clear for Western Europe. Does this mean the current 27 countries of the
European Union or should it also include the EFTA countries (Norway, Switzerland, Iceland
and Liechtenstein)? This is probably the best way to view Western Europe today. The EU
and EFTA signed an agreement to form a trading area to be called the European Economic
Area (EEA). You should also note that other countries in Europe have expressed a strong
interest in joining the European Union (e.g. Turkey and the ex-COMECON countries, Poland
and Hungary).
The success of economic groupings (which will be discussed in more detail in the next study
unit) has not gone unnoticed by countries across the world. The tripartite NAFTA (North
American Free Trade Association) between the USA, Canada and Mexico may be a
precursor to a North American Common Market and there also appear to be efforts towards
the creation of a Pacific Rim Common Market (PRCM). These developments may influence
the primacy of the Triad in world trade in future years, as may the opening up of the Chinese
market.
C. CLASSIFYING THE WORLD
There are over 200 countries in the world. In a changing world, changes in nation states
sometimes happen quite easily and sometimes with great difficulty. Namibia emerged in
1990 after a considerable struggle to gain independence from South Africa. Yugoslavia has
been ripped apart during the 1990s, making the end result into country divisions difficult to
predict. On the other hand, the division in 1993 of Czechoslovakia into two countries, based
on Czech lands and Slovakia, was negotiated peacefully.
Classifying by Gross National Product
It would be possible to rank all the countries in the world according to the total size of their
gross national product (GNP). GNP data is available for most countries in the world, making
it one of the most widely available statistics, and this makes it helpful in comparative
analysis.
To facilitate comparison, it is necessary to convert the total GNP for every country to a
common currency. It is usual to use US dollars ($), but you should note that, as exchange
rates vary, often considerably, the process of conversion causes some distortions and can
give different rankings from one time period to another.
GNP figures give an indication of the likely business opportunities in a country. In a very
general way, countries with high GNPs will provide larger market sizes than countries with
lower GNPs. However, the figures themselves can be misleading as some countries include
certain items, whereas others omit them.
A more useful approach than using total GNP is to compare countries on the basis of per
capita GNP (GNP per person in the total population). This allows account to be taken of the
number of people living in a country to give a more realistic view of spending power. Using
this basis, we can divide countries into high income and low income countries. We need to
take some dividing line between high and low. This is open to debate, but if, say, $5,000 per
capita were taken, we would obtain the breakdown shown in the following two tables.
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Examples of High Income Countries
Australia Libya
EU countries (exc. Portugal) New Zealand
EFTA countries Oman
Israel Saudi Arabia
Japan United Arab Emirates
Kuwait United States of America
Examples of Low Income Countries
Afghanistan Ethiopia Pakistan
Bangladesh Gambia Malaysia
Brazil Ghana Uganda
Myanmar (Burma) India Vietnam
Chad Kenya Zaire
Classifying by Stage of Economic Development
As mentioned when looking at world trade shares earlier in the study unit, there are a
number of different ways of grouping countries by stage of economic development. For our
purposes we do not need to go into great detail. Remember that one of the most common
ways of classifying by stage of economic development is into lesser-developed countries
(LDCs), newly industrialised countries (NICs) and highly industrialised countries.
Lesser-developed countries
This group includes most of sub-Saharan Africa, some of Asia and South America.
These countries are poor, have low GNPs and often lack many of the conditions for
economic development. In particular, they might lack capital, trained and well educated
workers and managers, natural resources (for example, good agricultural land, energy
sources, and raw materials), a developed infrastructure of transport and
communications and political stability.
On the face of it, LDCs offer little encouragement for business. They are often
associated with greater environmental uncertainty as political regimes can change
abruptly, this, linked with low market size, discourages long-term investment by
international companies.
There are, however, some market opportunities and sometimes the hope of growth in
the future. Opportunities can result from the spending associated with economic aid
packages from richer countries or projects financed through loans from institutions like
the World Bank.
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Newly industrialised countries
In relative terms, this group would include the South-East Asia countries of Singapore,
South Korea and Taiwan. They are sometimes called the S.E. Asian tigers.
There are considerable variations in the industrial development of the NICs. During the
development process some countries, for example Brazil, have run into substantial
economic difficulties. This can result in high inflation rates, balance of payments
difficulties and the imposition of government controls on foreign exchange.
NICs can offer considerable business opportunities. If their development is successful
they will usually be growing rapidly. This growth gives increased market opportunities
for consumer and industrial products.
NICs also pose something of a threat. In the process of growth, they might
aggressively develop their production capabilities as well as their approach to
exporting. They might take some export markets from other established exporters and
may even penetrate domestic markets of the more developed nations. In addition,
NICs often provide a low cost base for production. Moving production to such
countries as Taiwan reduces employment opportunities and GNP in the more advanced
countries, forcing them, in turn, to move increasingly into more sophisticated products
and services with higher amounts of added value.
Highly industrialised countries
This group would include the Triad, but goes wider. One manifestation of the major
industrialised nations is the so called G7, Canada, France, Germany, Italy, Japan, the
United Kingdom and the United States, who, as the seven wealthiest nations in the
world, meet once a year to discuss economic and political issues. The continued
attendance of Russia has raised the expectation that it will eventually be asked to join.
Other countries, for example Australia, could be included in the highly industrialised
country group.
This group of countries is especially attractive to business. They have high levels of
income spent on a variety of consumer and industrial goods and, whilst there are
various restrictions placed on exports to these countries (e.g. tariffs, quotas, technical
standards and health and safety requirements), they are usually much more open to
international trade than the LDCs and NICs.
The sheer attractiveness of this group of countries also results in them being very
difficult markets. The existing companies fight hard to maintain market share and they
are usually very aggressive towards new entrants into their markets. The Japanese
market is usually portrayed as particularly difficult. This is partly the result of very
competitive domestic (i.e. Japanese) companies, partly the result of strong cultural
differences between Japan and the rest of the world, partly the result of Japanese
restrictions, and partly the result of poor quality marketing by companies attempting to
enter the Japanese market.
Recent changes in the China and India must not be underestimated growth in these
countries is on the verge of surpassing all known records. It is now the worlds third
largest economy and is likely to be the largest by the turn of the century. However, this
growth is not equal across the whole country. Major growth has generally been limited
to the coastal regions where approximately one quarter of the population lives and
where income growth is approaching 10% per year, whilst inland China should perhaps
be included in the LDC category. This will, of course, present particular challenges to
international business.
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D. A NEW FOCUS GLOBAL CONVERGENCE
As we saw in Study Unit 1, most companies start by selling to their local or regional markets.
There is then a development, as the domestic market becomes saturated, towards an
international focus, based on the following pattern:
Domestic sales.
Domestic sales with a few exports, usually resulting from reacting to orders received.
Domestic sales plus exports; exports are now important to the company and it will
become more proactive in seeking such opportunities.
The development of international markets by investing in other countries, i.e. setting up
sales offices, distribution depots and production units.
The development of an international approach that looks at world opportunities, a
global approach.
Note that the trend is not necessarily a linear one through the various stages in terms of the
growth of a company. In very large countries like the United States, companies can become
very large but still not have a complete coverage of their national market, whereas in much
smaller countries, for example, Finland, Sweden or Switzerland, companies can quickly
develop in their own national market and then seek to grow through export markets well
before the American company. Also, whilst many companies experience a gradual
development towards more sales to non-domestic markets until they reach a point in which
international sales are more important than domestic sales, other companies quickly develop
a strategic approach that seeks to achieve international success.
There are a number of forces that have encouraged the development of this global approach.
However, not all forces are moving companies in this direction and there are significant
factors pushing in the opposite direction.
Drivers of the Global Approach
We can identify eight major forces:
Similarity in market needs
Some markets cannot be adequately segmented within country boundaries. The
market for jeans or pop music, for example, is widespread and is not restricted to any
particular country. Despite significant basic cultural differences the product appeals to
a worldwide audience. In business-to-business markets there are increasingly similar
needs around the world for computer systems, telecommunications solutions and for,
say, business travel.
The high cost of new technologies
New technologies are usually much more expensive to develop than the ones that they
replace. Old electro-magnetic telephone systems are being replaced by high cost
electronic ones driven by costly software systems. Previously, the electro-mechanical
system costs could be recovered by sales within the country. This is no longer possible
as the costs are too high. The result is that fewer companies can afford the high
research and development costs and few have the operational capability to sell across
the world on a sufficient scale to break even on the initial costs. Those that do are the
companies that have to take a much wider world view; a global approach.
Communication and transport systems
The development of communication and transport systems that enable rapid message
transmission, person transport and freight delivery around the world has resulted in the
feeling that the world is becoming a global village. Whilst this is an exaggeration, it is
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undoubtedly true that the differences in the world are being reduced by international air
travel and international voice and data transmission.
Controlling costs
Increasingly, survival in a tough world depends on driving down costs whilst
maintaining or improving quality. Lower costs are increasingly achieved through
buying, sometimes called sourcing, products from low-cost countries, particularly newly
industrialised countries such as China or others in the Far East or South East Asia.
Other companies have established their own factories (or joint ventures) to take
advantage of lower labour costs and lower land costs.
Competition
There is a need to develop a more sophisticated approach to competition strategy and
the extent of increasing internationalism is very much influenced by the actions of
competitors. If competitors are more efficient because they operate globally, then this
becomes a strong driving force. With some companies using a co-ordinated global
strategy, those competing on a simple national level are at a disadvantage. Companies
are being forced to look at markets together, to attack in some and to defend in others.
Transference of experience and learning
The ability of large companies to transfer experience from one market to another and
learn from business activities in different parts of the world means that they are able to
apply that knowledge quickly in other parts of the world. They can learn how to do
things, and how to do things cheaper, to obtain competitive advantages and
improvements in efficiency in all parts of their operations. The opportunities to
standardise, make economies and to transfer good practice from one market to another
encourage moves to a more and more international approach.
The development of world region markets
European colonisation of large parts of the world had a profound impact on the patterns
of world trade over the period from the 16th to the mid-20th century. In some senses,
for the developed countries of Western Europe, this trade was almost an extension of
domestic selling in that their markets were essentially the colonists in another country.
However, the patterns and links between countries built up during this period have
endured to provide worldwide markets for both the former colonising powers and the
ex-colonies themselves.
Regional groupings like the ASEAN group of countries in South-East Asia and the
European Union have similarly encouraged a wider focus. It has become evident that
the development of the Single European Market starting in January 1993 led
companies in Europe to consider countries with which they had never traded before as
being their natural markets.
When this is linked with the pattern of trade resulting from the history of European
colonisation, you can see the opportunity for a more global approach.
Quality
Quality has become a major factor in market success. Good quality has always been
important, but in increasingly competitive market places, the goal is a zero defect, total
quality every time philosophy. Japanese companies spearheaded this approach and
their success has meant that others have had to follow suit.
A further factor here is the increasing use of benchmarking. This is the process of a
company comparing its performance across a range of indicators with others in the
same or similar industry. The aim is to achieve continual improvements along the path
to the goal of excellence. The approach of drawing comparisons with the best
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performing companies inevitably causes the company to look at international
competitors.
The reason why quality necessitates a global approach is that high quality demands
excellent systems. It is easier to spread the costs of those systems if the sales volume
is high, hence the need for a wider than domestic approach.
We should note, though, that developing approaches to take advantage of these drivers is
not, of itself, a guarantee of success. As with all business, it is necessary to develop
sustainable differentiation to achieve success. Whilst lower costs need to be gained, it is
difficult to sustain lower costs than the competition over a long period of time. Technologies
change, markets change and, therefore, past cost advantages can disappear. Companies
have to develop superior systems and superior brand and company images to make
customers prefer their product.
Forces Working to Keep Markets Localised
Whilst these drivers toward global business are strong, you should not form the impression
that the trend is inevitable in all aspects. There remain a number of forces that work to keep
markets localised:
Market differences There will always be particular differences between markets.
For example, different countries have different climates and different cultures, warm
clothing is necessary in Scandinavia, but cool clothing in Central Africa, and frogs legs
and snails are delicacies in France but few will eat them in England.
History Companies will have different market shares and different competitive
positions in different country markets. It is often difficult to standardise these
differences to go for a global approach.
National controls/barriers to entry As we shall see in the next study unit, most
countries will have tariff or non-tariff barriers (NTBs). These restrict entry and increase
costs and delays, all resulting in difficulties in the development of global business.
Management myopia and organisational culture In some companies, the wider
international and global opportunities are not seen because management is too
wrapped up in its domestic market. The global approach requires vision, international
experience and a good understanding of managing complicated organisations.
29
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Study Unit 3
Understanding International Trade
Contents Page
Introduction 30
A. The Reasons for International Trade 30
Theories of Advantage and Factors of Production 30
More Recent Theories of International Trade 31
B. Trade Barriers 34
Reasons for Erecting Trade Barriers 34
Tariffs 34
Non-Tariff Barriers (NTBs) 35
Dumping and Anti-Dumping 35
C. World Trade Bodies and Institutions 36
The General Agreement on Tariffs and Trade (GATT)/The World Trade Organisation
(WTO) 37
The International Monetary Fund (IMF) 38
The World Bank 38
D. World Regional Groups or Trading Blocs 39
Types of Grouping 40
The European Union (EU) 40
30 Understanding International Trade
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INTRODUCTION
This study unit continues the process of understanding and analysing the world trading
environment begun in Study Unit 2. In this study unit we shall be looking at the economic
rationale for international trade, introducing, in the process, some of the major theories that
have been proposed to explain why, and how, nations trade. We shall also explore why
international free trade is generally favoured and supported by economists and many
governments, and how, despite this support, there are also many barriers to international
trade. Finally, we shall review the main international bodies that influence, promote and to
some extent regulate world trade, and consider the worlds major economic regional groups
or trading blocs as they are often called.
A. THE REASONS FOR INTERNATIONAL TRADE
International trade, of course, is not new; nations have been trading, and often fighting to
trade, with other nations for thousands of years. The simple reason for this is that trade, and
especially international trade, brings wealth and economic growth. Furthermore, few
countries if any, can be totally self-sufficient in all the goods and services that are needed to
be consumed within a country. The only solution is to do without or trade with other nations.
Sometimes, of course, nations trade with other nations for non-economic reasons, for
example, to develop international relations with other countries for strategic and political
reasons, or perhaps even to help other nations develop their economies. The primary
reasons for international trade, however, are essentially economic. Perhaps as we would
expect then, it was the economists who first provided a rationale and a set of theories to
explain the reasons for, and the patterns of, world trade. We shall begin by examining the
economists earliest theories of trade before moving on to consider more recent theories,
including the emergence of more market and competitor-based theories of trade.
Theories of Advantage and Factors of Production
The 17th and 18th century economists were amongst the first to provide a rationale for
international trade. Perhaps the first recognised theory was that developed by Adam Smith
based on the notion of absolute advantage. This theory was further refined in Ricardos
theory of comparative advantage. Each of these theories is outlined below.
Absolute advantage
This is developed from the work of Adam Smith in The Wealth of Nations published in
1776. If one country can produce, for the same costs, more products than another
country, there is an advantage to be gained by specialising production in the higher-
output country. In effect, the costs per unit are lower.
Comparative advantage
Attributed principally to David Ricardo, the important idea here is the economists
concept of forgone opportunity. In producing, say, aeroplanes, the opportunity to
produce consumer durable products will be missed. The ideal approach is to
concentrate on those products and services that give the best relative position.
To take an extreme example, country X might have an absolute advantage over
country Y in every type of product and service. Country X should concentrate on those
items that give the best returns i.e. those items in which it is able to add most value. It
is probable that country X will concentrate on complicated manufacture requiring a
talented and well educated and trained workforce. Country Y will produce more
straightforward products and services. Country X will gain because it produces more
Understanding International Trade 31
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high added value items. Country Y will gain because it will have access to the products
produced by country X at lower prices than country Y could achieve.
These early economic theories were very influential, not only in exploring the rationale for
international trade but also in doing so, providing the basis for the promotion of such trade by
governments and individuals. There is no doubt that the major legacy that these early
economists left was the justification, ever since, for the protagonists of free trade. Important
and influential though these early theories were, they did have shortcomings, particularly as
countries and international trade itself began to develop further. Changes in the patterns of
international trade led to two further additions to the economists theories of international
trade, in particular, the so-called productivity theories and the factor proportions theory.
Each of these theories is outlined below.
Productivity theories
There are various explanations for trade flows that look in detail at the productivity of
factors of production. Early theories concentrated on the productivity of labour. If one
country had people who produced more products or services, their costs would be
lower. Trade would flow from this country to the other less productive countries.
The weakness with the labour productivity theory is that labour is not the only factor of
production. In the 20th century, the full range of factor costs or factor output per time
period is still important. However, this needs to be balanced by the different factor
inputs. Some companies can compensate for high labour costs by applying capital to
increase the use of machinery. In addition, those companies tend to specialise in
advanced innovative products with high levels of service. Germany and Sweden, both
high-cost labour countries, are examples of this approach.
Factor proportions theory
This theory assumes different factor proportions for different products. It also assumes
that different countries will have different amounts of resources (i.e. factors of
production). For example, if the UK wishes to gain more exports, it might wish to
consider investing in education and training to develop a workforce capable of
generating the kinds of added-value, knowledge-based products and services likely to
be demanded in the future.
More Recent Theories of International Trade
We have seen how dynamic the world trading environment is. In order to explain some of
the changes in the patterns of world trade which we have seen in recent years, a number of
comparatively new theories of international trade have been developed which reflect some of
the marketing and competitive strategy reasons for the nature and patterns of world trade.
Amongst the most important theories to emerge recently, are the so-called Diamond
approach theory developed by Michael Porter and Raymond Vernons theory of an
International Product Lifecycle which was briefly introduced in Study Unit 1. Each of these
theories is outlined below.
The Diamond approach
Recent work by Michael Porter developed from dissatisfaction with the completeness of
comparative advantage based on factors of production. Porter concludes that at best,
factor comparative advantage theory is coming to be seen as useful primarily for
explaining broad tendencies in the patterns of trade (for example, its average labour or
capital intensity) rather than whether a nation exports or imports in individual
industries.
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The problems with the standard theory of factor comparative advantage are that it
assumes:
(i) That there are not economies of scale.
(ii) That technologies everywhere are identical.
(iii) That products are undifferentiated.
(iv) That the pool of national factors is fixed.
(v) That factors such as labour and capital do not move between nations whereas,
for example, the Single European Market is designed to allow the free movement
of factors of production across the national boundaries of the member countries
of the EU.
(vi) That all companies follow the same strategy.
It also makes no allowance for the competitive forces that operate within industries.
The explanations of the classical economists were much more appropriate for the 18th
and 19th centuries. During this time, industries were more dependent upon local
supplies of raw materials and production was more labour- and less skill-intensive.
Most industries were fragmented and there was little concentration of power. Business
acted in a way that was close to the economist's concept of the perfect market.
During the 20th century, industries have become more knowledge-based, with higher
levels of capital employed relative to labour. Industries are no longer forced to exist
close to raw material supplies. Japanese industries rely on raw materials transported
hundreds and thousands of miles. Industries are now, usually, composed of a few
large companies along with many smaller companies. The concentration of power
generally follows the Pareto principle of the 80:20 rule. In these situations, strategic
decisions by the major companies (sometimes they are referred to as players) can
change the industry shape, and can influence which countries export and which ones
import the goods that they manufacture.
In seeking answers to why nations achieve international success in a particular
industry, Porter has constructed a diamond-shaped diagram. The four broad attributes
that shape the competitive environment that help or hinder the creation of competitive
advantage are placed at the four points of the diamond. The four broad attributes are:
(i) Factor conditions The types, availability and quality of the factors of
production.
(ii) Demand conditions The demand patterns in the domestic market for the
companys product or service.
(iii) Related and supporting industries The existence or otherwise of
internationally competitive companies that provide components, systems and
other services.
(iv) Company strategy, structure and rivalry This point includes much of Porters
original work on the competitive forces facing companies in an industry. How are
companies created, organised and managed? What are the competitive
pressures in the country for this industry?
A significant factor appears to be the development of sufficient expertise and support to
enable the industry to grow. The growth must, however, be accompanied by the strong
shaping force of competition. In this way the industry becomes internationally
competitive and will be able to export goods and services to other countries.
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International product life cycle
The standard product life-cycle (PLC) concept was applied in the 1960s by Raymond
Vernon to international markets. The basic idea was a trickle down from advanced
countries to the less advanced countries.
It assumes that advanced countries will innovate products and services. Over time,
these new products will mature in their domestic markets and will, then, be introduced
into the developing and the less-developed countries. In these countries the PLC will
start with the introduction phase, etc. Thus, products would be developed in, say, the
US, but the PLC for that product would be straddled across the export of the product to
less developed markets.
Figure 3.1: The trickle or cascade approach
This approach was much less likely to happen in the turbulent 1990s. Many
companies take a strategic approach to product development and product launch, with
products often being launched, in a co-ordinated way, into several markets at once.
This more modern approach has been referred to by Keegan as the shower
approach.
Figure 3.2: The shower approach
In addition, the concept of the international PLC does not take account of other
changes in the late 20th century:
(i) New products and services are being developed in many different countries, not
just advanced countries.
(ii) There are fewer demand differences between countries. We have not moved to
the global village, but there are considerable signs of convergence.
(Note that, despite these reservations about the international PLC, there is little doubt
that the original concept of the product life cycle will operate for each product in each
country market.)
Advanced Country
(e.g. US)
Developing
Countries
Less Developed
Countries
Co-ordinated
Launch Programme
Advanced Country
(e.g. US)
Developing
Countries
Less Developed
Countries
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B. TRADE BARRIERS
Many of these theories of world trade, and particularly those of Adam Smith and Ricardo,
sought not only to explain the rationale of international trade, but also the benefits and
therefore the importance of this trade being unrestricted or free. As we shall see shortly, this
explains the commitment of many governments to developing free trade by removing
restrictions and the formation of world trade bodies and institutions to promote and facilitate
the growth of such free international trade.
Notwithstanding this, however, and notwithstanding, as we shall also see later, concerted and
continuing attempts to remove them, there exist a number of barriers to international trade
which serve to make such trade more difficult and sometimes impossible between nations.
Before we look at some of the world trade bodies that exist specifically to promote freer world
trade, we need first to understand some of the main reasons and types of trade barrier,
together with the notion of dumping in international trade.
Reasons for Erecting Trade Barriers
Countries, or rather governments, may erect trade barriers for a number of reasons. Some
of the most frequent reasons are as follows:
Protection of home markets/industries and employment. In some instances, barriers
might legitimately allow an infant industry to establish itself before the full forces of
competition can shake it, perhaps to breaking point. In other instances, the barriers
might allow the domestic industry to become inefficient, resulting in domestic
consumers paying higher prices and having less up-to-date products and, perhaps,
lower levels of customer service.
Strategic (military) reasons.
Retaliatory reasons, political, economic, etc.
As bargaining levers to secure desired objectives in international relations with other
countries.
These, then, are some of the major reasons (or rather justifications) for introducing and/or
increasing trade barriers. One author has in fact identified some 850 different types of trade
barrier used by countries and companies, but the main categories and types found in
international markets are outlined below.
Tariffs
Tariffs are taxes or duties that are placed on imports and their use is widespread around the
world. The purposes of tariffs vary from a means of raising revenue for a government to
creating barriers to entry to the domestic market.
The main types of tariff are as follows.
Ad valorem This is the adding of a surcharge as a percentage value of the goods
say, for example, 9% to the landed price of the product at the port of entry.
Specific duty This is a duty charged on the physical specifications of the product
for example, two dollars per ton of steel. In this instance the duty falls more heavily on
lower priced, less-value-added variants of the same product type. A special steel might
have a much higher market value than ordinary steel. With a specific duty, both would
be charged at the same rate. Obviously the percentage increase in price is higher for
the ordinary steel than it is for the special steel.
Special and temporary tariffs In some instances, countries will apply surcharges to
increase the price level for specific goods. This may be to protect particular domestic
industries or, sometimes, may be applied as an anti-dumping measure.
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In addition, compound or mixed duties, which are combinations of types Ad Valorem and
Specific Duty, may be applied.
Non-Tariff Barriers (NTBs)
Whilst there has been a general reduction in the range and levels of tariffs, non-tariff barriers
have tended to increase. For example, the Single European Market eliminated tariffs
between the 27 member states, but is still wrestling with the need to harmonise NTBs.
The main types of non-tariff barrier are as follows.
Public procurement policies This is selective and discriminatory buying policies on
the part of governments and state-owned-industry. In many countries there is either an
explicit or implicit buy our own national products policy (e.g. in the UK, Buy British).
In the EU, no favouritism can be shown to national or local suppliers. Goods and
services have to be selected either at the lowest tendered price or by an agreed best
value formula.
Quotas Under this type of barrier, only a specified amount of particular goods are
allowed to be imported during a time period (usually, over a year). Once this amount is
filled, no more goods can be imported until the next time period.
This restricts the potential market for exporters and makes it easier for domestic
producers to gain market share. In addition, the exporter is faced with uncertainty, it
might be difficult to establish whether the quota is full or not. If the quota amount has
been reached, the exporter will have to wait until the next time period when the quota
resumes.
Technical standards Many countries have technical requirements applying to
specific goods within the domestic market. Sometimes these can be used to make it
easier for domestic suppliers than those seeking to gain entry. The domestic suppliers
might understand the regulations better, perhaps continually changing the regulations
to keep the balance of advantage on their side.
Health and safety standards These can be used in much the same way as
technical standards.
Restrictive administration procedures A classic example of this occurred during
the 1980s when the French attempted to slow the entry of Japanese-made
videocassette recorders. They did this by making the only entry into France through
one town for Japanese videocassette recorders. This caused very considerable
delays.
Dumping and Anti-Dumping
Although generally speaking, barriers to trade are, in economic terms at least, largely
indefensible, there are sometimes good reasons for imposing them, at least in the short term.
One situation where barriers to trade might be justified is in the case of anti-dumping
legislation that is enacted to protect a market from unfair competition.
Dumping occurs when a product is sold in another country at a price below its actual costs.
There may be some difficulty in establishing what the actual cost is it can be argued that it
should include all costs (i.e. direct and indirect costs) although it is generally agreed that, in
the short term, the price should cover the direct, attributable costs of producing a specific
quantity of product.
There are three main types of dumping:
Sporadic This happens from time to time, usually as a result of surplus inventory or
stocks. A company might prefer to find an export market to unload the surplus rather
than risk unsettling the domestic market in which the company has a major interest.
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Predatory This is a type of competition strategy in which a company seeks to
destabilise a market with the objective of gaining market share by selling at very low
prices. Once the domestic producers are driven out of business, the company can
increase prices and recover profit levels.
Persistent This is the continued sale of products at very low prices. This was a
particular problem with ex-COMECON countries where, in countries like Poland,
Hungary and the USSR, central planners established prices and costs arbitrarily. Costs
and prices showed no relationship to conventional western accounting practices.
Most countries have anti-dumping legislation. In the main, this revolves around particular
commodities, steel, coal and basic industrial chemicals, textiles and agricultural produce.
Such actions are permitted under WTO (see later) rules under two specific criteria:
1. Sales at less than fair value.
2. Material injury to domestic industry.
Note that anti-dumping rules influence both domestic and international markets. In domestic
markets, home-based companies have a measure of protection from unfair competition
caused by very low prices from imported goods. This is necessary to prevent them losing
market share with damaging implications for both the companies concerned and the
domestic economy as a whole. In international markets, businesses are restricted in respect
of their pricing policies, because very low prices will be challenged by anti-dumping actions.
C. WORLD TRADE BODIES AND INSTITUTIONS
We have already discussed the fact that the early economists established the rationale and
the benefits of free world trade. During the 1920s and 1930s, a major recession spread
throughout the world. As economies collapsed, governments sought to maintain domestic
output and employment in their own economies and a wave of trade protectionism swept
across the globe. Tariffs, quotas and outright bans on imports were introduced in a bid to
prevent industries collapsing further.
We now know, of course, that this did not help. Indeed, as Smith and Ricardo would have
predicted, it made the worldwide recession even worse.
Economies were just beginning to recover from this recession when the Second World War
intervened. As a result, a large part of international trade, or at least conventional trade,
collapsed, as did many economies as a result of their war efforts and damage to
infrastructure and industries caused by hostilities.
By the end of the war, therefore, many economies were totally crippled and some countries
such as Germany and Japan were totally crushed. In an effort to help these countries, and
thereby the world economy, a number of international bodies and institutions were formed,
principally with the objective of helping this worldwide reconstruction, but underpinned very
much by the philosophy of promoting the growth and return of free world trade. Since their
establishment, some of these bodies and institutions have had a major influence and impact
on world trade and continue to have an important impact still today.
Of particular significance and importance are the General Agreement on Tariffs and Trade
(GATT), more recently known as the World Trade Organisation (WTO), the International
Bank for Reconstruction and Development (often referred to as The World Bank) and the
International Monetary Fund (IMF). Each of these is discussed below.
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The General Agreement on Tariffs and Trade (GATT)/The World Trade
Organisation (WTO)
GATT was set up after World War II in an effort to avoid the difficulties of the 1920s and
1930s. During the inter-war years the world recession had been compounded by countries
individual policies on importing and exporting that were aimed at ensuring their preferential
position in the international market place. GATT aimed to create order and predictability in
world trade with the objective of encouraging the development of this trade around the world.
GATT as it stands today is not just one treaty agreed in 1948 but also a large cluster of
around 180 that over the years have shaped its constitution and thus its direction, its
membership and its mission. There have been seven negotiating rounds, each lasting an
average of nine years, which clearly demonstrates the complexities of the issues that GATT
tried to address in a fast changing world trading environment.
Following the approval of the Final Act of the Uruguay Round of GATT in 1993, the World
Trade Organisation (WTO), a permanent body with a status commensurate with that of the
International Monetary Fund or the World Bank, effectively replaced GATT.
It is the responsibility of the WTO to monitor agreements to reduce barriers to trade, such as
tariffs, subsidies, quotas and regulations that discriminate against imported goods.
All members of GATT automatically became members of the WTO on ratification of the
Uruguay Round. Currently, the WTO has 132 members and a further 29 countries which
have observer status.
The aim of the WTO is to create order and predictability in world trade. The principles that
are embodied in the WTO are:
Reciprocity The idea is that if one country reduces its tariffs against another
countrys exports, then it can expect the other country to reduce the tariffs against its
exports.
Non-discrimination Under the terms of membership, nations agree to apply their
most favourable tariff rate to other WTO signatories. It is, however, possible to have
preferential rates that may be used to encourage trade with particular nations. For
example, the UK may wish to use a preferential rate with Commonwealth countries,
particularly those that are less developed. The highest degree of preferential status is
the most favoured nation (MFN) status and is accorded on a bilateral basis.
In recent years the granting or withdrawal of MFN has been seen as a political means
of rewarding or punishing countries. For example, President Carter of the United
States of America withdrew MFN from the USSR over the human rights issue with the
Communist country, and President Reagan withdrew MFN from Central and Eastern
European countries when martial law was imposed in Poland.
The potential economic impact of either losing or gaining of MFN status should not be
underestimated. As we have already discussed, self-sufficiency is virtually impossible
and the stability of most countries economies is tied into the import and export market
and more importantly into the countrys position within that market.
Fair trade This principle prohibits export subsidies on manufactured goods and limits
their use on primary products.
Whilst the aim and principles of the WTO are relatively simple, the complexities surrounding
their application and indeed their influence as we begin the new millennium must not be
underestimated.
Since the establishment of GATT, more and more groups of countries have looked to become
unified from an economic viewpoint, the European Union being perhaps the most successful
to date. Increasingly the dimensions of the Pacific trading markets are changing as a
response to shifts in regional trade flows. Economic indicators are pointing to an increasing
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interdependence among these nations. At the same time, Europe continues to debate the
strengthening and extension of its economic ties.
The impact of the WTO can appear to be most significant at a national level. However, its
potential impact at an organisational level is something that should not be overlooked and we
will consider this further in the next unit when we look at influences on the international
business environment.
The WTO is not without its critics. Towards the end of 1999, anti-globalisation protestors
held a series of demonstrations which turned into riots outside the building in which the WTO
was holding its next round of meetings. There were a number of reasons for these protests,
but essentially, a number of critics feel that the WTO represents the interests of the highly
industrialised countries, and particularly of the United States, at the expense of the lesser-
developed countries. This, they suggest, continues to repress these developing countries,
despite the WTOs commitment to raising the living standards for all the people of the world.
There are also those who believe that the WTO represents the epitome of commercial greed
and capitalism and hence are determined to destroy it. Yet others believe that world trade
helps destroy the environment. These demonstrations were so successful that the
discussions had to be postponed. There is little doubt that the interests of such pressure
groups and a more socially responsible attitude will have to be taken into account in any
future considerations by the WTO.
The International Monetary Fund (IMF)
The idea for the IMF was developed at the Bretton Woods Conference in New Hampshire, in
the United States, towards the end of World War II in 1944. The IMF was designed to
provide a stable framework for international currencies. Members of the IMF subscribed to a
quota based on expected trade patterns. One quarter of the quota was to be paid in gold or
dollars and the rest in local currencies. The funds were to be used to provide support for
currencies during fluctuations in exchange rates and thus provide stability in the foreign
currency exchange rates that are so important to the development of world trade.
The original intention of the IMF was to provide a support system for fixed exchange rates
between countries. However, in 1971, the US abandoned the gold standard and devalued
the dollar, the end result of which was the development of flexible or floating exchange rates
instead of the fixed rate system.
The structural problems of developing countries often pose grave difficulties for the IMF in
finding acceptable ways to support the developing country whilst at the same time
safeguarding the funds of the IMF. In the 1980s, the IMF had to cope with severe difficulties
experienced by a number of lesser-developed and newly industrialised countries, for
example, Mexico, as a result of their substantial accumulated debts that they were unable to
pay. In the 1990s, the IMF had major new pressures resulting from the collapse of the USSR
when many countries in Central and Eastern Europe needed economic and foreign currency
support during their reconstruction.
The World Bank
The World Bank, officially called the International Bank for Reconstruction and Development,
was also founded in 1944. Its initial role was to assist the redevelopment of countries
crippled economically by World War II. Since the completion of this role, the World Bank has
played a major part in developing the economies of the poorer countries, particularly new
countries emerging into independence from their former colonial status, such as Nigeria and
India (from the UK) and Mozambique and Angola (from Portugal).
The World Bank finances several hundred major projects each year. Loans must be repaid,
with interest, and are subject to guarantee by the government of the borrowing country. The
projects range from developments in agriculture, to telecommunications, to population
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planning, and there are international business opportunities to be gained from World Bank
projects.
The World Bank is also not without its critics. Again, the main criticism is that many of the
lesser-developed countries who have been recipients of World Bank funds in earlier years
have effectively been crippled economically by their large debt repayments and interest
charges. In fact, some countries will never be able to repay the interest, let alone the capital
and so their debts will simply accumulate. Recently, steps have been taken to address this
problem. Some countries have had their debts reduced, and more recently, the United
States and the United Kingdom have cancelled some of them completely.
D. WORLD REGIONAL GROUPS OR TRADING BLOCS
Various groupings of countries have existed throughout the history of the world. These
groups, in the past, were based on empires, for example the Roman Empire. More recently
we have seen the grouping of countries into various types of coalition and federation.
The reason why countries should group together is usually to encourage trade between
them. Subsequently, other forms of economic, political and social integration might be
sought.
Here we shall be looking at some of the major world regional groups or trading blocs. There
are literally dozens of such groups throughout the world if we consider informal groupings,
but we are only concerned with the largest, most powerful and influential. These are listed in
the table below, together with the part of the world in which they operate and their current
member countries.
Table 3.1: Major world trading blocs
Abbreviation Title/Area: [Member Countries]
NAFTA North American Free Trade Agreement: [Canada, Mexico and USA]
EU European Union: [Austria, Belgium, Bulgaria, Cyprus, Czech republic,
Denmark, Estonia, Finland, France, Germany, Greece, Hungary,
Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, The Netherlands,
Poland, Portugal, Romania, Slovakia, Slovenia, Spain , Sweden and
UK]
ASEAN Association of South East Asian Nations: [Brunei, Cambodia,
Indonesia, Laos, Malaysia, Burma, the Philippines, Singapore,
Thailand and Vietnam]
LAIA Latin American Integration Association: [Argentina, Bolivia, Brazil,
Cuba, Chile, Colombia, Ecuador, Mexico, Paraguay, Peru, Uruguay
and Venezuela]
MERCOSUR Southern Common Market: [Argentina, Brazil, Paraguay and
Uruguay]
APEC Asia Pacific Economic Co-operation: 21 nations surrounding the
Pacific rim, including US
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Types of Grouping
There are five main types of market grouping or trading bloc. We can see that there is a
progression through these groupings in terms of their having increasingly ambitious aims:
Free trade area This is an area that has no internal tariff barriers between member
countries. Each country can have different tariffs with other countries. Examples
include ASEAN or EFTA.
Customs union This builds on a Free Trade Area by developing common external
tariffs between the members of the union and non-member countries. Until the end of
1992, the European Community was a customs union.
Common market This builds on the first two by allowing the free flow of factors of
production within the external boundaries of the combined member countries, for
example, in respect of the mobility of people who have the right to live and work in any
of the member countries. The European Community moved to a common market
phase from 1 January 1993.
Economic union This is achieved when the market group shares a common
currency, central bank and other aspects of a harmonised economic policy.
Political union This would be the final step in the harmonisation process.
It is important to be aware of the changing nature of these groupings. Thus, some world
regional groups are developing and moving through the stages from Free Trade towards
Customs Union and Common Market and perhaps Economic Union or even Political Union.
Others are seeking to consolidate their position and draw in more members, thus increasing
their regional spread. At the same time, yet others have been less successful and started to
break up.
Note, too, that different types of group present different threats and opportunities to
international business. Remember that the reasons for the grouping will include similarity of
member interests and a probable increase in trade between the member countries of the
group. Thus, a free trade area developing in the countries of Southern Africa will encourage
trade between the member countries, whilst those outside the free trade area might find it
more difficult to export goods to countries inside the group.
It is important to be aware of the implications of different tariff policies. In a free trade area,
there might be different tariff levels, say 5% in one country and as much as 20-50% in
another country. This will result in considerable price variation and therefore the need for
variety in marketing from one country to another. Within a common market, a common tariff
will be in force, the tariff level will be the same for each member country. Thus, marketing
differences will be based on market and customer differences rather than the tariff difference.
The European Union (EU)
As already mentioned, it is impossible to describe all of these trading blocs, their history and
their aims, objectives and operation in detail. As an example, therefore, we shall consider
the development, objectives and policies of the European Union in some detail, as well as
noting the implications of this form of trading bloc for businesses. (It would be a good idea to
build your own fact file about perhaps two more of the other trading blocs.)
A brief history
The Treaty of Rome established what was then called the European Economic
Community (EEC) on 1 January 1958. Twenty-one other countries have over the
years, joined the original six member countries, Germany, France, Italy, Belgium, The
Netherlands and Luxembourg:
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1973 The UK, Ireland and Denmark
1981 Greece
1986 Spain and Portugal, Sweden, Finland and Austria
2004 Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland,
Slovakia and Slovenia
2007 Bulgaria and Romania
The European Community established a close relationship with EFTA. This has
resulted in the formation of the European Economic Area (EEA). There are no tariff
barriers within the EEA. This extends the tariff-free area beyond the 27 EU countries to
Iceland, Liechtenstein, Norway and Switzerland.
There are a number of preferential trade agreements between the EU and a number of
less-developed Caribbean, Pacific and African countries. These were incorporated into
the Lom Convention signed in 1976.
A major impetus for the EC occurred in 1985 with the issue of the EC White Paper,
Completing the Internal Market. This resulted in the Single Market Act that was
enacted in 1992 by the UK and in 1993 by most other Europeans. The Single Market
was designed to create the freedom of movement of goods, services, capital and
people. To do this a large number of barriers needed to be dismantled. The customs
union phase of the EU had eliminated internal tariff barriers and created common
external tariff barriers. However, many non-tariff barriers remained, for example,
different technical standards, different health and safety regulations, etc.
A strong logic for the creation of the Single Market was to improve the performance of
Europe. The EU with over 370 million people is larger than the United States (250
million) and Japan (125 million), and yet, in almost all respects, it was being
outperformed by the US and particularly by Japan. A dynamic, unified EC (in 1985 the
major recession of the early 1990s was not predicted) would achieve faster economic
growth. The main ways to achieve this were through:
(i) Eliminating different technical standards.
(ii) Eliminating border crossing documentation and delay.
(iii) Eliminating inefficient national preferences in public procurement contracts.
(iv) Eliminating restrictions on citizens of the EC from living and working in other
member states.
(v) Reducing the controls on financial and capital movements.
(vi) Harmonising VAT and excise levels.
(vii) Economic and Monetary Union.
The last step, i.e. the move towards economic and monetary union is perhaps the most
far-reaching, and hence controversial of the developments of the EU so far. A major
step itself towards achieving economic and monetary union was the introduction of
European Monetary Union (EMU) in 1999.
The main features of the EMU are the establishment of a single currency, the Euro, and
control of European interest rates through the European Central Bank. Individual
countries could only join the EMU if they met strict conditions and criteria with regard
to, for example, their interest rates, growth in GNP, inflation and so on. But some
members, most notably the United Kingdom, have at this stage decided not to join the
EMU and the single currency, but rather to wait and see how it works. In the event, 11
of the founder members joined the EMU with the United Kingdom negotiating an opt-
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out. At the moment it is too early to say how well the single currency is working, but it
will certainly be some years before the UK considers joining.
Nevertheless, the introduction of the single currency has already affected trade in the
European Union for all of those countries subscribing to it. Many companies in Europe
are now pricing in Euros, including, in fact, UK companies. There is no doubt that the
European Monetary Union will have a major effect on trade in this bloc in the future.
A final point to note about the EU is that it increased in size substantially from 2003. At
2007, at least two central European countries were waiting to join including, for
example, Albania. Turkey, too, has wanted to become a member for some time. The
current EU members are committed to enlarging this already substantial trading bloc. It
will therefore continue to present major opportunities and threats to business.
Business implications
The Single European Market has changed the environment in which business
operates. Freedom of trade means that the EU countries can be evaluated as a single
geographic region. This makes it a very large market and one that, if the aim of making
the economies of the EU countries more competitive is successful, will expand more
rapidly than would have been the case. Growing markets are very attractive to
business and an increase in competition may be expected, both from within the EU or
from outside. This is already becoming evident with investment by multinational
companies in individual EU countries as a means of getting a foothold in the market
(for example, Toyota have built a car factory in Derby, England).
There are opportunities to gain grants and contracts from the various EU-financed
programmes. These programmes support a range of social, educational and
technological initiatives across the whole of the EU. There is also a flow of money from
the EU budget in support of agriculture and to promote development of the poorer parts
of the EU, mainly the Mediterranean countries and Ireland.
As the EU consolidates its achievements and prepares for expansion through
additional members, companies need to be aware of the changing nature of the
business environment and adjust their plans and activities to take account of the
implications. Thus, continuing changes to EU-wide regulations designed to eliminate
barriers and harmonise business practices, for example, in relation to product
standards and working practices, mean that business needs flexibility to maintain
compliance. The introduction of a single currency and the fact that not all major
European countries have agreed to join at the outset will also need careful
consideration.
43
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Study Unit 4
Understanding the International Business Environment
Contents Page
Introduction 45
A. Social/Cultural Factors 45
Defining Culture 46
Culture and Business 48
B. Legal Factors 50
The Law and Business 51
C. Economic Factors 52
Economic Resources 52
Economic Indicators 52
D. Political Factors 54
E. Technological Factors 55
Availability of Information 56
Technology Life Cycles and Development Costs 56
The Internet 57
F. The C Factors 57
Country 57
Currency 58
Competitors 59
G. The Use of Slept and C Factors in International Business Planning 59
Cross Cultural Analysis 60
Use of Interpreters 61
Identifying Opportunities and Threats 61
(Continued over)
44 Understanding the International Business Environment
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H. Social Responsibility and International Business 62
Ethical, Social and Green Issues 62
Pressure Groups 63
I. International Buyer Behaviour 63
Buyer Behaviour in Different Contexts 63
Buyer Behaviour in Lesser Developed Countries 65
Buyer Behaviour in Newly Industrialised Countries 66
Buyer Behaviour in Highly Industrialised Countries 66
J. International Business Research 67
The Research Problem 67
The Research Plan 67
Data Sources 68
Managing the Research 69
Trends in International Business Research 70
Understanding the International Business Environment 45
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INTRODUCTION
Business strategy, whether it be at home or abroad, can only be effective if it is developed to
meet the specific needs of a target group. In this study unit, we will use a structured way of
analysing the external environment that faces the company in an international setting.
The most common form of analysis in marketing is characterised by the initials SLEPT which
looks at:
Social (or social/cultural) factors.
Legal factors.
Economic factors.
Political factors.
Technological factors.
We shall use this approach and consider each element separately.
In addition to the SLEPT factors, we will also look at the significance of the C factors:
Countries.
Currencies.
Competitors.
These too have a substantial influence on the external environment of international business.
Finally, we will also look at additional and increasingly important ethical, social and green
considerations in the international business environment, together with the role of pressure
groups.
A. SOCIAL/CULTURAL FACTORS
The social/cultural element is particularly important in SLEPT analysis and plays a
considerable part in determining how the legal, economic, political and technological
elements work.
It is important at the outset, though, to raise a word of caution in looking at these factors.
There is sometimes a tendency to treat social and cultural differences in a rather superficial
way by thinking about stereotypes, for example, the British as being reserved, Americans as
being loud, Afro-Caribbeans as being colourful and gregarious, etc. This is a dangerous
oversimplification and needs always to be avoided.
We have linked social and cultural factors together because they are so inextricably
connected.
Social factors are reasonably straightforward to identify in terms of the concepts of reference
groups, social roles and status:
Reference groups are all those groups that have a direct or an indirect influence on a
persons attitude or behaviour. These include family groups, friendship groups,
workplace groups, religious groups and professional groups. The family probably
represents the most important primary reference group that will influence a persons
life.
In each group to which a person belongs (and it is important that we remember that
individuals will belong to a number of groups), his or her actions and influence in that
group will be determined by the role and status of the position held. For example, a
woman within a family may have a number of roles, wife, mother, daughter, etc. If she
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also has paid employment, her role and position within the organisation in which she
works is likely to be very different from that or those within the family.
But what influences these reference groups? Why do they behave the way they do?
Thinking of the family it is easy to see that this varies a great deal from country to country.
The answer is culture.
Defining Culture
Culture is the shared values and beliefs of a society, its design for living. However, with
such an all-embracing issue as this, precise definitions rarely give usable meanings. Thus,
within the culture of most societies, there are almost always a variety of different subcultures,
for example youth culture, student culture and so on.
Culture is learnt and the main force for transmission of whatever type of culture is the
reference group to which individuals belong. In this way, therefore, culture may also be
thought of as the way in which people interact with each other in a group that shares some
common sense of belonging.
One of the reasons that culture is so difficult to define is because it has so many elements
that interrelate and change over time. One way of analysing it is to seek categories of
significant elements as in the following diagram:
Language:
Spoken
Written
Official
Hierarchy
International
Mass media
Colloquialisms
Religion:
Sacred objects
Philosophical systems
Beliefs and norms
Prayer
Taboos
Holidays
Rituals
Values/Attitudes to:
Time
Achievement
Work
Wealth
Change
The scientific
Risk-taking
Possessions
CULTURE
A
e
s
t
h
e
t
i
c
s
Beauty
Good taste
Design
Colour
Music
Architecture
Brand names
Formal
Vocational
Primary
Secondary
Higher
Literacy level
Human resources
Planning
E
d
u
c
a
t
i
o
n
Home country law
Foreign law
International law
Regulation
Political risk
Ideologies
National interests
Law and Politics:
Transportation
Energy systems
Tools and objects
Communications
Urbanisation
Science
Invention
Technology/Material:
Family structures
Social institutions
Interest groups
Social mobility
Social stratification
Class systems
Social Organisation:
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You can probably add a number of other elements each of these categories, or even as sub-
divisions of individual elements themselves. To illustrate the complexities involved, consider
language. This is often a first consideration in looking at an international market. However,
not all countries are linguistically homogeneous, India or Nigeria, for example, comprise a
few hundred subcultures, each with its own language or dialect and who communicate only in
a national context with a common language. In a business context, this situation creates
further complexities as communication needs to be translated and, hence the communication
becomes vulnerable to distortion.
There have been many attempts over the years to devise a method of testing for cultural
significance across countries. The 72 cultural "universals" devised by Murdock (1945), listed
below, identify elements that can be found, in some form, in all societies.
Table 4.1: Common Cultural Elements
Age grading Folklore Mourning
Athletic sports Food taboos Music
Bodily adornment Funeral rites Mythology
Calendar Games Numerals
Cleanliness training Gestures Obstetrics
Community organisation Gift giving Penal sanctions
Cooking Government Personal names
Co-operative labour Greetings Population policy
Cosmology Hairstyles Postnatal care
Courtship Hospitality Pregnancy usages
Dancing Housing hygiene Property rights
Decorative art Incest taboos Propitiation of supernatural
beings
Divination Inheritance rules Puberty customs
Division of labour Joking Religious rituals
Dream interpretation Kin groups Residence rules
Education Kinship nomenclature Sexual restrictions
Eschatology Language Soul concepts
Ethics Law Status differentiation
Ethnobotany Luck superstitions Surgery
Etiquette Magic Tool making
Faith healing Marriage Trade
Family Mealtimes Visiting
Feasting Medicine Weaning
Fire making Modesty with natural functions Weather control
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Culture and Business
Comparisons of culture by identification of the differences and similarities in these elements
are the most effective way of utilising such a broad range of variables. For businesses
considering international markets it is essential to be aware of these cultural differences. The
relevant issues to consider are:
Self-reference criterion (SRC)
It is very easy to use ones own cultural experience and values when viewing other
people and cultures. In fact, it is almost impossible not to. In international business,
though, the ability to think about other cultures from a culturally neutral standpoint can
be very useful. It is the key to being able to identify differences in behaviour, markets
and systems resulting from differences in culture and thus understanding the
requirements of trading with and within another culture.
In 1966, Lee used the term self-reference criterion (SRC) as describing the approach
of judging other cultural values and practices based upon ones own cultural standpoint.
He went on to suggest a four-step approach to avoid it. The steps are:
(i) Define the situation, problem or goal in terms of the home country cultural traits,
habits and norms.
(ii) Define the situation, problem or goal in terms of the foreign culture traits, habits
and norms.
(iii) Isolate the SRC influences in the definitions and examine them carefully to see
how they complicate consideration of the issue.
(iv) Redefine the situation, problem or goal without the SRC influence and derive a
specification or solution that is appropriate for the foreign market.
Lees approach is a logical way to reduce cultural difficulties. However, in practice it is
quite difficult to be sure that step (ii) is carried out accurately. Accurate definition of
problems in terms of a foreign culture needs a good knowledge of that culture. Without
this it will be far too SRC biased and may result in inappropriate actions, for example,
offensive or misleading brand names being used and irrelevant product features being
promoted.
High and low context cultures
In communication, some information is transmitted by spoken and written language and
some by the context or setting within which the language is used. The relative
importance of these two means of transmission within a culture can have important
consequences for business communications.
Using this criterion, it is possible to classify cultures into:
(i) Low context cultures those where most information results from the language
itself; and
(ii) High context cultures those where much information is communicated by the
context within which the communication takes places.
We can place societies into these two broad categories as a guide to the use of
communication, for example:
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Table 4.2. High/Low Context Cultures.
High Context Cultures Low Context Cultures
Japanese German
Mediterranean English
Asian Scandinavian
Arab American
The importance of this distinction can be seen if we consider some of the facets of
business communications and processes outside of the purely written or spoken word:
(i) Body language This is a key element of oral communication and may serve to
confirm or refute the message conveyed as well as giving information about the
understanding and attitudes of the participants. Its importance can be magnified
when communicating in a different culture from ones own, when the role and
significance of the messages conveyed by body language may be also be
different. In high context cultures, adherence to particular norms of behaviour
and appearance considered appropriate to the setting within which personal
interactions take place can be much more important than in low context cultures.
(ii) Time Consider the following questions:
What is the importance of punctuality for meetings?
Is late arrival deemed to be discourteous?
Are meetings well planned and do they run to schedule?
In a high context culture, establishing mutual understanding and developing
friendship are seen as highly important. Time constraints will not necessarily take
precedence over this and, therefore, it may be quite normal for meetings to
overrun or to start late, or for individual punctuality not to be considered
particularly important. In contrast, these norms of behaviour are likely to be a
sign of inefficiency by participants from a low context culture.
(iii) Space Space should be looked at in two ways; physical space and personal
space, for example, does physical space confer status (in, say, office size) and
how close is it acceptable to get to people? Again, these elements are culturally
conditioned. In high context cultures, for example, it is more normal for there
people to feel comfortable close together and distance between participants may
be a sign of coldness.
(iv) Friendship In high context cultures, deals often relate more to the people that
you know and, therefore, social interaction and developing friendships is a key
aspect to business. In low context cultures, the UK and US are good examples,
friendship may be useful, but it is the contractual quality of the deal that is all-
important.
(v) Contracts The way in which contracts are negotiated differs. Lengthy haggling
is normal in high context cultures and various inducements to purchase, which
could be thought of as bribes in the US and UK, may not only be acceptable but
also expected.
The way in which contracts are interpreted and delivery monitored also varies. In
high context cultures, it is expected that friends will help each other out. In low
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context cultures it is more likely that lawyers will be brought in to argue
interpretation and resolve difficulties.
These issues highlight the need for the international marketing manager to be aware of
the dissimilarities in an international market. We must remember, however, that it is as
important to identify the similarities and to ensure that best advantage can be gained
from them.
The cultural sensitivity of products and services
The products and services offered for sale in a particular society, and the way in which
they are offered for sale, have to be acceptable to that society. In the main, consumer
products are more culturally sensitive than business-to-business products, and those
that are closest to the core beliefs of culture are the most sensitive of all. Often these
relate to family and religion gatherings.
Food is particularly culturally sensitive because it has strong symbolic values that have
been reinforced from our youngest days within a family. For example, in the UK,
although the traditional Sunday lunch is much less usual nowadays, it still conjures up
for British people a set of images that will cover the food served, the time it is served,
the formality of the proceedings, etc. In contrast, a comparable meal in say France, a
country quite close to the UK, will have significant differences, the time, the food, the
drink, the length of time it takes to finish the meal and the acceptable behaviour of
children. Pork is probably an extreme example of a food product that carries strong
taboos in some cultures, for Jews and Muslims it has particularly offensive overtones
and they will not eat it. Other religions also specify acceptable and non-acceptable
foods.
Thus, when we look at products for an international market we must try to estimate how
different cultures will view those products. Note, though, that newer products to the
market, such as consumer durables, are invariably less culturally sensitive.
B. LEGAL FACTORS
The legal environment within which international business operates comprises three
elements:
Home country law this defines what is considered by the home culture to be
acceptable behaviour both at home and in dealings with a foreign country.
Host country law this defines acceptable behaviour within the country in which you
wish to trade.
International law there is no international legislative body but there are a series of
conventions, agreements and treaties, the enforcement of which relies on national
sovereignties.
In light of this the international business must be aware of which jurisdiction will apply.
Inevitable conflicts will emerge which may give rise to not only practical problems, but also
moral issues as the legal environment in a foreign market conflicts with the cultural values of
the home country.
There are also three main types of legal system operating in the world, common law, civil or
code law and Islamic law:
Common law This system of law, used in the UK, the United States and Canada, is
based upon tradition and on legal precedents. Laws are passed by government, but
are then interpreted by the courts. The interpretation of the law then becomes the legal
precedent for similar cases in the future.
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Civil or code law Civil or code law is based upon laws that are written down. It is
usual for there to be three different written types of law, commercial, civil and criminal.
The aim in code law is to develop an inclusive set of written codes that will cover all
possible situations.
Islamic law This type of law, based upon the Koran, incorporates social and religious
obligations in addition to legal duties. An important element in Islamic law is the
achievement of social justice. One feature of Islamic law that shows the difference
between it and common and civil law is that it is unlawful to charge interest on loans.
The Law and Business
Legal factors provide the regulatory framework within which international business must
operate and the legal system applying to business in a particular country has an important
influence on many aspects of international trade, for example:
Regulation of contracts This involves:
(i) The establishments of the legal rights of the buyer and the seller.
(ii) The establishment of the terms and conditions between agent and principals.
(iii) The mechanisms for the resolution of disputes regarding both the
appropriateness of the quality of the merchandise (and so on) in respect of
exported goods and responsibilities of agents.
Regulation of the business environment Legislation can condition what companies
can and cannot do, including:
(i) Export/import controls, tariff/non-tariff barriers and competition controls.
(ii) Pricing controls, for example, resale price maintenance and price increases.
(iii) The registration and enforcement of trademarks, brand names and patents.
(iv) Product liability and product safety.
(v) Advertising and sales promotions what can be promoted and how it can be
promoted.
(vi) Labelling.
(vii) Environmental issues, for example, Germany has strong laws regarding excess
packaging that makes manufacturers responsible for the responsible disposal of
extra packaging materials.
It goes without saying that businesses must be careful to operate within the laws and
regulations of the countries in which they are trading. This is particularly important when the
business is trying to establish a global approach and, therefore, wishes to standardise
operations and marketing as much as possible. So, for example, in some countries certain
types of advertising may be illegal and the business cannot apply an approach used
elsewhere in the world. Countries often differ considerably with regard to, for example,
competition policy and price legislation. In the same way there is considerable difference
throughout the world with respect to what is considered legal when offering gifts to
organisational and government buyers.
Even countries, which, in all other respects, appear to be very similar and are even
supposedly bound by trading agreements because they are members of a trading bloc can in
fact be very different when it comes to legislation. So, for example, Germany has much
stronger legislation with regard to green issues than many other members of the European
Union. For example, all packaging in Germany must be recyclable and the supplier is
responsible for any pollution caused. This is very different to legislation operating in, say, the
UK or France.
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C. ECONOMIC FACTORS
The economy of any country is the end result of the production and the distribution of wealth.
As we know this is a continually moving feast, but whereas in some countries the fluctuations
are small over a prolonged period of time, in others changes can be great and almost
overnight.
Before we look at some of the indicators of the economic environment of a country, we
should briefly note some of the underlying resources that influence it.
Economic Resources
The three factors of production, labour, land and capital, are the key resources of economic
activity. We shall interpret these factors in a broader sense here in as much as they
represent important considerations for business.
Population
Since the 18th century the world has undergone a population explosion that has
impacted on all aspects of life. In economic terms, population is an important factor.
The availability of labour is an essential resource in the manufacture of goods and
services, whilst at the same time the population as a whole provides a market for the
goods and services produced.
However, it is not just the size of the population which is important but also its age, sex
and geographic distribution. If, for example, as is the case in most advanced countries,
there is an increasing proportion of dependent population i.e. the old, the young and
the unemployed, then resources will be channelled into supporting them and
consequently economic growth will be slow.
Natural resources
A countrys ability to generate wealth will be linked not only to its population but also to
its geography. This conditions not only the availability of natural resources, land, water,
minerals, etc. but also its ability to exploit them productively. Thus, the climate and
terrain can be important in respect of the ability of a country to develop, for example,
forestry as a productive industry and to develop effective transport systems (including
port facilities).
Infrastructure
The ability of a country to utilise its labour and natural resources will be influenced by
its infrastructure. By this we mean the stage of development of its housing, transport,
communication, energy, etc. systems.
These elements are very much linked to the existing stage of economic development
and you will remember, in Study Unit 2, that we classified countries into three groups,
less developed countries, newly industrialised countries and highly industrialised
countries.
Economic Indicators
These are factors that provide information about the economic development and conditions
in a country:
Income
When we consider the economic factors, the distribution of wealth is perhaps the key
consideration in the selection of target markets.
Countries can be considered in terms of their total income, or gross national product.
Using such a league table, the US, Japan and Germany tend to occupy the top
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positions. Indeed, the concept of the importance of the Triad is based upon the large
size of the GNPs of the US, Japan and Europe.
From an individual company point of view, the total income figure for a country can be
used as a rough guide to a specific market size. Thus, a country might already be in
the maturity phase with its markets reliant upon low levels of replacement sales. In
other less developed countries, with lower levels of GNP, the market might be growing
rapidly with initial purchasing. For example, the electricity supply industry in the top
GNP countries is well established, but in countries with lower levels of GNP but with
high growth rates, the demand for electricity might be increasing rapidly, this would
create a strong growth in the market for electricity supply equipment and transmission
in those countries.
In most instances, though, companies are more concerned with market segment(s)
rather than the total market in any one country. Because of this, companies will be
more interested in the GNP per person or per capita than the grand total. Breaking
down GNP per capita further, companies will be interested in the level of disposable
income after various commitments of taxes, health and social security payments and
other major payments have been made. This is usually a better indicator of available
expenditure, in the majority of consumer markets, than GNP per capita. If this
approach is used, considerable market segments can be identified in countries that are
often thought to be quite poor. For example, in India there is an affluent middle class
with a considerable disposable income. The total size of this segment is larger than the
populations of most other countries in the world.
Certain general relationships exist between income levels and expenditure patterns.
For example, the amount of income spent on food, expressed as a percentage of
income, is higher in poor families and in poor countries than it is in richer countries.
There are variations in the general rule. For example, at the beginning of the 21
st
century, in Japan almost 20% of consumer spending is allocated to food, compared
with 15% in the US, 13% in Germany and 11% in Britain. The explanation for the high
spending on food in Japan is partially based upon the high prices of food there, caused
by protectionist economic policies in Japan to support local agricultural products. In
part, though, expenditure on food is influenced by culture food in Britain is given a
comparatively low priority, whereas in Japan and France food is seen to be more
important. This results in higher consumer expenditure on food.
Inflation
This is a major influence in most countries. In some countries, for example the UK,
one of the main reasons explained by government for economic decisions is a desire to
control inflation to a particular target level. In other countries, inflation rates are so high
that pricing and other decisions have to take account of the constantly increasing price
of goods and services.
The Asian countries of China, India, South Korea and Taiwan have all achieved rapid
growth during the past 5 years or so, with inflation rates usually below 10%.
Latin and South America is different and here there are several stories to tell. Some
countries, for example Brazil that has sometimes experienced inflation rates in the
order of 2,000%, have a long history of uncontrolled inflation. Argentina had very high
inflation rates in the 1980s but had now brought the rate down to 11% by the year
2000. Mexico, whilst never as out of control as Argentina, has succeeded in bringing
its inflation rate down from over 100% to under 10%. Chile has maintained an
impressive record; its inflation rate never increased much above 20% in the 1980s and
is now down to around 12%.
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Capital investment
This is associated with economic growth. Recently, countries in Asia have been
spending a higher proportion of their Gross Domestic Product (GDP) on fixed capital
investment than other countries around the world. At the beginning of the 1990s,
financed mainly by the high level of domestic savings, the Asian countries of South
Korea, Thailand, Singapore, China, Malaysia and Indonesia all invested 30% or more
of their GDP into fixed capital. Latin American countries typically invested around 20
25%.
Government policies
Other economic influences that can be important are the level of government budget
deficit or surplus.
The level of official reserves of foreign currencies and gold and special drawing rights
in the International Monetary Fund shows a countrys ability to meet its external
obligations. If reserves are going down rapidly, this will have an almost certain
downward effect on the value of that countrys currency. Declining official reserves
shows a decline in confidence in the countrys economy. It could be linked to
deteriorations in the countrys balance of trade and the balance of payments.
Government decisions taken to influence economic performance by, for example,
reducing inflation or to stabilise the foreign exchange rate, will affect the level of
personal and corporate taxation. If taxation increases, other factors remaining
constant, market sizes will decrease in the consumer and most business markets. On
the other hand, government markets will increase to reflect the higher influence of the
government in the total market place of that country.
D. POLITICAL FACTORS
In an ideal world, companies would like to have a political climate that does not change and
is supportive to business interests. They would like to see policies that lead to:
Low inflation rates.
Steady market growth.
Low taxes on company profits.
No restrictions on the ability to repatriate profits.
No restrictions on local content.
Support for a market economy.
A lack of government intervention, for example no controls on price levels or profit
levels.
The encouragement of inward investment by foreign companies.
However, it is unlikely that this situation would persist in any country.
From a business point of view, the major political problem is likely to be instability. Instability
may arise through frequent changes in the ruling political party or elite, and/or through
frequent changes of policy by a stable ruling political party. If the political situation is one in
which the environment surrounding the company is predictable, companies can develop and
implement international business plans with some confidence. If the government changes
direction frequently, medium- and long-term planning becomes very difficult and companies
will feel forced to adopt short-term, highly pragmatic approaches.
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Note that, even in politically stable countries, democratic elections which could change the
ruling political party take place every five years or so. When a new party takes power, there
is likely to be a measure of uncertainty whilst it settles into the job of running the country and
the effect of new policies is awaited. Even if the same political party is in power for many
years, there will be a variety of political and economic issues that will cause it to make
changes in political and economic directions, and most governments pass laws which affect
market opportunities from time to time.
Other forms of stable government may create problems for business, for example:
Where the political party in power does not support business interests, as was the case
in most of the ex-COMECON countries from the end of World War II to 1989.
Where the ruling power base is autocratic and is not subject to various checks and
balances to prevent the abuse of power, the regime of Idi Amin in Uganda was an
unfortunate example of the excess that can result from autocratic political power.
Stability, though, is not the only issue of interest to business. It is also concerned that
governments take political and economic decisions that do not cause the economy to decline
or become less profitable for companies. For example, many Latin American countries were
not able to prevent runaway inflation in the 1980s, and other governments have acted in
ways which conflict with business interests by such policies as increasing corporate taxation
or using price controls to try and control inflation.
There have been various attempts to identify the level of risk inherent in a country. One such
approach is the Business Environment Risk Index (BERI), which was started in the US in
1972. In the BERI ratings, countries are evaluated on 15 economic, political and financial
factors on a scale from zero to four. The factors that relate most strongly to political areas
are political stability, attitudes to foreign investors, nationalisation, bureaucratic delays, and
currency convertibility. Scores on the BERI scale are calculated out of 100 and a score of 80
or more indicates an acceptable level of risk. However, scores of 40 or less suggest that the
level of risk is probably unacceptable and companies should think carefully before
commencing business in countries with this sort of score.
E. TECHNOLOGICAL FACTORS
You will be well aware that there has been a rapid growth in the speed of technological
advancement over the recent decades. One of the remarkable features of this has been the
way in which access to advanced technology has spread from one or two countries to many
countries around the world. It is now not unusual to see people, without what many cultures
would perhaps consider the essentials for existence, using computers in offices and shops,
communicating by mobile telephone and watching television programmes via satellite. Wide
variations in technology between countries are less a feature of the international environment
than is the case with legal, economic and political factors.
This has partly been the result of the development of multinational and transnational
companies and partly the result of government intervention because:.
The practice of multinational companies basing their operations in those countries
around the world that provide the best returns has increasingly meant that countries
with low costs for labour and for factory and office sites are being used to produce
components and sometimes the final assembled product. As part of this process, a
great deal of technology transfer takes place. Many NICs and LDCs have benefited
from the acquisition of technological and production-process know-how.
In addition, governments in many countries have encouraged the development of high-
tech industries and investment in education and training to ensure a competent, skilled
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workforce as a means of accelerating economic growth and to reduce levels of
unemployment.
The availability of technology is, therefore, less based on a few countries; although it would
be true to say that some countries have a much wider range of advanced technology than
others.
There are a number of issues in respect of this spread that have important consequences for
Availability of Information
The developments in communications, and by that we mean personal communications,
transport and the media, mean that we live in a shrinking world. Information about events
almost anywhere in the world can be obtained almost immediately by anyone anywhere. For
example, when mineral water manufacturer Perrier experienced a pollution problem at the
bottling plant in France, this was flashed all over the world within 24 hours, and by the next
day, shelves in supermarkets and retailers throughout the world had been emptied of Perrier
products.
Consumers can access information now at the touch of a button making it much easier to,
say, compare prices. This puts a premium on information, and particularly on its access,
control and analysis.
A number of developments arise from this:
Satellite and cable television has opened up the number of ways in which people
across the world can receive information, and particularly advertising, with minimal
control over content by individual states.
Companies need to pay particular attention to the need to get their own interpretations
across to the public in the face of competing analyses, and this has given rise to the
phenomenon of spin doctors attempting to manage the way in which events are
reported and perceived.
Businesses need to exploit a wide range of technologies in communicating and
conducting operations.
Technology Life Cycles and Development Costs
New technologies and products can be extremely expensive to develop, for example, a new
pharmaceutical product will cost millions of dollars to bring to the market, and a new model of
car for mass production will entail a huge amount of investment. On the other hand, the
speed of technological and market change means that technologies and the products they
underpin have ever shorter product lifecycles before the next generation of technology and
products is developed.
The high cost of research and development to produce the next generation of products
coupled with shorter technology life cycles has given an impetus to two developments:
The need to market products to more and more country markets in an attempt to justify
and recoup the high costs of research, development and product launch. In many
products, the market in any one country is less and less likely to be sufficiently large to
achieve a break-even position. This has resulted in regiocentric and geocentric
planning becoming more relevant.
The use of alliances, of various types, in an attempt to share some of the costs of
product development. Often, businesses are not able to recoup the high costs of
investment in new products and technologies before they are made obsolete. As a
result, we are increasingly seeing the joint development of technologies and new
products between different companies throughout the world so that investment costs
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and risks can be shared. So, for example, the Advanced Photography System was
developed through the joint efforts of the leading companies in this market including, for
example, Kodak, Fujitsu and Sony. In the future, we can expect to see even greater
co-operation and collaboration on an international basis by companies to develop new
technologies.
The Internet
It has been widely predicted that the Internet is destined to change virtually every facet of our
lives, including the whole nature and operation of business. Its major impact in respect of
international business is that it enables the process of buying and selling across international
boundaries without any reference to the traditional methods of conducting such transactions,
face-to-face contact, use of agents and intermediaries, offices and facilities abroad, etc.
The characteristics of the Internet are such that:
It facilitates global marketing for the smaller companies that in the past perhaps have
faced major disadvantages compared to their larger counterparts.
It enables customers to compare and contrast competitor offerings much easier and on
a much wider basis than before.
It is a cost-effective and convenient way of purchasing products and services for both
consumers and business-to-business customers.
Of course, none of this will happen if customers do not have access to the Internet, but
increasingly they will. The costs of computers and access to the Net are dropping
significantly. Further, technological developments mean that access is now available through
other means, such as conventional digital TVs and mobile phones. Thus, more and more
customers have to access the Net.
The use of the Internet by businesses is growing rapidly, both for advertising their products
and services and for actually selling them. Virtually all the large multinational companies
have now developed web sites, but interestingly enough, it is the smaller, newer companies
who have been the quickest to realise the potential of the Internet for commercial purposes.
Companies like Amazon, an Internet book sales company, which has grown from nothing in
less than a decade to being one of the largest in the market, all through Web-based sales.
There is no doubt then that the Internet will give rise to some of the major opportunities and
threats for international business in the future. It is also likely to impact on the whole nature
of marketing operations ranging from access to, and the use of, data through to the concepts
of market segmentation and targeting, and the way in which elements of the marketing mix
are applied.
F. THE C FACTORS
In the same way that the letter P is used to help us remember the elements in the marketing
mix (product, place, promotion and price), a number of writers have used the letter C to
identify various elements in the analysis of international markets.
Country
The concept of the country is significant in international business. This might seem rather
self evident, but it is important to understand how the concept is used and what its limitations
are.
Companies often use countries both as a unit of analysis and as a basis for their
organisational structure. In terms of analysis, in many ways the boundary between one
country and the next country changes markets. We often find that the laws change, the
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types of retail outlet are different, the types of tax paid on income and on expenditure are
different, and newspapers, radio and television are different. In addition, the spoken
language may well be different, although in the border areas it is not uncommon for people to
speak both the languages of the neighbouring countries. Thus, it is very often the case that
there are many differences in the business environment caused by the different rules,
regulations and customs that relate to one country and not to the next.
It is important, however, not to fall into the trap of assuming that a country constitutes a
homogeneous market. We have already used the example of India, where there are many
different languages, considerable divisions in the society caused by the caste system and a
large proportion of wealth is owned by approximately 5% of the population. Consider also
the United States of America. They may be united, but many states have their own laws and
very different cultural values, consider the difference between those living in multicultural
New York State and those living in the Deep South.
Additionally, in some parts of the world, the development of trading blocs has started to mean
that companies need to consider trading blocs or world regions as another basis for their
analysis. For example, Japanese and US companies might need to develop analyses based
upon the European Union as well as the individual countries within the EU. In addition,
companies might change their organisational structures to allow a pan-European
organisation and culture to develop. A European head office might be started in Paris,
Brussels or perhaps London.
Finally, in some ways, countries and country boundaries may increasingly not be the best
way of thinking about market boundaries and target markets for the international business.
As we shall see in later study units, it may be more useful to look for similarities and
differences with respect to, for example, customer needs and wants, in order to group
customers and markets rather than grouping them by country.
Currency
One of the major differences between countries, and one that keeps the concept of the
country strong in business terms, is that each country has its own currency. Thus,
neighbouring countries, which may be similar in many other respects, will have different
currencies.
This is a significant issue for international business. At its lowest level, the problem is simply
the need to change one currency into another in order to effect payment for international
transactions, thus, if you export products to a company in Argentina, your customer will
normally only have pesos to pay your invoice and either you or your customer will have to
exchange currency so that both parties end up with currencies that are acceptable to
themselves. The other, more significant, problem is that currencies change values. For
example, over the past ten years or so, the pound has exchanged at rates varying from
approximately 1 to $1 to 1 to $2, which is an effective change in value of 50% from the
strong sterling position of gaining two dollars for every one pound sterling. Variations in
exchange rates cause considerable problems for business.
In terms of the financial implications, companies need to take steps to manage the risk that
variations in the exchange rate will cause the value of payments due in a different currency to
fall in terms of their own domestic currency. There are number of measures that can be
taken, for example, buying foreign currency forward at a fixed rate, in order to remove the
risk and obtain certainty about its future income and profit levels. We shall return to this
when we consider international finance later in the course.
Large international companies often try to develop their international operations to avoid the
need to exchange currencies. If they can exchange products and services between different
subsidiaries in different countries, they can minimise the amount of currency that needs to be
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exchanged. Most of the exchange can be handled internally within the company accounting
system.
Changes in foreign currency exchange rates can also influence pricing decisions. Over
minor exchange rate fluctuations, the company can invariably adjust its profit margins in
order to maintain a constant price to the customer. However, if the fluctuations are
considerable, the company might need to change its business strategy radically. The
problems arise when its own currency is appreciating, therefore making its products more
expensive in other currencies and, hence, less competitive with other producers, principally
local ones that are not affected by exchange rates. One solution would be to drive down
costs in order to avoid increasing prices, for example, embarking on substantial cost
reduction programmes in its home production or finding different distribution channel
arrangements with lower distributor margins. Alternatively, it might attempt to develop a more
expensive image and positioning to help to justify the higher price.
As we saw in Study Unit 3, regional trading blocs may attempt to minimise some of the
problems caused by different currencies by adopting common rules for, say, fixing exchange
values between member countries. In the case of the European Union, we have seen the
introduction of a common currency, the Euro, in order to reduce some of the problems
caused by volatile currencies and exchange rates.
Competitors
In international markets, competition is often more difficult to manage than in the home
domestic market. The reasons for this include:
In international markets the company often has a lower market share, sometimes very
much lower, than in the domestic market. This results in a less powerful position. It
also results in costs that are relatively higher, because of the lower scale of operations,
activities such as marketing research or advertising are more expensive per unit of
product sold.
The development of more international companies means that, in any one market, the
number of companies looking for a share of that market is increasing. As business
looks beyond its domestic markets, companies from all around the world are becoming
more world regional and global in their business strategies and in the co-ordination of
their strategies towards competition.
Companies in the NICs are becoming more and more successful in their own markets,
developing products and services that can compete with foreign multinationals on most
terms and often undercutting them on price. The more successful such companies
become, the more difficult it is for international companies to retain their share of the
market. Further, many of these companies are themselves looking to international
markets for growth, for example, the Proton car from Malaysia.
When added to the difficulties of obtaining high quality information and the barriers resulting
from cultural differences, these factors make it increasingly difficult to compete successfully
with competitors in non-domestic markets. Furthermore, some competitors will have
advantages resulting from lower operating costs and/or from currencies that are depreciating.
G. THE USE OF SLEPT AND C FACTORS IN
INTERNATIONAL BUSINESS PLANNING
Whilst essentially straightforward, the information covered by the SLEPT and C factors is
extensive. However, understanding the factors is only of value if they are applied to assist
the organisation deciding where to go in international business planning. Successful
business strategy, whether at home or abroad, is about developing markets for products and
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services, and this can only be effective if it is applied to meet the specified needs of a target
group of customers i.e. individuals making their purchasing decisions against the background
of a dynamic macro environment.
The overall importance of the SLEPT and C factors is that together they constitute the macro
environment within which business operates.
Cross Cultural Analysis
Cross-cultural analysis is a means of bringing together the factors by considering them
against a number of key business elements:
Needs and wants
Here the key question is what needs or wants does the product or service satisfy at the
moment in the particular market? To answer this, the SLEPT and C factors need to be
assessed against the particulars of the product in question.
If the answer is not readily apparent, or there is none, then the business needs to
consider either how the product should be presented to satisfy current needs or wants,
for example, should the product be made cheaper, does it need a more comprehensive
and locally responsive level of customer service, etc. or whether the product itself
needs to be modified.
Patterns of buying behaviour
Here the key questions are who buys, who influences the buyer and who uses the
product?
The answers here are likely to be strongly influenced by social and cultural factors such
as the roles of men, women and children. Note, though, that in all societies, cultural
patterns change over time and these roles are themselves changing in many countries.
We need, therefore, to try to establish how deeply culturally ingrained are buying
behaviour patterns, for example, who goes shopping and how much influence each
participant in the buying process has in the final purchase decision.
We shall consider buyer behaviour patterns in more depth in the next study unit.
Cultural influences
Using high and low context culture and the cultural sensitivity of products, we can look
to see if there are important cultural influences that relate to the product or service and
the way in which it is presented. Big context differences between markets will almost
certainly point to differences in the way the product will be perceived and the way it
might be used. It is also important to consider the way in which the product relates to
values in respect of religion, family, morality, work and recreation. If these values are
likely to affect the way in which the product is viewed, marketing plans will need to be
amended in some way.
Methods of communication
We need to know how differences in the SLEPT and C factors will influence the
effectiveness of marketing communications, advertising, public relations, sales
promotion and packaging. What languages should be used, what sort of messages
seem to work best, is advertising an accepted method to communicate persuasive
messages?
Again, cultural values and context will be significant, for example, in the US, many
advertisements feature a direct hard-sell style, whereas in Japan, advertising is much
more likely to develop images and in the UK, humour is an accepted form of
advertising. The economic and technological framework of the country will also
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influence communication through the ways in which the message may actually be
delivered to the target market.
Methods of selling
Here the main concerns are what types of salespeople are likely to be effective, do
they need to come from a particular race or religious background, what language(s) do
they need to speak, etc.
Social and cultural factors will predominate. Thus, it is probable that considerable
cultural training will be required before a salesperson from a low context culture such
as the US will be successful in a high context culture such as Japan.
Methods of distribution
We need to be aware that entrants into a country market are frequently unable to put
together their ideal distribution channel. Other companies will have established
distribution arrangements and, therefore, there might not be space for the new entrant.
In Japan, the particularly closely knit distribution systems operating between several
layers of wholesalers and the retail level make it especially difficult for non-Japanese
companies to establish effective working contacts with distribution channel
intermediaries. We have to consider how customers view different types of retailer,
wholesaler, agent and distributor.
Use of Interpreters
One means of bridging the social and cultural divide is to use interpreters to aid
communication.
Interpreters are very useful in international business because of the need to find a common
language in situations where people are not fully conversant with the different languages
involved. They are, therefore, widely used to translate from one language into another in
meetings, conferences, exhibitions and trade fairs, sales negotiations and factory visits.
(Note that interpreters are used in spoken language situations, translators will be used in
written language situations.)
The following points need to be understood about use of interpreters:
100% accurate interpretation of one language into another is rarely possible, no matter
how much that may be expected by the participants. Misunderstandings will be limited
when high quality and reliable interpreters are used. The more that they know about
the product, the industry and the technology used, the more likely they are to be
accurate.
It is common for certain words or phrases to be impossible to translate without a
complicated explanation of the cultural context in which they are used. For example, in
Japanese, the word no practically does not exist, and in some situations the word yes
can in fact mean no. A straightforward interpretation of the words will result in
misunderstanding.
It is clear that translation and interpretation often cannot be avoided in international business.
However, it must be remembered that changing the language does not necessarily mean the
correct messages will be transmitted. It is important to manage the process of translation
and interpretation to limit the extent of poor and incorrect communication.
Identifying Opportunities and Threats
Businesses must not only be aware of the SLEPT and C factors, but ideally must be able to
forecast and anticipate them. It is these factors, or rather trends and changes in them, which
give rise to the major opportunities and threats which the international business must take
account of. In fact, being able to anticipate and respond to these trends and changes is
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increasingly the key element in competitive success for the international business. In
particular, adaptation of marketing strategies and plans through the marketing mix, in order to
achieve a strategic fit with the environment, is essential. We must remember, however, that
achieving this is much more difficult in international business because of the following
aspects of the environment:
The international business is faced with much more diverse environments than the
purely domestic marketer.
Unlike the domestic environment, often these environments will be relatively unfamiliar
to the business.
International business environments are generally more dynamic and therefore difficult
to predict.
The business therefore needs good systems of marketing research and intelligence coupled
with an awareness and sensitivity to different environments. Finally, sensing opportunity and
threats and responding to these requires good forecasting systems and flexible systems of
company operation and structure.
H. SOCIAL RESPONSIBILITY AND INTERNATIONAL
BUSINESS
In addition to the conventional SLEPT and C factors, recent years have seen the growth of a
number of other macro-environmental issues that the international business must be aware
of and respond to. Of particular significance has been the growth in importance of
ethical/social and green (environmental) issues. Related to these, and indeed partly
responsible for their growth in importance, has been the emergence of often very highly
organised and vociferous pressure groups.
Ethical, Social and Green Issues
Concern with social and ethical aspects of international business and marketing has grown
as customers have become more aware of their possible harmful social implications and the,
admittedly and thankfully relatively small, amount of unethical practices by some businesses.
Of particular concern is the exploitation of developing countries by multinational companies
through the depletion of their natural resources for little return, the degradation of their
environment and the payment of low wages for the production of products that sell in
developed countries for very high prices. The global tobacco companies have been criticised
for switching their marketing efforts from the developed countries, where cigarette sales have
been falling, to the newly emerging industrialised countries who have been persuaded to
increase their purchases of cigarettes.
The size and power of the multinationals has, in the past, enabled unscrupulous companies
to get away with socially unacceptable and unethical practices. However, this is changing
partly as a result of legislation by both home and host countries, partly as a recognition of the
public relations problem that such practices can pose to companies, but most importantly
because of changing social values, with customers throughout the world now demanding that
companies operate socially and ethically acceptable business policies and programs.
Hill (2007) notes that in the international business setting, corruption is among the most
common ethical issues involve employment practices, human rights, environmental
regulations, and the moral obligation of multinational corporations.
In 2005, UK catering group Eurest Support Services (ESS), a company that supplied the UN,
allegedly used leaked details of UN tenders to win contracts.
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In October 2006, ESSs parent company Compass settled lawsuits with certain of its
competitors and stated that the settlements had been reached purely because of its interest
in avoiding a prolonged legal battle; it did not admit liability.
Green issues, too, have become an important concern for customers throughout the world.
We have already referred to the depletion of the worlds resources through the worst
excesses of some of the multinationals, particularly in industries such as mining, forestry and
oil extraction, but governments are increasingly requiring that companies operate and
implement policies that do not harm the environment. Similarly, customers are increasingly
demanding green products, produced with green credentials.
For the company unable, or unwilling, to respond to this increased awareness of social,
ethical and green issues, consumer demands for socially responsibility represents a distinct
threat. However, the more astute companies have recognised that, in fact, this represents a
distinct marketing opportunity. Such companies have responded to this growth in awareness
and the emergence of pressure groups by introducing business policies and strategies which
are more socially and ethically sensitive and products and services which are distinctly green
in their credentials. So, for example, increasingly timber companies operate environmentally
friendly policies of only producing and marketing timber from managed forests.
Pressure Groups
There is no doubt that pressure groups of one sort or another have been important and
influential in encouraging companies to be more socially/ethically and environmentally
responsible. For example, Shell recently proposed to sink a disused oil drilling platform in
the North Sea leading, it was suggested, to potential significant levels of pollution. Only after
concerted efforts by pressure groups, and in particular Greenpeace, were these proposals by
Shell withdrawn.
Furthermore, these pressure groups are increasingly organising on an international/global
basis so as to match the power of the global companies. We saw in an earlier study unit, for
example, that the recent world trade discussions were effectively destroyed by the activities
of a number of pressure groups who organised demonstrations to disrupt the talks.
Moreover, these pressure groups organise themselves internationally through the use of the
Internet. It is likely that pressure groups will continue to grow in importance with regard to
the operation of international business, and that access to and use of communications
technology will enable these groups to act quickly and powerfully to make their feelings
known.
I. INTERNATIONAL BUYER BEHAVIOUR
Buyer Behaviour in Different Contexts
Consumer buyer behaviour
Consumer buyer behaviour is concerned with the buying of goods and services by
individuals and households for personal consumption. Consumers buy a large range of
goods and services, although in general they are frequently much less well informed
than business buyers at the point of purchasing the product.
There are certain influences on the buying process that should be put under the
spotlight here because there are likely to be differences in them from one country to
another. You should note the following points:
(i) Social Class In some countries, social class is very rigid; little movement up or
down is possible.
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(ii) Family The concept of the family varies from the narrow version of the family
(parents and their associated children) to the extended family (including
grandparents and other relatives) as is the norm in, say, Italy.
(iii) Age and life cycle stage Consumer purchases are influenced by age and by
the stage in the family life cycle. Thus, a two-year old will have different
requirements from a middle-aged person, and a 24-year-old person, married with
young children, will buy with a different set of priorities when compared with a 24-
year-old single person.
In different countries the age composition varies. A typical difference is that
industrially advanced countries (such as Germany) will have ageing populations,
whereas in lesser developed countries the population will have a much younger
profile, with large numbers of babies and children.
(iv) Gender The roles and status associated with men and women vary within most
cultures and between cultures. You need to be aware of these differences and of
the way in which changes are occurring.
(v) Needs and motives In many Western countries, customers share similar
motives and motive hierarchies, such as the desire to succeed and belong and
achieve social affiliation. These derive from Maslows model of a hierarchy of
needs, which has been very influential in the way consumer behaviour is
considered. However, these are not consistent across cultures. So, for example,
in some parts of the world, self-esteem needs are met before physiological
needs.
What needs to be stressed here is the fact that consumer behaviour is not the same in
different international markets. Again, even countries, which in many respects have
very similar cultures and/or are geographically proximate, can be very different with
respect to consumer buying processes.
Business-to-Business Buyer Behaviour
Business-to-Business Buyer Behaviour is sometimes referred to as industrial buyer
behaviour, or organisational buyer behaviour.
Various people are involved in the buying process within an organisation. Collectively
they constitute the decision making unit (DMU) or buying centre.
The structures and culture within the organisation and the culture of the broader society
will condition this group in the way they interact and the processes through which they
make decisions.
As with consumer buyer behaviour, the international business needs to be careful not
to assume that the processes of buying from other businesses, and the factors which
affect them, are the same in every country, again they are not.
Governments and other governmental institutions
Governments and other governmental institutions, such as local authorities and
nationalised industries, are important buyers in most national markets. In many
countries, governmental bodies account for around 50% of all goods and services
purchased within the country. The methods used in buying by governments and other
institutions are therefore very important.
The key distinguishing characteristics of buying by governmental institutions are as
follows:
(i) Buying will be a bureaucratic process A bureaucratic process is more likely
to apply than an open DMU approach, or, at least, the DMU roles are likely to be
submerged within the bureaucratic framework.
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(ii) A tender system is usually used Governmental bodies to ensure public
accountability use the tender system. The taxpayers money needs to be spent,
and to be seen to be spent, efficiently and without corruption.
(iii) Political influence The decisions of governmental bodies are ultimately the
responsibility of politicians and buying decisions, particularly those involving the
award of large contracts, may have political importance.
The more democratic systems of the US and EU countries will buy differently
from central controlled and command approaches, such as those in Cuba, China
and, in the past, the COMECON countries, the USSR, Poland, Bulgaria, etc.
(iv) National preference In most countries, for all the obvious reasons (political,
economic, employment, etc.) governmental institutions will try to buy from their
own nations.
In the EU a high priority has been placed on reducing the barriers created by
national and regional preference. Legislation has been enacted to provide free
and fair competition in the area the EU calls public procurement (i.e. government
and institutional buying).
(v) Types of business and government buying Certain types of business are
more dependent upon government buying than others. Government and
institutions can buy most goods and services, but some markets revolve solely
around government decisions. A good example of this is companies selling
defence equipment, tanks, guns, radar, night sights, etc.
Once again, it is important to stress that business must carefully look for differences in
institutional or government buyer behaviour in international markets. Once more,
cultural factors will play a key role in giving rise to differences here, but so too, given
the nature of the buyer, will political differences.
Buyer Behaviour in Lesser Developed Countries
We identified that these countries are poor with comparatively low levels of economic and
social infrastructure. It is difficult to market to these countries because there is little
consumer spending power and market sizes are small in most instances.
This does not mean to say that these markets should necessarily be ignored. In most LDCs
it will be possible to sell some products. In particular, companies might be willing to accept
low sales because they hope to become well established and be in a position to benefit when
the country begins to grow and develop larger, more worthwhile markets.
However, most consumers will have very low levels of income and little discretionary
spending power. Consumer buying decisions will, therefore, be considered more carefully
because, relatively, the cost of purchase will be very high.
Think, for example, of the different significance for a consumer in an African country with a
family annual income of less than a few hundred pounds sterling considering whether to buy
a portable radio priced at 15, compared with a consumer in Germany with a family income
of 30,000 considering the same purchase.
In many LDCs, the influence of the government and government-influenced buying
departments is high. For major capital projects, for example irrigation systems or hydro-
electricity schemes, the domestic government, together with foreign country and major world
agencies, will be important participants in the buying and the financial funding processes.
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Buyer Behaviour in Newly Industrialised Countries
The main attraction of NICs is the growth potential that they represent. Some NICs,
particularly some countries in S.E. Asia (such as Malaysia, Korea, Singapore and Taiwan)
have consistently shown faster than average growth for a number of years.
The consumer markets in NICs can develop rapidly once a certain critical point of income
level has been reached. In consumer durables, the growth possibilities of opening up the
market in NICs are very attractive; particularly where the markets in more developed
economies have reached the maturity phase of the product life cycle. Increasing affluence
also allows the development of FMCG markets that initially might have been slow to grow
because of income constraints and conflicts with indigenous culture.
Retailers are changing their approaches from small, customer-service market stalls and small
fixed units into some of the larger, more capital-intensive styles of Western retailing. These
changes provide opportunities for retailers from other countries to enter the NIC market.
Many of the NICs are in Asia and Latin America. For international businesses operating from
Europe or the US, this poses problems. The cultural differences between the comparatively
low context Europeans and North Americans and the high context Asians and Latin
Americans are quite large.
The increased opportunities to market to businesses have to be set in the context of the
cultural differences of many of the NICs. This may mean that understanding the ways in
which business buys is more difficult than in low context culture countries.
Government buyers in NICs will be a major source of business. The need to maintain
control of inflation, government spending and the balance of payments during the turbulent
times of fast growth will encourage overt or covert support for local businesses.
Buyer Behaviour in Highly Industrialised Countries
In considering business activity in highly industrialised countries, it is perhaps more useful to
think about the problems facing an LDC or an NIC producer in attempting to market products
in the US, the UK or Germany.
For consumer buyers a major problem will be overcoming the country of origin problem,
especially in the purchase of consumer durables. To overcome this problem, the NIC or LDC
company might need to sell products at a low price and include many additional features
within that low price. In addition, they will need to fight hard to secure adequate distribution
channels. After-sales service will need to be convincingly strong to reassure potential
buyers.
The main markets for LDCs are in craft products and ethnic fashion clothing, as well as
certain food products, for example, bananas from Caribbean countries.
The difficulties are somewhat lower amongst business buyers. It is likely that business
buyers will be more receptive than consumer or government buyers since they will judge
products on more objective and careful evaluative criteria.
The opportunity that LDC and NIC suppliers have is the lower costs of land and labour. The
difficulties that they face are those of convincing the business buyer that high quality product
will be supplied consistently with reliable delivery.
There are opportunities to sell to government buyers, but in practice it will be difficult for
LDC and NIC suppliers to gain contracts. Geographical distance and political pressure, plus
the sophisticated manufacturing and marketing expertise of the local suppliers, will offer few
gaps in the market.
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J. INTERNATIONAL BUSINESS RESEARCH
The Research Problem
In any business research the crucial first stage is to define the problem that the company is
trying to solve.
Let us take the example of a company suffering a 25% sales decline in Italy. What is the
problem that research is helping to solve? Is the 25% decline the suitable definition of the
problem? No. We need to find out the reasons for the decline and some of the reasons for
the decline might be:
A general reduction in the Italian market.
Increased competition from Italian or other companies.
Defining the research problem can be particularly difficult in international markets because of
the number of markets that have to be covered because we normally have less knowledge
about the non-domestic country markets.
Examples of research problems on which international business research might focus
include the following:
Exploring similarities and differences with a view to country selection.
Competitor analysis.
Identifying modes of entry.
Selection of suitable intermediaries.
Overall, however, although we have stressed the importance of defining the specific research
problem, more than anything else, research in international markets is underpinned with
identifying business opportunities. In addition, because, as we have seen, the distinguishing
feature of international business is that it is carried on across international frontiers, we often
find that international business research is concerned to identify similarities and differences
between international markets.
A research brief is a formal written document that specifies the key requirements and
background context of the defined research problem. The brief should cover the following:
A definition of the research problem.
The objectives of the research.
The information that needs to be collected.
The benefits of collecting the information and the potential costs in making the decision
without the research.
The time plan for the research, this is often a critical factor and one that will influence
the research methods used, the reliability of the information and the cost of the
research.
An estimate of the research costs.
The Research Plan
The research brief is an important step in the research process, but to manage the process a
detailed research plan needs to be developed.
This will take the general elements of the brief and specify the way in which research will be
conducted in order to meet the objectives. Thus it will specify the research methods to be
employed, with particular reference to the use of secondary research sources and methods
of collecting primary data.
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Data Sources
There are two types of data sources in any form of research primary and secondary.
Secondary data is that which is already available, whereas primary data is that which is
obtained specifically for the particular research objectives at the time, usually by asking
people about certain things.
Secondary data
Secondary data forms the basis of comparative analysis and is generally used first in
the research process, before moving on to the more expensive process of collecting
primary data.
It is important to use information that is available to start the research process for the
two obvious reasons, money and time:
(i) Cost Most forms of secondary data are quite cheap to acquire and use. The
reason for this relates to the definition of secondary data. Because the data
already exists, the costs of developing the data have already been paid. In some
instances, secondary data might be free, for example, the statistical yearbook
published by the United Nations, or the reviews of countries in the world by the
World Bank.
(ii) Time Companies can save time by paying higher prices for faster methods, but
secondary data sources are usually the best and first way to save time in
research. Time is saved because the information already exists. The time taken
is thus restricted to the time needed to find the data.
Initially the sources for potential secondary data need to be identified. One of the
important skills in international business research is knowing where to find appropriate
information.
There are four main sources of secondary data:
(i) Internal sources Internal sources include company sales figures, financial
information, reports from sales visits, reports from agents and distributors, and
previously obtained research reports.
(ii) Government publications Most industrially advanced countries will have large
amounts of published data. On the other hand, less well-developed countries
usually have fewer publications and less reliable data contained within them.
(iii) Other publications Organisations like banks, trade associations, chambers of
commerce and export associations are useful sources of secondary data. Data
availability might be restricted to members, or members can buy publications at
lower prices than non-members.
(iv) Commercial data This type of data is different from (3) because the data is
developed for business motives. Commercial data is usually produced by
research companies and sold at prices judged to be the market price.
There are a number of problems associated with attempts to use secondary data in
international business:
(i) Lack of data In some markets there might be little or no secondary data.
(ii) Accuracy Different statistical methods may have been used and with varying
degrees of efficiency. The result is considerable variation in the reliability of
secondary data produced in different countries.
(iii) Age Data will have been collected at different times and with different time
spans between the collection of data.
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(iv) Comparability This is a major difficulty in international business and one that is
of increasing importance as companies seek clusters of countries in which to
trade and adapt pan-regional strategies.
(v) The quality of secondary data.
Primary data
Primary data is more costly and takes longer to collect than secondary data, especially
in the international context where there are particular problems. Its use, therefore,
should be limited to those areas shown to be necessary after defining the research
problem and after using secondary data.
There are two forms of primary research:
(i) Qualitative research This is research designed to answer the why? question.
It seeks to explore attitudes and impressions, and is often carried out through
focus groups (sometimes called discussion groups) or in one-to-one in-depth
interviews.
(ii) Quantitative research This, as the name implies, seeks to count the number
of respondents with particular attributes. Typical examples include how many
people own bicycles?, how many people use their bicycle to travel to work?, etc.
The main methods of contacting people and collecting information from them are by
post, telephone, email, the Internet and personal contact. Each of these has its
advantages and disadvantages from an international perspective, for example:
(i) In respect of the post and telephone, the infrastructure, quality of the service and
availability varies. In general, the LDCs will have poorer and less reliable
services.
(ii) In respect of using the post, the literacy levels of the population would be a factor.
A further factor may be that, in high context cultures where information is often
communicated by non-verbal means, postal surveys may not capture the
information sought.
(iii) In respect of personal contact, cultural factors may have a significant bearing.
For example, in Arab countries, contact with women members of society is
strongly disapproved of in many circumstances. In other countries, those seeking
personal information (of any kind) may be viewed very suspiciously, both by
those from whom the information is sought (interviewers may be seen as spies)
and by government bodies who may distrust the role of interviewers.
The most appropriate method of data collection will have to balance the same factors that are
relevant in the domestic market, response rates, type of information that needs to be
collected, the speed of response required, and cost factors (personal interviewing is a much
more expensive method than post or telephone) and assess them in respect of the
international context.
Managing the Research
There are two main alternatives methods of managing a research project, doing it in-house
or using a research agency.
As we have seen, a considerable emphasis in international business research will be placed
on defining the problem accurately and on using secondary data.
There are several different types of research company arrangement, and these are
expanding with the tendency for companies to decrease the size of in-house marketing
research services departments.
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Select research companies in each country to be researched The selection of
research companies based in the country you wish to study gives certain benefits:
(i) Expertise in the local environment.
(ii) Expertise in the local language(s).
(iii) Expertise in the local cultures.
Select a research agency that specialises in the industry in question Such an
agency might well have expertise in carrying out research in different countries around
the world. This approach will reduce some of the difficulties shown above, but may
create other problems, particularly if there is no specific experience in respect of the
language and culture of the market in question.
Select a global research agency or an agency with a well-established network of
co-operating agencies This approach could be attractive for the client company with
global scope to its operations.
Trends in International Business Research
Perhaps not surprisingly, in such a dynamic area as international business, techniques and
approaches to international business research are themselves dynamic and changing.
Some of the more important developments and trends in international business research are
outlined below.
Increasingly, companies operating in and needing to research international markets are
looking towards the use of multi-client and/or consortium approaches to conducting, and
therefore paying for, research.
There are many companies that specialise in providing cost-effective, quick, and accurate
databases for companies wishing to research international markets. Examples include:
Reuters.
European Kompass.
Extel.
Business International.
Euromonitor.
The Internet has proved particularly useful for the collection of competitor intelligence,
market appraisal and screening, intermediary selection and in the search for similar
segments across geographically dispersed regions and countries.
Companies that have already built successful Internet businesses based, for example,
Amazon, have been quick to spot the potential for building and using databases and
information that the Net offers.
Needless to say there can be problems with using the Internet. In particular, systems need to
be secure
There are a number of aspects to research providing different views:
Comparative Analysis
The most useful approaches to comparative analysis are those that provide the broad
background to a country, allowing these general opportunities to be identified. A further
consideration is that general statistics on population size and certain economic
indicators are usually widely available.
Once the company has collected information from a number of countries, it is able to
compare and contrast one country with another.
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Although the scale of the comparative analysis will vary, it is an approach that is
relevant to the different types of international business, for example:
(i) Smaller companies are most likely to use comparative analysis to assess market
opportunities, to decide which countries they should enter and which countries
should receive priority.
(ii) Larger companies are more likely to use comparative analysis as part of their
international business information system. In addition, by collecting information
and then comparing it, country by country, a more sophisticated approach to
international business planning can be undertaken.
The General Level of Economic Development
There are a number of indicators that can be used to compare the stage of
development in different countries.
(i) Types of economic activity
Countries develop income from one of three types of economic activity:
Primary These activities are to do with agriculture and extractive
processes, for example coal or diamond mining and fishing.
Secondary These are manufacturing activities. A common early form of
manufacturing is food processing, for example, canning vegetables, fish
and meat products. Manufacturing moves through a wide range of low
value-added activities, for example assembling pre-manufactured
components, to very high value-added activities in the biochemical
industries.
Tertiary These are activities based on the provision of services.
Insurance, tourism and education would be good examples of services.
In general, the more developed the country, the more likely it is to have an
increasingly significant part of its income derived from the service sector.
(ii) Other factors
It is worth noting that there are relationships between economic development and
the following factors that may influence the assessment of business
opportunities:
The general infrastructure in the country Countries at lower levels of
economic development usually have less well developed road, rail,
telephone and electricity systems.
Education and literacy levels These are usually lower in less well-
developed economies. Education is a high cost item for any country and
the ability of a country to afford it affects the quality of education provided,
the duration (say 8 13 year olds), whether attendance is compulsory, and
what is provided free by the State and what has to be provided by pupils.
Ownership of consumer durables In general, less developed
economies will show lower levels of household ownership of consumer
durables such as cars, televisions, telephones and air conditioning
systems.
National Income
The normal way to compare the national incomes of countries is through the Gross
National Product (GNP). GNP is similar to Gross Domestic Product, but it takes
account of net income from abroad. GNP is therefore based on the consumption,
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investment and government expenditure in a country during a given time period
(usually a year) plus exports minus imports plus (or minus) net income from abroad.
Population
There are considerable variations in the population size in different countries.
Population has an influence on market size, but a more important consideration is the
existence of effective demand within the population and this depends upon the
spending power inherent in the country.
Geographical Influences
You should take note of differences in markets caused by the influence of climate,
altitude, the nature of the terrain and so on. In a small country like the UK, it is
sometimes difficult to visualise the impact that extreme heat, little or no rainfall or vast
distance might have on attitudes and buying behaviour.
Import-Export Statistics
By comparing the products exported from and those imported into a country, it is
possible to gain a generalised understanding of a country market. This approach is a
good, quick method to screen possible opportunities, but should be followed up by
more detailed, and also more expensive, market analysis before the company commits
itself to that market.
Absolute and Competitive Analysis
Although comparative analysis predominates in the development of international
business plans, businesses also need to consider aspects of a market in its own right.
Thus, a large and growing market size may be sufficient on its own terms to override
negative comparisons with alternative markets. This approach is known as absolute
analysis, which looks at, markets as entities in their own right rather than necessarily
comparing them with, say, home markets in the assessment of business opportunities.
A further form of analysis of a market on its own is competitor analysis. This is crucial
to the development of specific international business plans and should run throughout
the process of planning from the identification and selection of target markets through
to the development of specific action programs. Competitor analysis is perhaps the
most important single factor influencing the relative attractiveness of an overseas
market is the nature of the competition in that market. Often, this factor may be
important enough to override all other factors in market attractiveness.
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Study Unit 5
International Business Strategy
Contents Page
Introduction 74
A. Business Planning 74
The Planning Framework 74
Approaches to Planning 77
Benefits of Planning 78
Difficulties of Planning in International Markets 78
B. Strategy Development 79
The Ansoff Growth Matrix 79
Key Strategic Decisions Areas 80
C. Strategy and Company Factors 82
Size, Strengths and Resources 82
Orientation 83
Type of Involvement 84
D. Strategy and Competition 86
Analysing Competitors 87
Generic Competition Strategies 88
Competitor Defence and Attack Strategies 89
E. Strategy and Level of Economic Development 90
Industrially Advanced Countries 91
Newly Industrialised Countries 91
Lesser-Developed Countries 91
F. Strategy and Finance 93
Capital Requirements 93
Foreign Exchange Risk 93
The Need to be Paid 94
74 International Business Strategy
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INTRODUCTION
Having considered the environment of international business, and identified and analysed
opportunities in that environment, we now move on to look at the way in which companies
decide what they are trying to achieve and how they might get there. This involves the
development and agreement of objectives and the consideration of different strategic options.
In this study unit we will review the international planning process and consider the main
elements and decisions of strategic international business plans. This also sets the
background for many of the following study units.
We start by exploring the need for a planned approach, the different planning stages and the
key elements of international business plans, together with some of the difficulties associated
with planning for international markets. We concentrate on the key decisions in the
international business and some of the major factors that will serve to influence and shape
these decisions. Throughout, we emphasise the additional complexities and issues that arise
compared to developing purely domestic plans. Important options for the international
business include, for example, the importance of non-domestic sales to the company, the
range of countries, selection of individual countries and modes of market entry. Once these
decisions have been made, the business must further consider options with regard to
standardisation and adaptation, the marketing mix, and implementation and organisation,
issues that we shall continue to explore in Study Units 8 and 9 that follow.
A. BUSINESS PLANNING
The process of business planning is concerned with forecasting the future and deciding what
changes to implement to take the best opportunities and minimise the main problems.
Objectives are an important foundation for the planning process. The organisation needs to
decide what it wants to achieve. What it can achieve will be determined in part by the
selection of the main means of getting to those objectives. These main means we refer to as
strategies. If poor quality strategies are selected, it will not be possible to achieve good sales
and profits results. The level of the objectives that can be set realistically will be strongly
interrelated with the strategies that are identified. Other factors are, of course, influential in
the actual levels of sales and profits that are achieved. The quality of the implementation is
one factor. The accuracy of forecasting the future is another factor. The nature and intensity
of competitive actions are yet another important factor.
It is important for companies of all sizes to plan their international activities. It is very
wasteful to rely on reaction as a management process; for example, opportunities might
come and go before the reactive company tries to implement a business strategy aimed at
meeting the needs of a specific international market. In large and complicated organisations,
planning becomes even more important as a means of co-ordinating and integrating the
geographically spread organisation.
The Planning Framework
The process of developing an international business plan is shown diagrammatically in
Figure 5.1. You will recognise that the main elements of the framework are essentially the
same for international planning as those found in purely domestic business.
International Business Strategy 75
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Figure 5.1: The planning process
1. Analysis of strengths and weaknesses; the company mission statement and
stakeholder expectations
As in all strategic planning, the process starts with the analysis of strengths,
weaknesses, opportunities and threats. This involves the identification and analysis of
markets in which the company can effectively compete and therefore includes an
assessment of company resources and capabilities. We have discussed the
importance of the analysis of business opportunities in earlier study units. Through
marketing research and intelligence gathering activities, the business must seek to
achieve a strategic fit between the companys capabilities and the opportunities
presented by a dynamic environment.
At this stage, the company should also consider its mission statement and stakeholder
expectations. These concepts serve both to shape and constrain business strategies.
In the international market, of course, stakeholders must include not only domestic
country stakeholders but also those of any host country in which the international
business operates. This would include, for example, local employees, pressure
groups, host country governments and host country communities. Obviously having
such a potentially wide range of stakeholders to consider in international markets
makes this task that much more difficult.
2. International business objectives
This stage of planning involves the company determining what it wants to achieve.
Without clear objectives, an organisation is unable to delineate and select between
strategies, nor to evaluate the extent to which desired outcomes have been achieved.
1. Identification and analysis of business opportunities
Assessment of company resources and capabilities
Company mission statement and stakeholder expectations
2. International business objectives
3. Development of strategic options
4. Selection of strategic options
5. Implementation of strategies
6. Evaluation and control
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Remember that objectives should ideally be Specific, Measurable, Achievable,
Realistic and Timed (the SMART criteria).
When it comes to international business the company must not only decide what sales
and profits it wishes to generate from international operations, but also the related
issue of, for example, what degree of involvement and commitment the company
wishes to achieve for its international operations.
3. Development of strategic options
This stage in the development of the international business plan involves identifying the
broad strategic routes that a company can select between in order to achieve its
objectives. There are a number of ways of thinking about strategic options and a
number of models of strategic alternatives have been developed. Perhaps one of the
best known of these, however, is again one that you will probably be familiar with and
indeed can be used in both domestic and international markets, namely the Ansoff
Growth Matrix. We look at the use of this in the next section and consider other issues
to do with strategic options in the rest of the unit.
4. Selection of strategic options
Having identified the strategic options, the next step is to select those that are most
appropriate. A number of considerations are important here. Obviously the options
must match the companys resources and capabilities and the companys mission
statement and stakeholder expectations. The options must also be assessed with
regard to risk and investment requirements, etc. Needless to say, the options selected
should be those that enable the company to meet its international business objectives
in the most cost-effective way.
5. Implementation of strategies
The implementation stage involves decisions about the nature and application of
operational activities designed to meet the businesss objectives. This involves
acquiring and deploying the resources necessary, financial and human, and
establishing the organisational structures and management systems which enable
those resources to be appropriately applied in the pursuit of the companys objectives.
It will also include designing and implementing the elements of the marketing mix; we
shall be considering this aspect of the international business plan in some detail
therefore in later study units.
6. Evaluation and control. The final stage in the framework is the assessment of the
extent to which the plan has worked and objectives have been met. Control involves
the measurement and analysis of performance against evaluative criteria established
as part of the objectives, and the taking of corrective action.
Recently, research and literature on planning strategies in practice has illustrated the fact that
very often actual strategies arise in very different ways to the text book planned fashion of a
sequence of logical and intended steps as set out above. Instead of planning being a linear
and systematic approach, it is suggested that much strategy arises as a result of companies
actions over time. There are many reasons why this happens, but the intended strategy can
be changed as a result of changes in the business environment such as cultural and political
changes that in turn require changes to the intended and planned strategy.
Of course, it could be argued that such changes should themselves be planned for in the
intended strategic plan through the use of contingency planning. Any surprises that force
the business to change plans in mid-stream, therefore, could be looked at as a failure or
deficiency in the planning systems. However, a number of factors make such surprises and
changes to intended strategies more prevalent these days, and more importantly, more
appropriate to effective business operations. These two factors are the increasingly dynamic
nature of the international business environment as we have discussed in earlier units,
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together with the ability of organisations to access ever increasing amounts of detailed
information through on-line systems, again as discussed earlier, and thus make speedy
decisions.
Taking the first of these, the dynamic nature of the international business environment, the
speed and pace of change in this environment puts an increasing premium on companies
being flexible in their planning systems rather than developing plans and then sticking to
these whatever the circumstances. The pace of change in the environment requires that
management be alert and responsive to these changes and be able to incorporate them in
modified strategies. Indeed, speed of response and flexibility are key facets in competitive
international business strategy. Such emergent strategies, as they are often referred to, are
based on the notion of organisational learning over time.
Effective strategies, therefore, are based on managers being sensitive to environmental
signals through environmental scanning and by evolving strategy in small-scale steps to
match these. Clearly, there is a danger in this approach that companies are pulled off target
and away from their intended objectives and strategies, a process sometimes referred to as
strategic drift. This can result in companies simply muddling through a series of crisis
changes as the organisation is battered by the vagaries of a stormy environment. Needless
to say, such an ad hoc approach to planning is not to be recommended.
Approaches to Planning
The way in which organisations approach the issue of planning may differ as follows:
Planning and the organisational hierarchy
There are three main ways in which the planning process may be undertaken:
(i) The top-down planning approach is one in which the most senior managers
prepare broad strategic plans and then rely on local managers at country level to
implement the plans.
(ii) Bottom-up planning is the reverse process. Here, managers at country level
prepare their plans, which are then passed on to the central headquarters for
senior managers to adjudicate. This approach uses local knowledge and
encourages local involvement, but can be time-consuming before the final plan is
agreed. It can also be frustrating if the local plan is extensively modified or even
rejected in total.
(iii) In an attempt to gain from the positive features of top-down and bottom-up
planning, some companies use goals-down, plans-up planning. This approach
aims to achieve a blend of consistent strategic planning through setting
objectives or goals and deciding the main strategic options with the locally
developed and implemented plans.
Moving towards strategic planning
Even though there are differences, the development of a planned strategic approach to
domestic markets and to international markets might well evolve through approximately
the same stages. These stages are:
(i) Unplanned stage The company manages in a reactive way without a planning
process or a formal written plan.
(ii) Budgeting stage The company develops a plan, but the plan is primarily
composed of numbers that have little justification from business research or
market opportunity analysis. The figures in the budget reflect financial forecasts
of sales, cash flows and profits. These figures are often projected from past
results. The great weakness with this approach is that it makes little attempt to
forecast what customers will want to buy in the future.
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(iii) Annual business plan stage This approach to planning shows a considerable
improvement on the budget stage. In an attempt to gain more accurate forecasts
of the future and to involve managers actively in the planning process, the next
stage in planning is reached. The plan is developed across the business
functions of production, finance and marketing but is often limited in time-scale to
the next financial year.
(iv) Strategic planning stage This approach to planning takes a longer-term
perspective. Whereas the earlier approaches will be based on a one- or two-year
cycle, strategic planning will operate over five to ten years or maybe longer. This
longer-term plan is much more appropriate for international business because it
often takes a long time after entering a country market before substantial market
shares are established. An important step in good strategic planning is to build
the more detailed annual planning into the overall strategic direction. If this is
achieved, it avoids the annual plan being a tactical implementation of something
that is always remote from the long-term strategic plan.
Benefits of Planning
The benefits of planning include the following:
The company is encouraged to be proactive rather than reactive. It tries to anticipate
environmental change, changing buyer needs and wants and competitor activities. It is
most unlikely that the company will forecast the future with total accuracy, so it will
therefore have to react to some unforeseen events. It is obviously better to plan
proactively and take the benefits from this approach and to confine reactive activities to
those areas that were not anticipated.
Planning encourages the involvement of many international personnel in a process of
analysis, discussion and decision. The end result should be one of improved decision-
making about the need for future activities. It should also provide some sense of
ownership in the final international business plans.
The clear statement of time-scaled objectives and the strategies to be employed to
achieve those objectives should prevent misunderstandings and delays in the
implementation of plans in different country markets around the world.
There is the opportunity to develop consistent business information systems to help
inform decision-making.
The evaluation and control of implementation will be easier if there is a consistent
process and written-down plan.
Difficulties of Planning in International Markets
If there are many benefits to international business planning, there are also many difficulties.
In fact, international planning poses several difficulties and complexities over and above
those encountered in purely domestic business. Some of the reasons for this added difficulty
and complexity are listed below:
The planning process is done at a distance from where the plans are implemented.
Planning is done in the context of an unfamiliar environment.
Related to the above, the planning must encompass different cultures.
Information is more difficult to obtain.
The political environment is often much more uncertain.
Different stakeholder expectations have to be dealt with.
Evaluation and control are more difficult.
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B. STRATEGY DEVELOPMENT
The Ansoff Growth Matrix
The Ansoff growth matrix can be used to explore the different strategies open to a company
around markets and products, as shown in Figure 5.2.
Figure 5.2: The Ansoff growth matrix
EXISTING
PRODUCTS
NEW
PRODUCTS
EXISTING
MARKETS
Market
Penetration
Product
Development
NEW
MARKETS
Market
Development
Diversification
From an international perspective, growth can often be obtained by developing into new
country markets through the strategy of market development. It is particularly risky to
attempt to launch new products into new markets, and this is particularly the case in
international markets. However, the degree of risk will vary according to the degree of
difference between the existing market and the new market, and the existing product and the
new product. A useful way to visualise this is by developing the Ansoff growth matrix from its
standard four-cell format to a multiple, incremental scale on both the market and the product
axes.
This modification can be used when considering options and assessing strategies for
entering new international markets. This adapted model is often referred to as the Ansoff
Incremental Matrix. This is shown in Figure 5.3 below:
Figure 5.3: The Ansoff growth matrix using an incremental scale
The idea of this matrix is that it is possible to assess different degrees of risk in entering new
international markets by considering degrees of market newness and product newness. So,
for example, it will be more risky to launch a product into a new country with considerable
distance, both geographically and culturally, from the country markets that the company is
Increasing increments of product
newness
Increasing
increments of
market
newness
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used to. For example, a UK company that has developed markets in the EU will experience
higher risks in marketing to Latin American countries or to Japan and China than it would to
Turkey and Switzerland. All the countries mentioned would be new markets, but Switzerland
and Turkey are closer geographically and culturally than the high context and geographically
distant Latin America, Japan and China. Entering these markets therefore would be a very
high-risk strategy, particularly if it were combined with the need to produce entirely new
products.
Key Strategic Decisions Areas
Although Figure 5.1 shows the key elements of an international business plan, it does not tell
us what the key decisions are in developing the plan, and in particular those decisions which
are special or different when considering the planning of international as opposed to purely
domestic business. In this section, therefore, we shall examine these special decision areas,
focusing on them in the sequence in which they arise in strategy consideration for the
international business. (In the forthcoming sections, we shall consider the impact of a
number of features and factors on these decision areas.)
The importance of non-domestic sales and profits
This first decision for the business concerns the extent to which non-domestic sales will
contribute to overall company sales and profits. Obviously a company that decides that
this contribution is to be zero will not get involved in international operations at all. On
the other hand, the company that determines that non-domestic sales are to contribute
the bulk of sales and profits over time will have a very different approach to strategy
and planning in the international arena.
The range of countries selected
This decision area is concerned with the extent to which the company will concentrate
its efforts on one, or perhaps a few, selected international markets, or whether it will
attempt to target many markets throughout the world. Essentially this decision is the
same as the segmentation and targeting decision encountered in any business
planning process. So, for example, a company can choose between a range of
targeting strategies as follows:
A concentrated targeting strategy, i.e. targeting only one selected country.
A targeting strategy based on doing business in several countries which are
possibly related in some way, for example, member countries of the European
Union.
A targeting strategy based on selecting any country in the world that is assessed
as providing a business opportunity, i.e. a global targeting strategy.
Obviously, many factors will affect this decision including, for example, company
resources, company objectives, experience (or lack of it), etc.
There is some evidence to suggest that companies that concentrate their international
business efforts on fewer countries tend to be more successful compared to companies
that spread themselves too thinly across different international markets.
Selection of individual countries
Having determined whether to opt for a concentrated or market spreading strategy,
again, as in any business plan, the business must decide which specific markets to
target. Again, this decision is no different to that encountered in purely domestic
business, and many of the considerations are the same. The characteristics of an
attractive international target market include, for example:
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Market size and potential.
Extent of competition.
Some relatively unsatisfied customer needs that the company could satisfy.
In addition to these basic characteristics of an attractive market target, however, the
following considerations in assessing market attractiveness come into play when we
consider international business:
Nature and extent of trading barriers.
Physical and geographical ease of access.
Political and economic stability.
Currency and exchange risks.
Understandably, very often companies will initially choose target markets that are
similar to their own domestic markets and/or are geographically in close proximity.
Ideally, however, again as in the selection of any market target, a careful analysis of the
business opportunities offered by the markets should be conducted.
Mode(s) of entry
Having determined which countries to enter and the concentration or spread of these
markets, the business must next decide the way of entering these markets. We shall
consider this important aspect of international business in more detail later in the
course, but we shall consider the key characteristics and importance of this decision
here.
The mode of entry is probably one of the most important decisions that the international
business has to make. This decision affects all of the other functions and aspects of
the strategy and programme including, for example, the type and extent of resources
required, the most appropriate form of organisational structure, the business
operations, and so on. As we shall see later, there are in fact a myriad of alternative
ways of entering an international market, but broadly, we can distinguish between two
major alternative routes. The first of these involves a company entering a market
through some sort of exporting arrangement. The alternative is through some sort of
foreign ownership. Again we need not concern ourselves with the specific mode of
entry alternatives under each of these broad categories because they are examined in
detail in a later study unit. At this stage it is sufficient to note that the mode of entry is
one of the most important and pervasive decisions in the international planning
process.
Standardisation and adaptation
As you have probably already guessed, this decision area in the international strategic
planning process involves decisions regarding the extent to which business strategies
and programmes will be adapted to different markets/countries, particularly with
reference to market-related activities. As we shall see in later study units, these
decisions encompass not just standardisation and adaptation with regard to the
elements of the marketing mix, although these are key decisions in this area, but also
decisions as to the extent to which, say, organisational structures, systems and
procedures will vary throughout the different countries or markets which a company
operates in. As with mode of entry decisions, this area is so important in international
business that a whole study unit, Study Unit 8, is devoted to this area. In addition, we
shall see that issues of standardisation versus adaptation run throughout the study
units that encompass the marketing mix elements of international marketing. We shall
therefore return to this area several times throughout the rest of the course.
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Implementation and organisation
This final area of decision-making involves decisions about how to implement
strategies. It therefore includes decisions about detailed action programs and
encompasses the more tactical, but nevertheless crucial, aspects of international
business. This decision area also encompasses issues regarding organisational
aspects such as the most appropriate structures and staffing arrangements for
achieving objectives.
C. STRATEGY AND COMPANY FACTORS
The first set of factors affecting the key decision areas outlined in the previous section
includes those relating to the company itself. Examples of company factors that will affect
the range and choice of strategy options include:
Size, strengths and resources.
Orientation (Ethnocentric, Polycentric, Regiocentric and Geocentric).
Type of involvement in international business (Exporting, International, Multinational
and Transnational).
Obviously, these company factors will in various ways affect the previously discussed key
decision areas, so, for example, the smaller company with fewer resources is more likely to
have a concentrated targeting strategy with regard to the selection of overseas markets.
However, it is dangerous to make a watertight link between the different classifications. For
example, it would not be correct to say that small companies inevitably have concentrated
targeting strategies, regard international business as important or are likely to be
ethnocentric companies involved only in exporting.
We shall now consider each of these company factors in more detail.
Size, Strengths and Resources
A company will be constrained in its choice of international strategies by its size and the
availability of resources. Of particular importance in this respect are the financial implications
of different strategies.
One of the reasons for the growth of Japanese companies in international markets is that
they have had better access to resources, including financial resources. Japanese
companies are less subject to the short-term stock market pressures that are so influential for
UK and US companies, and this, when translated into possible strategic options, has meant
that Japanese companies have been able to undertake longer-term growth-oriented
strategies. US and UK companies have been more restricted. Smaller companies are also
restricted, for example, budget sizes for advertising and sales promotional support will be
smaller and the number and calibre of people to support international business operations is
often restricted.
Companies also differ, of course, with regard to their strengths. Understandably, when it
comes to identifying and selecting international markets, the business should be looking to
match company strengths to the most attractive markets. A useful approach linking company
strengths and the attractiveness of different country markets has been developed by Harrell
and Kiefer (1993). Country attractiveness is measured by criteria such as market size and
growth, economic and political stability and the lack of tariff and non-tariff barriers. Company
strengths are measured by criteria to evaluate the relative competitive position, the degree of
co-operation to be expected from distribution channel members and the fit between the
existing range of products produced by the company and the need to adapt products to make
them acceptable in the country market. The market share available for the company in the
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country market is also usually very important because it influences the economies of scale
and experience that can be gained in that market.
The country attractiveness/company strengths matrix can also be used to help identify
suitable strategic options. Countries that are, in themselves, highly attractive and which
overlap with countries in which the company already has a high strength, will be countries in
which the company should develop strategies for investment and growth. On the other hand,
countries with low attractiveness in which the company has few strengths, will require
strategies to harvest the profits that are available or the company should consider selling off
its interests in the market (see figure 5.4 below).
Figure 5.4: The Harrell and Kiefer country attractiveness/company strength matrix
Company Strength
High Medium Low
High Invest/Grow Dominate/Divest/
Joint Venture
Country
Attractiveness
Medium Selectivity
Low Selectivity Harvest/Divest
Companies might well wish to develop their own modified versions of the Harrell and Kiefer
Matrix using their own criteria with regard to what constitutes the important elements
underpinning country attractiveness and company strength.
Orientation
In an earlier study unit we discussed the different orientations towards international business
that a company can have. We called this EPRG (Ethnocentric, Polycentric, Regiocentric
and Geocentric) orientations approach and it is useful because it helps us to understand
possibilities and limitations caused by the prevailing culture or orientation within the
company.
Companies with an ethnocentric orientation are unlikely to be culturally sensitive to the
needs of non-domestic customers. They are likely to develop strategies that are
influenced too strongly by their own national experiences. In some situations this can
develop a strong consistent strategy; for example, champagne from France or fashion
clothing from Italy. In other situations, opportunities are lost because the strategy does
not allow the possibility of adaptation.
Companies that follow a regiocentric orientation are likely to miss strategic
opportunities outside their region. A European company following a regiocentric
approach might be strong in Europe but miss the growing market opportunities in Asia.
The polycentric-orientated company will have strategies with highly tuned adaptations
to host-country markets. Its weaknesses will revolve around missing standardisation
opportunities and the lack of an internationally co-ordinated competition strategy.
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The geocentrically orientated company should be capable of developing a wide range
and balance in its international business strategies. It can plan globally, but develop
relevant country and world-region adaptations.
Type of Involvement
Remember that companies have different degrees of involvement in international business.
One way of classifying such involvement is to distinguish between exporting, international,
multinational and transnational business. Each of these, together with their implications for
some of the key decision areas in business strategy that we have outlined, is discussed
below:
Exporting
Exporting involves simply the physical movement of products across country
boundaries. This is the lowest level of commitment and therefore can encourage
companies to develop a market spreading strategy without formally evaluating the
benefits to be obtained from key market concentration. In export business, many
companies do not have a clear strategic plan; opportunities are exploited in a more
entrepreneurial way. The company usually limits its long-term commitments to any one
market. Country markets might not be selected by a careful analysis of opportunity but
might be more influenced by the ease of dealing with the markets. In this way, British
companies have often selected Commonwealth countries. It is only relatively recently
that Continental/European markets have been the main focus for British companies.
Exporting companies will rarely have a specific strategy towards standardisation and
adaptation. The product is usually the same product as for the home domestic market.
Products are developed for the home market and then exported if there appears to be
potential. It will be necessary to adapt products to make them acceptable in different
countries with regard to laws, technical standards, climatic conditions, cultural factors
and so on.
The other elements of the marketing mix will change in different countries, but usually
without any overall co-ordination. If agents and distributors are responsible for
marketing communications, large differences may develop between the messages and
the positioning in each market.
International business
In international business, the company will, by definition, use entry modes that include
sales and distribution depots in other countries and they might include a complete
production and marketing operation. There will be a greater range of strategic options
possible and the company is more likely to formalise its international business planning.
It is possible that this planning will be limited to annual budgeting although such
companies are increasingly taking a longer-term and more strategic view of their
planning processes.
Multinational business
The importance of international sales and profits becomes larger and larger as the
company expands its international exposure. Multinational enterprises (MNEs) have
direct foreign investment in a number of countries. Different writers on the subject
quote different numbers of countries. However, to be an MNE the company must have
at least one other major country operation.
The planning process becomes much more formalised. The high costs and risks
associated with direct foreign investment mean that the company must take a long-term
view. There will be a more formal approach to country selection. The selection of
certain countries for investment is likely to bring with it a market concentration
approach. It is, however, possible that companies could separate their production
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operations from other strategic considerations, including marketing. The low cost
advantages of certain countries might result in their usage as an operations site rather
than as a key market.
The MNE in its standard form has a polycentric orientation. This results in a low level
of standardisation because each subsidiary, as it becomes more entrenched within the
culture of the host country, seeks to adapt the centralised plans developed at the
headquarters of the company. Often the product will remain standardised, but the other
parts of the marketing mix will be subject to adaptation. This variability in approach and
the subsequent higher costs that result from the diversity of methods and the marketing
mix have made the MNE vulnerable to aggressive local competition and to competitors
that operate from a more co-ordinated global perspective.
Transnational business
A recent trend has been the move of MNEs towards a more global approach. In its
pure form a transnational company would develop international strategies based upon
a thorough assessment of market opportunities around the world. The transnational
would then configure its activities in order to exploit those opportunities to the full. It
would not be tied to any one country or world region. It would be culturally neutral in
the way that it evolved and implemented international strategies.
It is exceedingly difficult, though, to develop a true transnational company in the way
described. Most very large MNEs are moving away from a polycentric orientation
towards a geocentric orientation, but to change the culture of an organisation takes
time. The company is usually locked into various countries because of decisions
taken previously in its history.
Our view of transnational business is more evolved than most companies have been
able to reach so far. For the pure transnational company, international strategies will
be based on a careful calculation of opportunities around the world, paying particular
attention to the importance of the triad markets and to other parts of the world where
growth opportunities are significant. For many companies the growth opportunity
markets are countries in Asia and Central and Eastern Europe.
The likely strategy characteristics of these different types of company are summarised in
Table 5.1.
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Table 5.1. Likely characteristics of international strategy by type of involvement in
international business
Export
Marketing
International
Marketing
Multinational
Marketing
Transnational
Marketing
Importance of
Non-Domestic
Sales
Varies but is
often small.
Becoming more
important.
More important. Very high
importance.
Range of
Countries
Selected
Often based on
geographically
or culturally
close countries
More formal
country
selection.
Careful
selection
because of
foreign direct
investment.
Selected on a
worldwide and
market
importance
basis.
Market
Concentration
or Market
Spreading
Often market
spreading.
Market
concentration
becomes more
important
although, as the
company size
expands, more
countries will be
entered.
Market
concentration
becomes more
important
although, as the
company size
expands, more
countries will be
entered.
Resources are
allocated on a
world strategy.
Standardisation
or Adaptation
Product the
same but
adapted to local
conditions.
Other elements
are usually
adapted.
Considerations
of
standardisation
and adaptation
are examined.
Aims to be
centralised and
therefore
standardised
but
considerable
adaptation by
subsidiaries.
Formalised to
gain global and
local benefits.
Product Mix
Used in
Different
Countries
Will vary from
country to
country.
More
experience and
resources used
internationally
will permit more
control of the
product mix.
Tendency to be
similar to the
headquarters
country but with
local
adaptations.
As above.
D. STRATEGY AND COMPETITION
We have already examined the probable weakness that a company will have when it enters
new country markets. In its own domestic market, a company will, if it survives, gain a better
understanding of its customers and its competitors this enables it to build its sales. In new
country markets, it has to start again from the beginning it has to contact customers for the
first time; it needs to develop a customer base. Whilst doing this, the company has to
compete with companies that are already established within that market.
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Analysing Competitors
There are a variety of ways in which we can analyse competitors. There is no one way in
which we can fully understand them, but a combination of approaches can be very helpful in
understanding the influence that they might have on a businesss activities. The approaches
include:
International and segment coverage
This looks at the international scope of competitors and their market segment and
industry coverage. This can be realised through considering their place on the type of
matrix shown in Figure 5.5.
Figure 5.5: Competitor analysis By international coverage and degree of
specialism
Domestic International Global
Specialist limited to
one or two market
segments
Generalist, including
specialist expertise
covering all the main
segments in an
industry
Multi-industry
It is easy to identify competitors who operate within just one domestic market. Some
companies operate more internationally. Global coverage is more difficult to define. To
be global, a company would need significant involvement in at least two, and preferably
three, of the triad markets.
Competitive positions
Within any country market a company will occupy one of several possible competitive
positions. Kotler identifies four different competitive positions:
(i) Market leader has the largest share of the market.
(ii) Market challenger has the second largest market share and is usually striving to
increase it.
(iii) Market follower has smaller market shares, but is still a significant player. They
develop strategies to conserve their existing market position and, thus, rarely
undertake marketing activities that are aggressive in taking market share from the
market leader or the market challenger.
(iv) Market niche concentrates on the small market segments that make up the total
market of most consumer or business markets.
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Generic Competition Strategies
According to Michael Porter, there are three generic strategic approaches designed to
outperform other companies in an industry. These are lowest cost position, differentiation
and focus.
Lowest cost position strategy
Companies that have the largest share of a defined market usually use this. Whilst
sheer size, through the economies of scale and the experience curve effect, offers the
opportunity of lower costs, it does not necessarily give a cost leadership position.
Companies that are particularly efficient in managing their affairs can sometimes claim
the lowest cost position, the cost leadership position. Cost leadership does not mean
having lower expenditure than competitors. If a company has a higher level of sales, it
can achieve cost leadership if its costs per unit sold are lower than competitors. For
example, advertising, research and development, marketing research and sales-force
costs need to be considered as a cost per unit sold, in addition to the total cost.
Companies selling large volumes of product will gain advantages over smaller
companies because they can reach the minimum threshold levels of most, if not all,
strategic options, and for most options they will have lower costs per unit.
The lowest cost position in the past was measured within a national domestic
framework, but increasingly, industries are developing on a world scale. This means
that cost leadership has to be viewed more from a global than a national perspective.
Japanese companies have been particularly forceful at developing international
strategies that drive for increased market share. Increased market share allows lower
costs to be achieved. If this is applied to a constant drive for quality and for efficiency,
a powerful position is built up. Japanese companies in the car, motorcycle, camera
and hi-fi industries have achieved international positions based on cost leadership.
Differentiation strategy
This is a generic strategy that operates on an industry-wide multi-market segment
approach that relies on customers regarding the product or service as unique.
Customers provide the protection for the company in the differentiation approach. If
customers regard Mercedes cars as high quality and high status cars that cannot be
equalled by other car-makers, then Mercedes can defend its market share position. It
is a strategy that will give above-average industry profit returns. If Benettons publicity
approaches, their closeness to the market in response to fashion trends and colours,
and their efficiency in managing the whole process of new product development to
retail availability to the customer, enable the customer to think of Benetton as an
unrivalled source for their fashion clothing, then Benetton will be successful. That
success will be based on a differentiation strategy. Coca-Cola and Pepsi Cola use
differentiation strategies in their international marketing strategies.
Focus strategy
This is based on finding a particular market segment and serving that segment more
successfully than other competitors. Because the segment is one of other segments in
the market, the focus or niche strategy cannot give the lowest cost position. The large
volume producers with large market shares of the total market will have lower costs
than the niche strategy company. Internationally, the niche strategy depends on finding
similar small market segments in other country markets, particularly if those segments
are not well served by companies at the present time.
Porter quotes the example of Montblanc, the German producer of high quality pens, as
a company with a global focus strategy. In the past decades, a number of Japanese
companies that have since moved on to become global companies on a multi-segment
basis started by attacking markets on a narrow segment basis. Porter notes, In
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industries such as cars, lift trucks and television sets, for example, Japanese
companies established initial beach heads by focusing on the compact, and neglected,
end-of-the-product range. They later broadened their lines and gained commanding
worldwide positions (Porter, M.E., 1990, The Competitive Advantage of Nations,
MacMillan).
Competitor Defence and Attack Strategies
Companies in international markets usually operate from a market challenger, follower or
niche position in individual country markets. It is only the well-established companies that
will have market leadership positions in countries other than their own domestic market. If a
company wishes to gain market share in other country markets, it can either aim to increase
sales in a rather general way or it can try to attack the business of established competitors.
Most strategic thinking related to competitor defence and attack strategies is based upon
military strategies. A major idea in attack strategies is that of mass. It is important to
concentrate resources at particular points and at particular times in order to achieve results.
There are a number of attack strategies, the main ones being frontal attack, flank attack,
guerrilla attack and bypass attack.
Frontal attack
This means taking the competitor on across the whole range of the marketing mix and
in most country markets. In its pure form, it is most unlikely in international business. It
is much more likely that a frontal attack strategy will be used on a country basis. In this
way the attacker can concentrate its resources. On the full international front it would
be too expensive to mobilise enough resources of people, budgets and product to
attack in sufficient force to achieve any real effect. The net result of such a manoeuvre
would be substantial losses to the failed attacker.
Companies that have used the full frontal attack strategy have usually achieved a cost
leadership position, whilst still being a market challenger, and then used the cost
advantage to build resources to attack the market leader.
A modified form of frontal attack can be developed by companies using a price-
aggressive strategy, whilst matching the other elements of the market leaders
marketing mix.
Flank attack
This strategy has been used frequently in international business. Defenders will
concentrate their resources where they most expect to be attacked. This might be a
particular country or group of countries, it might be a particular market segment, or it
might be through one of the elements of the marketing mix. Accordingly, attackers will
be more successful if they can find less well-defended positions. The strongest
defences will usually be with the big important countries, in the main product line and
with the biggest customers. The weaker points, the flanks, will usually be in the less
prestigious areas.
Japanese companies attacked the flanks of UK and US industry in the motorcycle
industry through marketing very small capacity motorbikes. In the television industry
they marketed, initially, small size black and white televisions when the UK and US
industry interest was centred on larger colour sets. Once the Japanese companies had
established a distribution channel foothold in the UK and the US, and they had begun
to understand buyer behaviour and the dynamics of the marketplace, they started to
introduce other, more directly competitive products.
Guerrilla attack
This is an approach that might be suitable for companies with fewer resources than
those attempting flank and frontal attacks. The guerrilla strategy is to make small,
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unpredictable attacks in various geographical locations on an opponent. The aim is to
unbalance an opponent so that in the longer term significant advantages can be
gained.
In the short term it is imperative that the cost of guerrilla attacks is less than the
damage inflicted on the opponent. Guerrilla attacks will usually be based on selective
price cutting and marketing communications activity.
Bypass attack
This approach avoids direct confrontation with opponents. One type of bypass
approach is to enter country markets that are not currently served, or are very weakly
defended, by the main competitor. Thus, if the main competitor is strong in Europe and
North America, a bypass attack might be made by concentrating on, say, India and
China, countries in which the main competitor has no representation.
Another type of bypass attack is to channel resources into research and development
to develop new technologies to replace the existing products on which the competitors
strength is based. In the 1960s the UK company, Wilkinson Sword, developed razor-
blade technologies based on stainless steel. In a few years Wilkinson had gained a
significant share from Gillette, the world leader in the razor-blade market. Gillette for
some years clung to carbon steel blades that were sharper, but less long lasting than
Wilkinsons stainless steel blades. Unfortunately for Gillette, customers preferred to
have more shaves from a slightly less sharp blade. Without this bypass attack, it is
most unlikely that Wilkinson would have penetrated the markets that were dominated
up until that time by Gillette.
E. STRATEGY AND LEVEL OF ECONOMIC DEVELOPMENT
Economic factors are part of the SLEPT and C influences on the environment of business,
and they play a major role in influencing, directly or indirectly, many of the other factors,
social, legal, political and technological. They also directly affect such elements of the
environment as market size and growth. The type of economy, therefore, strongly influences
the rules of the game in the country market and strength of buyer demand, important
influences on international business strategy.
In a world of over 200 countries, in which the economic factors show considerable variation,
it is clearly necessary for business to recognise their impact. Taken to its logical conclusion,
though, this could mean that a company would need to produce a different marketing mix for
each country. This is likely to be impractical even for the largest and wealthiest companies
and most would resist this amount of change and adaptation to the particular needs of a
country market. They would prefer to take a more standardised approach, wherever
possible, in order to cut costs.
One compromise approach is to group or segment the world market by the level of economic
development. In this way countries could be segmented, as we have seen before, as
follows:
Industrially advanced countries these would include the US, Canada, the UK,
France, Germany, Italy and Japan.
Newly industrialised countries these would include South Korea, Singapore,
Taiwan, Malaysia and Mexico.
Developing countries these would include most countries in Africa, Asia and South
America. Since the break-up of the Communist bloc in 1989/90, many of the Central
and Eastern European countries would appear in this category.
The implications of this division for the development of strategic plans are discussed below.
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Industrially Advanced Countries
For most product markets, the industrially advanced countries will represent the most
important markets. In many product markets, 80 90% of the world market will be bought in
these countries.
Industrially advanced countries will have a comprehensive infrastructure of transport, power
and communication systems, together with a workforce and marketplace that has high
literacy and education standards. These standards will, of course, vary, Japan, for example,
has a particularly strong educational system.
These countries will have low levels of risk as measured by risk evaluation agencies (e.g.
BERI, the Economist Intelligence Unit). The result of this is that investment decisions will be
regarded more favourably than they would be for countries classified as more risky.
The level of market sophistication and the high likelihood of established national suppliers
and manufacturers in industrially advanced countries make these markets both expensive
and difficult to enter. Whilst the market sizes are large, the rate of market growth, because
these countries often have products in the mature stage of the product life cycle, is usually
quite modest.
International business strategies that include these countries call for large amounts of
resources, sophisticated business programmes and an ability to withstand fierce competitive
pressure and powerful buying policies of retailers and other buying organisations.
Newly Industrialised Countries
These are countries of considerable growth potential. Many markets will be in the growth
phase of the product life cycle. The economies of many NICs will show much faster growth
than industrially advanced countries and LDCs.
NICs are often difficult to enter because of entry barriers erected by protectionist
governments, who wish to nurture their local industries and to protect local employment
levels.
Initially, NICs had few indigenous industries, but as the term NIC implies, they have
developed an industrial capability. This means that local competition for some products will
be strong. The local manufacturers, for example Proton cars in Malaysia and Samsung
electronics products in South Korea, have several advantages over international competitors:
They often benefit from lower costs, resulting from labour and land costs.
The local suppliers will avoid the tariffs that an international company has to pay.
The local company may benefit from cultural knowledge.
As they become more successful, they can benefit from local country of origin effects
(see later).
International business strategies aimed at NICs often need to take a long-term view. The
market growth is attractive, but the barriers to entry may be high. To overcome the financial
and cultural barriers, some companies form joint ventures and strategic alliances with NIC
companies. This is particularly significant in China and more recently in India, where
economic and industrial growth is accelerating at a phenomenal rate.
Lesser-Developed Countries
These countries can be very risky, political control in some can be autocratic and economic
and financial control might be poor, with some countries such as Brazil suffering from very
high (100% or more per annum) inflation rates. The currency of the country might not be
easily convertible into the major currencies in the world.
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Market sizes in LDCs are often very small because of limited buying power, affecting
government and business markets as well as consumer markets. The whole system of
distribution channels, the infrastructure of the country and the media are all restricted
because of the relative poverty of the country.
International business strategies to LDCs have to cope with high levels of risk, a slow and
often inefficient bureaucracy, and small market sizes. However, the absence of local
manufacturers and the absence of powerful distribution channel members can make these
markets important additions to company sales and profits.
Table 5.2 summarises the main factors influencing international business strategies in the
markets of countries at different stages of economic development.
Table 5.2: Influences on business strategy in different types of economy
Type of Economy Main Business/
Marketing Factors
Lesser Developed
Country
Newly
Industrialised
Country
Industrially
Advanced Country
Market Size
Importance
Small, but in some
markets might be
important.
Of growing
importance.
Very important.
Barriers to Entry Often high. Often high. Formal barriers low,
but marketing
barriers high.
Level of Country
Risk
Very high. Varies but can be
quite low.
Lowest.
Infrastructure of
Transport, Power
and Communication
Systems
Very poor. Patchy. The fast
growth in the
economy means
that the
infrastructure
struggles to keep up
with the rate of
growth.
Very good.
Distribution
Channels for
Consumer Goods
Very fragmented. Urban centres
similar to advanced
countries. Rural
areas can be similar
to LDCs.
Very competitive.
High concentration
of power.
Strength of Local
Competition
Usually known. Becoming stronger
and stronger in
some markets.
Often intense.
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F. STRATEGY AND FINANCE
There are three particular financial implications that need to be considered:
The capital requirements of different strategies.
The extent to which different international business strategies increase or reduce the
risks from exposure to variations in foreign exchange rates.
The need to be paid!
Capital Requirements
There are two aspects of capital requirements:
Initial capital to start up the strategy.
The working capital that will be required to support the strategy.
The initial capital requirements of some strategies are considerable. In particular, market
entry strategies to establish a complete production and marketing subsidiary will require large
amounts of capital that will be repaid only over a number of years. Strategies that depend
upon major co-ordinated product launch programmes in a number of countries at the same
time will require initial capital for the large production that will be required.
Working capital requirements will relate to any expansion of the international programme. If
extra countries are added, more sales sought in particular countries, more products added to
the product mix, etc., extra working capital will be required to support the company in the
period between buying the extra raw materials and receiving the payment for the products.
You should note that it will be customary, in certain countries, to pay invoices after 60 or 90
days. This slower payment, when compared with the UKs more customary 30 days credit,
means that more working capital is required to tide the company over this one to two month
delay.
The decision to adopt a key market concentration strategy will have considerable financial
implications. The extra marketing research costs incurred in order to understand the market
better and the higher costs in the marketing mix programme incurred to increase market
penetration to build market share, need cover from a financial point of view. The company
might not break even on its key market strategy for several years. Most companies would
aim to balance this cost through a balanced portfolio of country markets in which some
require cash, this cash being funded by markets in which a strong business position has
been built in the past.
Foreign Exchange Risk
This is not, for many companies, a major constraint in the development of international
business strategy. However, you should note that foreign exchange rates could often
fluctuate to a much greater extent than the profit margin for the product or service. In the
short term, companies can buy currency forward. In this way they know exactly what rate of
exchange they will receive.
Major MNEs and transnationals will try to reduce the amount of foreign exchange exposure
by attempting to balance the need for different currencies through buying materials and
components in the same currencies as they receive in sales revenue and in profits. Whilst
this will never match completely, the desire to minimise the risk of foreign exchange
fluctuations will influence the large major world companies.
In exporting, foreign exchange relates to sales revenue; in entry modes in which the
company sets up a production/marketing subsidiary, the risk relates to the ability to repatriate
the profits that have been earned. In licensing and franchising arrangements, the returns will
be based on the fees and returns agreed in the licensing or franchise agreement.
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The Need to be Paid
This is obviously an important item. The functional detail will be handled at a legal and
financial level in the company. It is important to take account of the need to be paid. This is
partially assessed through country risk indices and relates particularly to major investment
decisions. It is usual for companies to seek insurance cover, through schemes like the
export credit guarantee arrangements, to protect themselves against default by buyers from
other countries.
95
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Study Unit 6
Organisational Structures, Cultures and Capabilities
Contents Page
Introduction 96
A. Organisational Structures 96
Centralisation vs Decentralisation 96
Extent of International Involvement and Structure 97
Management Structures and Horizontal Form 100
Factors Affecting Choice of Organisational Structure 102
B. Organisational Culture 102
Country Influences 102
Company Factors 103
Management Style and Structure 103
Employee Composition 103
C. Staffing and the International Business 104
In-House and External Resources 104
The Expatriate and the National Manager 104
The Development of a More Global Approach 105
96 Organisational Structures, Cultures and Capabilities
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INTRODUCTION
Planning, it is said, is nothing unless and until it generates action. This statement illustrates
the importance of having effective organisational structures, systems and procedures allied
to the strategic international business and marketing planning process. In addition, given
that plans are implemented through and by people, the human resource aspects of
international strategic planning are also crucial.
The way in which a company organises its activities has a significant influence upon its
success. Organisational structures and procedures influences organisational effectiveness
and efficiency in a wide variety of ways including, for example, speed of response to market
changes, access to and use of resources, communication systems and control and
evaluation of plans. In this study unit we will look at different organisational structures and
the reasons why some structures will be preferred in certain situations. We shall also be
examining the notion of organisational culture and its influence upon the international
planning process. The resources of the organisation influence the effectiveness and the
efficiency of the international organisation. Amongst the most important of these resources is
a companys human resources. We shall therefore, also address the management and
control of human resources in international business, although this aspect will be covered in
more detail in Study Unit 11
A. ORGANISATIONAL STRUCTURES
The type of organisational structure that is appropriate for an organisation will depend upon
many issues. Some issues are fairly obvious. For example, small and medium-sized
businesses will have smaller and less complicated organisational structures than very large
companies such as Unilever or Procter and Gamble. The number of different country
markets and the current size of the company market share in different markets will influence
the need for the number and type of people to be employed internationally. The types of
product and service and the overall product mix will affect the organisation. For example, a
management consultancy firm such as McKinsey and Company will require different types of
people from a manufacturing company such as Ford or Electrolux.
Perhaps less obvious as an influence on organisational structure will be the amount of
experience that the company has in international markets. New and inexperienced
companies in international markets are likely to use different approaches and have different
tasks when compared with companies who have been established successfully in the market
place for a number of years. Another important influence on the organisation is the level of
challenge of the objectives that have been set by the organisation. If the company is seeking
to grow rapidly, it will need a different type of organisation from a company that is attempting
to hold a stable position. Another important influence on the international organisation is the
extent to which the company is trying to standardise its activities. A company with a policy of
running separate country operations will organise itself quite differently from a company with
a pan-European or a global standardisation approach.
Centralisation vs Decentralisation
As in any organisation, the international business must weigh a number of competing bases
upon which to divide its operations and decision-making.
There are several conflicting pressures as companies expand their business internationally.
As the company enters new country markets and expands its product mix, it comes under
pressure to decentralise. By allowing more autonomy at the local country level, it can
develop and implement plans that are more appropriate for the specific needs of the
customers in that country. As the company allows more decentralised decision-making, it
finds that products are extensively adapted or are totally different between one country and
Organisational Structures, Cultures and Capabilities 97
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another. Company and brand names, trademarks, and advertising campaigns will spread
apart. In allowing differences, the company is denying itself the opportunities to make cost-
saving economies. It is denied large economies of scale. It is denied some of the benefits of
increasing experience, because the experience effect is limited to the country operation. If
the company operations were more similar, then the total volume of production and sales
would build up and thus allow economies to be achieved.
A different pressure is to centralise. Companies may wish to centralise their key activities in
order to co-ordinate and control their international activities. The centralised approach has
the benefits of organisational neatness, of standardisation and of the opportunities to profit
from scale and experience advantages. More recently, some companies have sought a more
centralised approach to allow them to develop an organisational capability to launch products
simultaneously in a number of different country markets. Another reason for more
centralised control is to mobilise the ability to plan and to implement international competition
strategies.
Certain difficulties result from an over-rigid approach to centralisation. The main difficulties
are that central headquarters will be too remote, geographically and culturally, to understand
the particular requirements of specific country markets. A further difficulty is the not invented
here syndrome. Managers who are required to manage programmes that have been
developed at central headquarters will not feel involved with the plans and will, therefore, not
be so highly motivated. The extent to which the objectives of the plans are achieved will be
influenced by the enthusiasm and motivation of the people employed at country level. The
not invented here syndrome, therefore, needs to be taken seriously.
In developing the international organisation, the company will need to take account of
specialisation across the dimensions of function, product and geography:
Function is concerned with occupational specialisation. Functional specialisation
becomes more important with the growth in organisational size and complexity so, for
example, the marketing function in a large organisation itself will require functional
specialists in marketing management, selling, sales promotion, marketing research and
so on.
Product is concerned with the co-ordination, integration and control of activities based
on the product. This type of specialisation enables the company to deliver high levels
of expertise in relation to particular products.
Geography is concerned with matching the company with its external environment. In
the domestic market, most companies organise their sales force with specialisation
based on areas and regions within the country. In international business, it is usual to
base some of the organisational structure around countries, trading blocs and world
regions. In this way, closeness to customers and an improved knowledge of the factors
influencing the market place are achieved.
In most organisations a balance between the conflicting interests of these three dimensions
needs to be reached.
Extent of International Involvement and Structure
We have previously identified various stages in the growth of international involvement from
an export selling to a global business stage. We can build a match between these stages
and the type of organisation appropriate to the approach to international business. This is
outlined in the following table:
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Table 6.1. Stages of International Business Growth.
Stage Organisation form
Export selling Ad hoc arrangements
Export business Export department
International business International division
Multi-national business Growing use of groups of
countries/continents- based organisations
Global business Matrix and transnational organisation
As the company expands its international sales and profits, it inevitably finds that ad hoc
arrangements are insufficient. The early arrangements are primarily concerned with
facilitating the order by arranging the physical despatch of the product, and the necessary
financial details of which currency is being specified and how the invoice will be paid. With
more orders the company will benefit by developing a specialist department to handle the
various demands of exporting. Over time the export department becomes less burdened by
the administrative detail of exporting and begins to become more proactive in developing
business plans.
Increasing size will cause the company to consider the need to expand the function and
status of the export department into a division. Further company expansion in its
international business will bring forward the need to co-ordinate activities by parts of the
world, for example Asia, and at its ultimate to attempt to develop a transnational organisation.
Examples of international structures are given below:
Figure 6.1: Export department in a functional structure
Board of Directors
Chief Executive Officer
Production Marketing and
Sales
Finance
Export Sales and Administration Domestic Sales
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Figure 6.2: International division in a product structure
Board of Directors
Domestic
Product
Division A
Domestic
Product
Division B
Domestic
Product
Division C
International
Division
It is probable that the international division would have specialist geographical regions based
on the most important regions for the company.
Figure 6.3: Continent/world region organisation with a functional structure
Board of Directors
Australia/ Asia Europe North American
Free Trade Area
Production Marketing Finance
Figure 6.4: Matrix organisational structure - product divisions and world regions
Board of Directors
Global Product
Division A
Global Product
Division B
Global Product
Division C
(Continent/
world/regional
managers)
General Managers General Managers General Managers
Europe Europe Europe Europe
Australia/
Asia
Australia/
Asia
Australia/
Asia
Australia/
Asia
NAFTA NAFTA NAFTA NAFTA
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Management Structures and Horizontal Form
A pyramid may represent the basic management structure in any organisation as follows:
Figure 6.5: Management levels in a basic pyramid structure
In all organisational structures, it is probable that there will be these three levels of
management responsibility. The recent moves by many companies to reduce costs and to
improve organisational responsiveness by reducing the number of layers in the organisation
would tend to flatten the pyramid, but there will still invariably be a small number of senior
managers involved in strategy and a larger number of tactical managers (middle
management) concerned with organising and leading lower level operational management
(supervisors).
The extent and the importance of these levels of management may vary with different
horizontal forms adopted by international businesses. These differences were considered by
Majaro who identified three organisational types, the macropyramid, the umbrella and the
interglomerate:
The macropyramid organisation
Here, the whole of the strategic function is performed in head office. In these types of
organisations the strategic planning is handed down to product, function and
geographic managers to plan in detail and then to implement. In Figure 6.6 three
country subsidiaries are shown.
Figure 6.6: Macropyramid organisation
In the macropyramid the main elements of the marketing mix are managed from the
main head office. Marketing is standardised as much as possible. Local involvement
in the main strategic decision process is limited. Unless the head office is very well
briefed about local conditions, its planning may result in missed opportunities at a local
level.
Central
Headquarters
Country C
Country B
Country A
Strategic
Tactical
Operational
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The umbrella structure
This is a decentralised system of planning and control. Subsidiaries are given full
independence at all three management levels. The centre concentrates on providing
very broad corporate objectives and has high-level expertise in various functional areas
that can be used to provide advice and support to subsidiary companies. The umbrella
structure is based on the multi-national enterprise with a polycentric orientation
operating in a multi-domestic way.
Figure 6.7: Umbrella structure
Whilst the umbrella organisational structure encourages local managers to plan for
their own market using their specialist local knowledge, it can be wasteful. It can result
in many broadly similar strategies in different countries, yet with fewer of the benefits of
shared knowledge or scale economies.
The interglomerate
In this organisation the centre is concerned with financial returns. The strategies to
achieve the required returns are the responsibilities of the subsidiaries.
Figure 6.8: Interglomerate organisation
Here, each subsidiary is responsible for its own strategic planning. This type of
structure, for example used by Hanson, is most likely to apply to large complex
organisations that have subsidiaries in different industries, using different technologies.
Central Services
Country A Country B
Country B Country A
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Factors Affecting Choice of Organisational Structure
We have already touched on several factors that will affect the choice of the most appropriate
type of organisational structure for international business. In summary the following
represent the major factors:
Company size.
Extent of international market spread.
Range and diversity of products/services.
Level and nature of involvement in international business.
Overall corporate and marketing objectives.
Company capabilities and resources.
Organisational culture.
Many of these are self-explanatory but the final two on our list of factors affecting
organisational structure, namely organisational culture and company capabilities and
resources, need exploring further.
B. ORGANISATIONAL CULTURE
Organisational culture refers to the values, beliefs and attitudes that influence decision-
making and behaviour within a company.
We can consider culture in several ways. We have referred to culture in the SLEPT context
with regard to customers and potential customers, and to company orientations using the
EPRG approach. Orientation is another way of referring to the culture that operates within a
company. In addition, we can consider the culture of the individuals that make up the
managers and employees of the company.
Here, we shall consider the following aspects of what constitutes organisational culture and
review their implications for the international business:
Country influences.
Company factors.
Management style and structure.
Employee composition.
Country Influences
All companies originate from a particular country. For many companies their organisational
culture is strongly determined by their country of origin. We have mentioned on a number of
occasions how Japanese companies differ in their organisational approach. Japanese
society is characterised by politeness and consensus decision-making, therefore
organisational culture will be different from the typical US company with its stronger
emphasis on directness and individualism.
The strength of the country influence on the company will vary. Companies with a
macropyramid structure might be unduly influenced by the location of the central
headquarters, which in turn is invariably based in the origins of the company. Atlanta in the
United States and Nottingham in England are the central headquarters of Coca-Cola and
Boots respectively, because this is where these companies started. As these companies
have grown, they have become less and less ethnocentric. Such major companies
deliberately strive to change their company culture in order to grow effectively.
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Company Factors
Company factors will revolve around the history and age of the company. Companies that
are new will have a different set of values from companies that have been established for a
long time. The origins of the company in craft practices might influence attitudes in the
company long after production techniques have changed.
The type of the EPRG orientation influences the attitudes of people employed within the
company. For example, a company with an ethnocentric orientation may find it difficult to
develop international markets, because the company is centred on the home market;
production might find it difficult to spare the time in the production schedule to produce a
strange foreign order; the advertising manager might be more interested in the home
market. On the other hand, a polycentric orientation will limit standardisation and co-
operation, and regiocentric will concentrate on one part of the world to the exclusion of other
opportunities. Geocentric culture will be much more expansionist, although it might,
however, result in lost opportunities at the country level.
Management Style and Structure
The values of managers are influential in shaping the culture of the company. Companies
can evolve into recruiting a certain type of manager to perpetuate the existing management
style. Different types of management style are related to those managers who seek to
defend the existing business, those that are more entrepreneurial by constantly looking for
new market opportunities, and those managers who look for more careful growth through the
rigorous analysis of market opportunity.
In considering management style, we find that some management styles might be culturally
related. For example, Chinese managers might be very hard working and inclined to
consider higher risk markets and product developments. UK managers have sometimes
been criticised for failing to take risks. They have tended to avoid commercialising the
apparent opportunities that have developed out of research and development programmes.
Management structure can also influence the culture of the company. The three styles
implicit in the macropyramid, the umbrella and the interglomerate, illustrate that controls will
be exercised very tightly in some companies and much more loosely in others. The
macropyramid style will be more enveloping than the umbrella style. The umbrella style will
give subsidiaries considerable autonomy, provided that they achieve the agreed objectives.
In one sense the interglomerate will be even looser. However, the financial controls set are
usually based on challenging financial objectives. The controls are fewer but the fear
engendered in failing to achieve the financial objectives can substantially invade the culture
of the company.
Employee Composition
Most companies start by employing people from within their own culture and/or nation state.
In some countries this will mean the same thing, for example, most people in Japan are
Japanese and therefore Japanese companies located in Japan will employ Japanese people.
A company in the US, though, whilst employing US citizens, might employ people from a
wide range of cultural influences; some employees might be of Italian, Irish, Dutch, Puerto
Rican or Mexican origin. The degree of international spread incorporated within the company
will initially, therefore, depend considerably on the country and the employment policies of
the company.
Growth in the company and in its involvement in international markets will result in the
employment of more and more people from different cultures and different countries. The
company can seek to develop a more international organisation by recruiting, training and
developing, and promoting people of different nationalities to achieve a team of multi-cultural
international managers.
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The company can make choices about the use of expatriates to staff its international
operations. The extensive use of expatriate managers on short to medium assignments of
six months to three years will provide expertise and consistency to the remoter parts of the
organisation. However, the damage caused is in the slowing down of a more international
organisation. It is the transnational organisation that will be particularly anxious to develop a
team of very experienced and culturally sensitive international managers. Ohmae refers to
the need to develop equidistant managers in the true global business. Such managers
develop and respond to the most important strategic issues wherever they arise around the
globe. This contrasts with the typical manager who tends to be most influenced by home-
country events.
The international company could use expatriates, nationals or global managers. For many
companies, expatriates have been used whilst the managers taken on at national level are
developed to reach the company standard. Once the national managers have shown their
ability to perform, expatriate managers are used less and less frequently. The more
successful national managers will be promoted into international positions.
The global manager, with equidistant cultural abilities, is quite rare. It is arguable whether
there are companies that are operating on a truly global basis. However, it is certainly true
that there is a shortage of international managers with a high level of country-specific
knowledge across many countries and a cultural awareness that enables them to analyse,
develop and implement successful strategies.
We shall discuss the issue of deciding between using expatriates, nationals or global
managers in more detail in the next section, together with the related issue of whether to use
in-house or external resources.
C. STAFFING AND THE INTERNATIONAL BUSINESS
As companies grow and become more dependent upon international business to contribute
to their total sales revenue and profits, they will employ more and more people
internationally.
In-House and External Resources
The general trend in many businesses is use direct employment of people within the
organisation to concentrate on the main activities of the business. For activities that are
undertaken less frequently or are less central to the company, the organisation will buy-in
agencies, consultancies and people on short-term contracts, it will use external resources.
For example, in the marketing area, many functions can be bought-in from outside. It is
common to use advertising agencies, their use being based primarily on the cost-saving
advantages derived through the commission system. In areas such as logistics, the use of
external resources will be justified partly through cost savings and partly through the need to
buy-in specialist expertise that is not available in-house, for example, freight forwarders can
use their considerable knowledge of freight handling and international transport systems to
make cost-saving, efficient decisions.
The Expatriate and the National Manager
Company personnel based in a different country are often referred to as expatriates.
Expatriates may exist at any level or functional specialism within the company, but the main
area of concern is at management level.
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The main types of manager employed by international companies can be classified as
follows:
Locals managers who are citizens of the countries in which they are working.
Home-country expatriates managers who are citizens of the country in which
company headquarters are based.
Third-country expatriates managers who are citizens of a different country from the
company headquarters and the country where they are working.
We could posit that most companies will want to use local managers to fill the positions in
both the company headquarters and the companys various subsidiaries around the world.
Thus, the typical company would have something of an ethnocentric bias in its headquarters
and polycentric influences in its subsidiaries, because of the proportions of nationalities and
cultures that it employs in its various countries of operation.
There are problems with using expatriates. For many people the difficulties caused by
geographic mobility are too great, the move affects not only the manager, but also the
managers family. There are also difficulties in career progression at the conclusion of the
expatriate assignment.
The Development of a More Global Approach
Companies are now developing ways in which they can be more flexible and more attuned to
the cultural requirements of the market place. One way in which this flexibility is being
sought is through approaches being propounded by gurus such as Tom Peters. They
propose breaking down typical organisational hierarchies to enable companies to be
disorganised, to allow them to cope with the disorganisation and change they face in their
environment and in their markets. The other main development is the borderless world view
of Kenichi Ohmae and the need to build management teams and managers to cope with the
new complexity of international business. One strong view propounded by Ohmae is the
need to develop equidistant managers. These managers would have the knowledge,
experience and cultural flexibility to operate on a global basis without their decisions being
flawed through self-reference criteria. This is obviously very difficult to achieve.
The equidistant manager will need a strong educational foundation. This foundation must
incorporate a fluency in several languages and an understanding of culture through
immersion in the culture and the language. The company will need to use selective
international experience and training courses, within a company that is developing an
equidistant culture, to build on the educational foundation. Of course, in addition to this, the
manager must be capable and successful in international management and business.
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Study Unit 7
International Strategy: Standardisation, Adaptation and
Globalisation
Contents Page
Introduction 108
A. Standardisation 108
Approaches to Standardisation 108
The Arguments for Standardisation 110
B. Adaptation 111
Approaches to Adaptation 111
Imposed Adaptation 112
C. Globalisation 113
Approaches to Globalisation 113
Influences on Globalisation 114
The Range of Globalisation Strategies 116
Global Branding 117
Customised Business Strategy 118
Company Size and Globalisation 118
108 International Strategy: Standardisation, Adaptation and Globalisation
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INTRODUCTION
In this study unit we examine in detail the significant issue of standardisation and adaptation
as a strategy in international business.
Standardisation refers to the approach taken in which the marketing mix is used in the same
way in different countries. There is an important distinction to be made between the same
and similar. It is unusual for exactly the same business strategies to be used in different
countries. It is more frequently the case that the intention is to introduce the same approach
but that minor changes are required for different markets. We will regard this as
standardisation. Adaptation relates to the approach in which the business strategy is
deliberately changed so that it relates to each market.
After looking at standardisation and adaptation, we will move on to examine the issue of
globalisation as a strategy. In itself globalisation could be regarded as an extreme form of
standardisation. As you will see, although globalisation does involve some standardisation, it
does not depend upon it.
A. STANDARDISATION
The ability of companies to develop standardised approaches to different markets is a major
debate in international business strategy.
Approaches to Standardisation
It is possible to view standardisation both as a process and in terms of implementation:
Process standardisation
Because a company can control the processes it uses, this is an easier form of
standardisation than implementation. A company can establish the particular planning
methods that it thinks appropriate. In this way, analytical methods, planning and
international strategy can be controlled substantially within the company and it can
insist that the same approaches are taken by subsidiaries in different parts of the world:
(i) Analysis can be similar, based on policy decisions to use the same marketing
research methods and surveys. Information can be collected, stored and
disseminated in the same ways using a common information system.
(ii) International strategies can be developed from the same analytical methods
using a standard format of business models and techniques.
(iii) Business planning can be based on similar lines in the company headquarters
and in country subsidiaries.
(iv) The business operations can be developed along standard planning
approaches. For example, the company could use the same planning methods
for advertising decisions.
Implementation standardisation
It is much harder to standardise implementation than the processes of international
business. The reason for this is that the implementation involves direct contact with
customers, potential customers, distribution channel members and others. Direct
contact will be influenced by the market structure and behaviour in the market. For
example, in some markets there may be strong competitors with aggressive business
strategy programmes designed to increase market share, whereas in other markets,
competition might be much less aggressive. Another direct contact issue is the need to
take account of the culture of the country market.
International Strategy: Standardisation, Adaptation and Globalisation 109
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Thus, we can see that, when a company attempts to implement its chosen strategies, it
may find that its various customers do not all react in the same ways. The company
has little or no control at the implementation level and it is more likely, therefore, that
the company will have to change parts of its business strategy in order to satisfy
customers:
(i) Product This is a part of the marketing mix that many companies aim to
standardise. The augmented view of the product includes the physical product
plus the brand and company name and trademarks. It includes the packaging,
warranties and guarantees. It is possible, therefore, to standardise part of the
product and adapt other elements. Some companies will have the same physical
product but may change the packaging and the labelling. Language change is an
obvious adaptation.
(ii) Price It is very difficult to standardise price because it is influenced by so many
country factors. There are many differences in the tariff rates charged for
imports, value added tax rates, distribution channel margins and the prices set by
the main competitors. In addition, there are considerable differences in the ability
of consumers to pay a particular price level. Whilst a company can have a policy
to charge good value prices in the middle of the market and, therefore, have a
standardised process approach, the practical implementation will give rise to
many detailed adaptations.
(iii) Promotion The selling part of promotion is usually adapted. The reason for
this is the interface between the sales force and the country distribution channel.
Because distribution channel members are strongly influenced by the culture in
the country, the sales force, if it is to be successful, has to adapt to local
requirements.
Public relations and sales promotions are also often adapted to fit local
requirements. It is the advertising decision that stands the best chance of
standardisation. This is because it uses media that are less culturally specific
than the other elements in the marketing mix. It can also standardise the
advertising message if customers have similar buying motivations and if they
seek similar benefits.
(iv) Place (Distribution) This is a marketing mix element that is strongly influenced
by market and country forces. It is difficult to standardise the implementation of
distribution.
In the case of service products of course, the traditional 4Ps of the marketing mix can
be extended as follows:
(v) People Perhaps as one might expect, this is one of the most difficult elements
of the services marketing mix to standardise. By definition, people are individuals
and in addition, of course, people differ between different cultures.
Standardisation can be achieved to some extent, however, through careful
training and staff development.
(vi) Process As you are aware, the process element of the services marketing mix
relates to things such as how the service is delivered, ordering systems and so
on. Compared to the people element, process is generally much easier to
standardise, so, for example, McDonalds processes for taking orders, cooking
these orders and treating customers in their outlets are very highly standardised
throughout the world.
(vii) Physical Evidence Like process, this element of the services marketing mix,
too, can be standardised to a high degree. Again we can use the example of
McDonalds where the layout and dcor is more or less standardised throughout
the world. Standardising physical evidence is particularly important in trying to
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develop a uniform company image, and is often a key part of franchise services
marketing.
You should note that we shall be considering each of these elements of the marketing
mix, including the issue of standardisation versus adaptation, in more detail in later
study units of the course.
The Arguments for Standardisation
The main arguments for standardisation are based on two areas, cost and customers:
Cost
The general and financial management of companies presents a strong argument for
standardisation. It can be demonstrated that the elimination of variety and the constant
repetition of company activities around the same products will give economies of scale
and experience benefits. Economies of scale relate particularly to manufacturing,
whereas the experiences effect can be gained in any part of the organisation through
the efficiency gains resulting from familiarity.
Within the marketing mix the main areas of saving will be based on the high cost areas.
The highest costs, for most companies, will be in the product area. Most companies
will attempt to reduce the amount of variety in the products that they produce. They will
prefer to produce one product that can be sold in all markets. Unfortunately, this ideal
state is rarely found.
The other main area in which companies seek to standardise is the marketing
communications (promotion) area. Companies that have large budgets for media
advertising can often make substantial savings by using the same advertisements in a
number of different country markets.
Customers
When customers are mobile between one country and another, as for example in the
purchase of film for cameras, there are benefits in selling the same product and
promoting it in the same way. If the product and the way it is presented change,
customers can become confused and end up buying a different product. For the
customer, a strong consistent brand image that does not exhibit variations in different
countries will be reassuring.
Even in markets in which customers are not internationally mobile, there can be
customer benefits in a standardised approach. If the same customer segments are
found across country boundaries, it makes sense to use similar products and
advertising. Whilst the benefits in this instance relate to cost savings, there is the
marketing logic of developing a marketing mix that is based on customers. If the
customers are the same, in terms of the benefits that they seek, why not make the
marketing mix the same?
In many companies the cost-saving argument will be stronger than customer similarity,
it is easy to demonstrate cost savings and harder to show customer similarity.
However, it is important for companies to be responsive to customer requirements. It is
quite possible that cost savings through standardisation will be pursued too vigorously
and ultimately to the dissatisfaction of the customer. Customer satisfaction, though,
can be achieved at the same time as benefiting from standardisation based on
customer similarity. The important proviso is that similar customer benefits have been
identified in different countries.
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B. ADAPTATION
The reasons for adaptation lie in specific attempts to develop an appropriate strategy to
satisfy a specific customer group.
The type of company culture or orientation can have a strong influence on the extent to which
changes are made. In a company with a polycentric orientation, adaptation is the likely
consequence. As each subsidiary becomes more and more familiar with its host country
market, it becomes more and more aware of the differences that exist between that countrys
requirements and the head office view of what it should be doing. This leads inevitably to a
situation in which the subsidiary aims to customise its business more precisely.
The ways in which this customisation will take place will be influenced by the overall
company policies and the strength and independence of the subsidiary. If the subsidiary is a
major contributor to sales and profits, and if the subsidiary regularly meets its corporate and
marketing targets, it will be granted more independence than a subsidiary with inexperienced
and unproven management.
Approaches to Adaptation
In a consideration of the business and the ways in which adaptation takes place, it is clear
that most companies will concentrate attempts to standardise on products and on marketing
communications. Price and distribution are influenced by so many local factors that very
precise standardisation is impossible. Some companies will use a standard price list and
some will use a standard distribution channel approach, but these are the exceptions.
For service products, as we have seen, it is process and physical evidence elements of the
mix which are likely to be standardised, especially where the operation is a franchise
operation. For the reasons stated earlier, the people element of the services business can
be much more difficult to standardise.
The main areas, therefore, in which the standardisation/adaptation argument will take place
will be products, marketing communications, physical evidence and process.
For many companies it will be easier to adapt marketing communication than products. It will
be usual for the company to have a sales force that is adapted to local customers and to their
requirements. Many companies use sales promotions in a tactical way that relates very
closely to the market and the competitive situation that exists in the country. Furthermore,
public relations is frequently developed around a knowledge of local media and journalists,
and is often, in addition, based on events and activities that are country-specific. For
example, in the UK with its intense liking for animals as pets, PR events can be based on
dogs and cats; that would be unworkable in many other countries.
Advertising, particularly if it is dependent upon the TV medium, is likely to be the exception to
the obvious need to standardise. The high cost of developing a TV commercial is one factor
that encourages its use across many countries. A further factor is the difficulty in finding an
advertising approach with a strong, positive, demonstrable effect. If the company develops a
very good TV commercial, there will be strong pressure on company subsidiaries to use that
TV commercial.
Table 7.1 summarises the position with regard to marketing communications in multinational
companies.
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Table 7.1: Standardisation and adaptation in marketing communications
Activity Standardisation or Adaptation
Selling It is very difficult to standardise the implementation of selling. The
interface with customers and the distribution channel makes
adaptation highly likely.
Sales promotion Many approaches are tactical and, therefore, will be adapted. Some
companies, especially major companies like Coca-Cola, Kodak and
Sony, sponsor major world sports events (such as the Olympic
Games and World Cup Football) and develop themed sales
promotions that can be standardised and used in many different
countries.
Public Relations Most events, media, journalists and political lobbying will be at a
local or country level. It is possible to develop a standardised
approach across countries, but it is not easy.
Advertising Lower-cost approaches, for example through the press and posters,
will usually be adapted to local requirements. Higher-cost TV
advertising, particularly if high-cost, specialised TV commercials are
important (as, for example, used by Levis and Coca-Cola), will tend
towards standardisation in attempts to cut the costs of producing
many different and expensive TV commercials.
Imposed Adaptation
Adaptation is not necessarily the outcome of a conscious decision by a company to change
its marketing mix to meet the needs of its customers in a particular country. A whole series of
rules, regulations and laws may also be imposed on companies requiring them to adapt the
business that has been developed in other countries, usually the company headquarters
country. Examples of such forced changes are given in Table 7.2.
Table 7.2: Causes of imposed adaptations
Marketing Mix Element Cause of Imposed Change
Product Safety standards legislation
Technical standards
Product liability laws
Price Laws on prices
Different tax levels
Distribution Restrictions on the types of retail outlet, the types of product
they can stock
Promotion Laws on which sales promotions can be used in a country
Legal and voluntary controls on advertising content
Controls on the amount of advertising that the media can carry
(which is particularly the case for TV and radio).
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Marketing Mix Element Cause of Imposed Change
People Employment legislation
Physical evidence Local planning regulations
Process Health and safety regulations
If we take the example of a car, we can see a number of imposed changes necessary in
different markets. The product will need to meet the safety standards required in different
countries, resulting in changes to seat-belt fittings, external and internal surfaces to reduce
injury on impact, the type of braking system, the strength of the body cage, etc. The product
will also need to be adapted for left-hand drive or right-hand drive. Other changes will be
imposed by local climatic and driving conditions; for example, in hot countries air-
conditioning might be an almost standard part of the car.
Other adaptations to the same product may not be imposed, but will be influenced by market
demand. These will be used to enhance the cars appeal in a specific market through such
adaptations as colour schemes, different levels of instrumentation fitted as standard or
different warranty arrangements (in one country the warranty might be for one year, whereas
in another, because of competitive factors, it could be as long as three or five years).
C. GLOBALISATION
Globalisation is a particular form of standardisation, perhaps even being seen as its ultimate
form.
The increasing convergence of customer demand for some products and services enables
those products and services to be thought of as serving a world market. For example, a
worldwide market exists for fuel for cars and lorries, for film for cameras and for many
consumer durable products. The demand for music and film entertainment services is a very
wide one across country boundaries.
With a market demand existing across many countries, and as communications and
transport systems in the world improve, it is not surprising that some companies have sought
to co-ordinate their marketing approaches. Companies have grown larger and have
resources that enable them to take a wider and wider view of world opportunity.
Approaches to Globalisation
The types of co-ordinated approach are obviously related to standardisation as we discussed
previously. We can see globalisation in the following ways:
Globalisation as a process
In this way companies can view the world market as a total opportunity. They can
develop analyses, plans, and international strategies using a standardised format.
Some companies will also develop a standardised approach to competitive strategy
that can be co-ordinated across the world, defending in some country markets and
being aggressive in others.
Using the process approach, companies can develop a completely similar strategy
across the world, or they can develop one that has major elements of standardisation,
or one that shows considerable degrees of adaptation. This is shown in Table 7.3.
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Table 7.3: Global process standardisation
Type Comments
Completely similar The world standard brand this hardly exists in its
absolute form. Even Coca-Cola and McDonalds make
some minor adaptations in various countries.
Major elements of
standardisation
This will reflect some significant customer differences in
parts of the world. Companies might take a different
approach in, say, Asia and in Europe.
Major adaptation This is most likely to occur in markets that are culturally
highly sensitive. Food products often, but not always, fit
into this category.
Global implementation standardisation
At the implementation level, standardisation is possible in certain parts of the strategy,
but other parts will continue to demand adaptation to the particulars of different country
markets.
Table 7.4 summarises the different approaches.
Table 7.4: Global Implementation Standardisation
Type Comments
Completely similar This does not exist. There are always local and country
and trading bloc differences that cause some adaptation,
even if it is quite minor.
Major elements of
standardisation
Standardisation might be groupings of countries, or by
standardising the product and perhaps the advertising and
then adapting the other elements.
Major adaptation This approach will benefit from the process
standardisation, but at the implementation level will look
as though everything is totally different. Companies like
Nestl will benefit from similar planning and strategy and
control processes, but will exploit market differences to the
full by using a highly adapted marketing mix.
Influences on Globalisation
There is no doubt that the trend towards globalisation has been one of the most significant
developments in international business during the last decade. More and more companies
have become, and many more would like to become, global in their operations. What then
are some of the factors that have served to drive this growth and spread of globalisation?
Some of the more important factors include the following:
Deregulation of trade/Open markets
We have seen earlier how increasingly world trade has become deregulated. As a
result, more and more markets have opened up to the aspiring global business. Even
markets that have traditionally been very difficult to move into, such as China and some
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of the former Communist Eastern Bloc countries, are now open. Japan, at one time
highly protected against foreign companies, has opened up in recent years.
Global competition
Partly as a result of freer world trade, we have seen the growth of global competitors.
Even companies that have traditionally been very insular in their outlook and approach
to business have woken up to the recognition that increasingly their competitors
operate in global markets. One approach to dealing with local competition is for
companies to go global themselves.
Risk spreading
We have seen that the global business environment is much more dynamic and
complex. In particular, financial and other global trading systems mean that markets
can change overnight. For example, recently the Asian economies, from being strong
growth economies, almost overnight began to experience major problems with falling
share prices, company bankruptcies and so on. So sudden were these changes that
some authors have referred to it as the Asian meltdown. A company can hedge
against the risks caused by such market and economic fluctuations by operating in
several markets/parts of the world. Global operations enable the business to spread
the risks of sudden downturns and changes in economies and markets.
Economies of scale/Experience curve effects
Usually, global business involves increases in the scale of operations of an
organisation. As such, it enables a company to achieve potentially large economies of
scale and/or experience curve effects that would be restricted if only domestic markets
or relatively few overseas markets were targeted. We saw in an earlier study unit that
new product development and the associated research and development costs for
many products these days are substantial. Very often these substantial costs can only
be recouped if the resulting products are marketed on a global basis.
Supply chain management
A further impetus to developing global strategies by organisations has been the desire
to manage the supply chain more effectively, so, for example, some companies have
been prompted to go global in order to secure access to low-cost labour or raw material
supplies. Sometimes companies are prompted to go global in order to gain access to
skills that are simply not available in domestic markets, such as research and
development skills, design skills, manufacturing skills, etc.
Global enabling technologies and skills
These perhaps facilitate the growth of global business and strategies rather than
prompt it. Increasingly, global business strategies may be developed through access
to new technologies and skills. So, for example, developments in information
technology and databases facilitate the growth of global strategies and positions.
These databases enable the construction of detailed customer profiles across the
globe by cross-matching this intelligence to other databases, such as economic data,
socio-economic groupings, geodemographic data and so on. The business can identify
global segments and their characteristics.
The global village
None of the above factors would be sufficient to encourage and facilitate the growth of
global strategy if customers were not receptive to global strategies and companies. We
have seen earlier, however, that the growth of international business itself has in large
measure been due to changing customer needs and wants, and in particular an
increased receptiveness and desire for global products and services. We have only to
turn on the television to see how the world has shrunk, a phenomenon that many refer
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to as the global village. So, for example, a news report covering the refugees in
Kosovo recently showed refugees wearing Nike caps, watching Sony TVs in their tents
and smoking Marlboro cigarettes.
These, then, are some of the key factors that have helped drive the growth of global
business and marketing strategies. You must always be aware, however, of some of the key
factors tending to inhibit this growth or at least which are considerations before decisions
about commitments to a global strategy are made:
Cultural factors
Clearly, one of the major factors limiting the growth of global business and particularly
standardised global strategies is differences in culture. Although we have mentioned
the growth of the global village, cultural differences still exist in different parts of the
world with these differences often being substantial. Businesses cannot simply
override these cultural differences.
Customer tastes and needs
Related to, and often underpinned by, cultural factors, the growth of global business is
restricted by differences in customers tastes and needs in different parts of the world.
Other environmental factors
Finally, a global approach is restricted where there are differences in some of the key
environmental forces and factors that we have already discussed. So, for example,
legal political and regulatory forces must be considered.
The Range of Globalisation Strategies
At first sight, the choice of strategies with regard to approaches to global markets would
seem to be a choice between the two alternative strategies of standardisation or adaptation
for both process and implementation aspects of business. However, we can distinguish
between three alternative strategies with respect to globalisation as follows:
Global strategy
A truly global strategy is characterised by an attitude and an approach to planning in an
organisation where no distinction is made between domestic and foreign markets.
Plans are developed on a global basis and the only consideration in considering each
market is the extent to which the market will contribute to the achievement of overall
corporate objectives. A company which has this truly global approach to its markets
and business, therefore, will not think of itself as primarily, say, an American or a
Japanese company, even though the company may have been founded in one of these
countries and may still have its headquarters there. A global strategy involves a
company looking for and planning for global opportunities irrespective of where in the
world these occur.
A global strategy may or may not involve standardisation depending on the
circumstances of the markets and other factors such as competition, the company itself
and so on. However, companies that pursue global strategies are often looking to
standardise their business plans as much as possible.
Multi-domestic strategies
Essentially, this strategy is based on developing different strategies for different parts of
the world and as such is based on the notion that the differences between markets are
more important than the similarities. This approach may still be underpinned by a
degree of standardisation, particularly with regard to the process elements of business
planning, but the elements of the marketing mix and, in particular, price and distribution
are likely to be adapted. Nevertheless, a company pursuing this type of strategy can
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still seek to prosper from global opportunities. A company adopting this strategy is
often said to be thinking global, but acting local.
Grouping/clustering strategies, global segments
This approach represents something of a middle ground between the first two
strategies and essentially is a segmentation and targeting approach. In this approach
customers and/or markets are grouped together according to the similarity of their
needs and wants. Once grouped in this way, these customers can then be targeted
with a standardised, or at least relatively standardised, strategy. Examples of ways in
which customers can be grouped and targeted in this way include groupings by
geographical area, grouping by trading blocs, grouping by stage of economic
development and so on.
Global Branding
Perhaps one of the most significant developments associated with global business in recent
years has been the growth of the global brand. Companies such as Nike, Levis, McDonalds,
IBM, Sony, Coca Cola and many more are all successful global brands.
A global brand is generally considered to be a brand supported by the same strategy
everywhere in the world. However, under this strict definition, it is very unlikely that there is
a global brand at the moment or that there will be many in the near future. If, though, we
amend the definition to allow for some minor adaptations in the strategy between country
markets, then we can identify global brands now and it is probable that more will appear in
the future. By minor adaptations we would include changes to translate the meaning of the
brand packaging into different languages as well as other minor business strategy changes
to accord with country rules and regulations. The substance of the product would, though, be
the same in each market and, importantly, the brand name and its trademark would remain
unaltered.
Global brands offer some key advantages and benefits both to companies and customers. In
the case of companies, global brands facilitate the growth of worldwide customer loyalty.
This, in turn, enables easier access to new markets and, in particular, to distribution
channels. Finally, a global branding enables a company to build a global presence whilst at
the same time achieving global economies of scale in areas such as advertising and
promotion.
As far as customers are concerned, global brands often bestow status on the customers who
display them. This is particularly important in some of the lesser-developed economies.
Similarly, global brands reduce the risks associated with purchase for customers, both in
consumer and business-to-business markets. Finally, global brands help facilitate the buying
process by making a companys products easily identifiable.
No wonder, then, that global branding has been such a growth area. However, there are
disadvantages to developing and supporting the global brand. For example, the business
must pay careful attention to managing and co-ordinating brands throughout the world. This
can be very difficult where some degree of adaptation is required in different markets. There
is also a risk with global brands that if there are any brand scares or problems such as the
recent problem with the Mercedes A Class product (which initially was found to be prone to
rolling over) these can have a very rapid knock-on effect for the reputation and image of the
brand throughout the world. Finally, global brands bring the attendant problems of pirating,
counterfeiting and parallel imports.
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Customised Business Strategy
Finally, no discussion of globalisation including aspects such as global branding would be
complete without a brief mention of the trend towards more customisation throughout the
world.
There is some evidence to suggest that customers are increasingly looking for customised
solutions to their needs, i.e. individual products and brands to satisfy their requirements.
Obviously, global brands and standardised business strategy are a complete anathema to
this. At one time, of course, developing customised marketing mixes for customers would
have been impossible apart from in the more specialised markets such as sales of high
priced fashion items, industrial products and services and so on. However, a number of
developments have begun to facilitate at least a greater degree of customised business
strategy that at least some customers are looking for. So, for example, manufacturing
systems have changed to include flexible manufacturing systems accompanied by
CAD/CAM. Coupled with this, as we have seen, businesses now have access to intelligent
databases and intelligence systems that enable them to identify more closely the needs of
individual customers. Finally, the Internet is increasingly facilitating the speed and ease with
which companies and customers can communicate on a real time interactive basis.
Company Size and Globalisation
The very large companies are those that most frequently attempt to change from the
polycentric orientation of the multinational enterprise to the geocentric orientation of the
transnational global company. These very large companies, for example Ford, Unilever or
Procter and Gamble, compete in a substantial way in many markets in the world. They are
able to make considerable gains by seeking process and implementation standardisation on
a worldwide scale.
Smaller companies are not necessarily prevented from taking a global stance. They are not
necessarily smaller in the relative terms of their position in the world market for the
products/services that they provide, for example, in the high technology area or, perhaps, in
entertainment services. Smaller companies can, therefore, develop both a process and an
implementation standardisation in a global way.
Many companies will not consider globalisation because of a limited management view. As
we have indicated before, some companies will be confined closely to their own domestic
market because of their ethnocentric orientation. Other companies will serve markets that
exist in few country markets (the markets for frogs legs or snake soup, for example) and
cannot develop a global view.
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Study Unit 8
Entry Strategies
Contents Page
Introduction 120
A. Choice of Entry 120
Exporting 120
Overseas Production 122
Ownership Strategies 123
B. Selection of Entry Routes 124
Sales Generation 125
Profit Earning Capacity 126
Investment Payback Period 126
Balance of Direct and Indirect Costs 127
Exposure to Risk 127
Speed of Achieving Market Coverage 127
Degree of Control 127
Match Between the Product and Entry Route 127
Sources of Global Finance to Support Entry Strategies 127
C. The Entry Decision 128
Subjective Approaches 129
Objective Approaches 129
120 Entry Strategies
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INTRODUCTION
For most companies, the strategic decision of how to enter a new country market is of the
utmost importance in international business. Once the decision is made and implemented, it
will influence the whole way in which the company will pursue its business in that country,
particularly in the medium- to long-term. The distribution channel selected has an important
influence on all the other business activities including marketing-mix decisions. Those
market-entry decisions that involve investment decisions, particularly the establishment of a
wholly owned subsidiary, are major strategic decisions. In many market-entry decisions
contracts need to be signed, for example with agents, distributors and EMCs, and these
contracts commit the company in important ways.
Market entry decisions are initially dependent upon country selection decisions. Once a
particular country has been selected, the most appropriate way to enter the market has to be
decided. There is no one best way. The decision has to be based upon the company, its
objectives, its resources, its international business experience, the country chosen and the
extent to which real choice exists.
In this study unit we will look at the range of entry choices that exist. We will then go on to
examine how a selection may be made from the options available and how to approach the
vital matter of entry decisions.
A. CHOICE OF ENTRY
Companies have a range of choices for how they can enter a new country market. These
can be broadly grouped into two main areas, exporting and overseas production. In addition,
companies need to determine the degree of ownership and involvement that they wish to
commit to in developing their international business.
Exporting
Most companies, large and small, use exporting as an entrance route for some of their
country markets. To generalise, smaller companies often use exporting for all their
international business. On the other hand, larger companies will often use a range of
exporting, foreign production and ownership approaches. The difference stems from the
greater resources of the larger companies and therefore their ability to choose between
different approaches.
In the consideration of exporting there are two main divisions:
Direct exporting takes place when the distribution intermediaries used are based in
the country market that is the target for the exports, for example, agents or distributors.
Indirect exporting takes place when the country market is developed through
distribution intermediaries, such as export management companies, who are based in
the same country as the exporting company.
Direct exporting
The main methods of entering foreign markets through direct exporting are as follows:
Distributors
A distributor earns a profit by selling products that have been previously bought by the
distributor. Distributors usually have a sales force and provide some logistics and
marketing inputs in addition to the sales function.
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Agents
Agents act on behalf of a principal. In the case of export distribution, the agent sells
products on behalf of a principal who is based in another country. The agent provides
a sales function but does not own the product that is sold. Agents receive lower levels
of sales commissions than distributors because they provide fewer services to the
principal. Agents are usually smaller organisations than distributors; they may be one
person who acts primarily in a sales capacity.
Agents are similar to distributors in that they often represent a number of companies,
sharing their time and efforts between a number of products and clients. The
companies that use agents and distributors need to manage them and to motivate
them to sell their products. There is a tendency for agents and distributors to cherry
pick in the sense that they put their main efforts behind those products that are easiest
to sell and those that provide them with the best profit earning possibilities.
Company sales force
A company can use its own sales force to sell in another country market. If the market
potential is sufficiently large, the company can use salespeople who are based in that
country. If the market is smaller or risky, the company is more likely to use salespeople
who merely visit the country and its customers from time to time.
An important consideration in using this method of entry is the nature of its cost. Most
of the costs of using the company sales force are fixed or indirect costs. This means
that if the level of sales is poor, the same indirect costs will be spread across a small
number of sales.
The decision as to which entry route is appropriate will partly relate to company experience in
international business, but it will also relate to the type of product. If the product requires
high levels of after-sales service, then there will be a need for in-country presence and
service capability. Some companies have the resources to be able to carry out customer-
responsible servicing, while other companies will need to delegate this to local companies. If
this is the case, the company would need either to appoint a distributor to carry out these
tasks or to appoint a service company in addition to the agent.
Indirect exporting
Indirect exporting is the method used by companies that wish to reduce their risk and
exposure to international business. It is a way in which companies can attempt to sell some
of their excess capacity without incurring the problems associated with dealing with
customers in different countries. The main problem with indirect exporting is the lack of
control over how the companys products are marketed. It is quite common for the company
to be unaware of who its customers are and how some of the marketing mix elements are
used, for example, being unaware of the final price charged to customers.
The main methods of entering foreign markets through indirect exporting are as follows.
Export management companies
Export management companies have similarities with agents and distributors but are
different because they are based in the exporters own country. For the exporter, the
export management company seems easier to deal with because of the absence of
language, cultural and export documentation difficulties. Export management
companies are sometimes called export houses and sometimes export marketing
companies (EMCs).
EMCs, by selling a range of products, can offer an interesting package of products to
foreign buyers whilst at the same time splitting the costs of selling, marketing and
physical distribution across a number of products from different client companies.
EMCs usually specialise in some way, for example by part of the world, by product type
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or by type of customer. An EMC might therefore sell toys to retailers in Asian countries
on behalf of UK companies. The company is able to have its products sold into a large
number of country markets.
Piggyback operations
This method of entry is based upon use of the established distribution arrangements of
one company by another company. One company gives a ride to the other company.
The ride consists of the selling and export administration, and benefits from the
ongoing nature of the sales contacts that the company has. The rider company
receives an immediate benefit by gaining access to the working system that has been
built up by the other company. The carrier is either paid a commission and acts as an
agent, or buys the product and acts as a distributor.
Purchase in domestic market
Some companies sell their products to companies that send buyers, or who have
established buying offices, in the domestic market of the selling company. Some large
retailing companies from countries such as the United States or Japan will buy products
in this way. This method, whilst creating export sales, keeps the selling company away
from a direct understanding of the country market and minimises their need to handle
the full range of export documentation.
Overseas Production
Overseas production in the country market will rule out exporting. There will be no need to
transport products physically across country borders as the products will be produced within
that country.
There is a range of methods of achieving foreign production:
Wholly-owned subsidiary
This would be a company set up in another country which is 100% owned by the parent
company. A wholly owned subsidiary with a complete production facility is the most
obvious means of achieving foreign production.
Foreign assembly
The company could produce most of the product in the domestic market and merely
assemble it in the country market.
Contract manufacture
The company could arrange for another company to produce the product for them
through contract manufacturing.
Licensing and franchising
The company could use licensing and franchising methods, which would result in other
companies being responsible for production.
Licensing is a method of entry in which a company, for a fee or royalty payment,
allows another company to use a patent or a trademark within the areas defined by the
licensing agreement. Licensing is a low-cost, low-risk way to enter markets. The
enterprise is only directly involved with the market through the company with which it
has its licensing agreement. It is a method used by small and medium-sized
companies, particularly those in advanced technology, because it enables quick returns
to be made with the use of extra capital.
The various difficulties with licensing relate to the usual low profit returns from
licensing, and the difficulty in selecting suitable licensees. It is not uncommon for
licensees to use the licence as a quick way to learn about new products and new
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technologies. In this way the licensee can often become a competitor. Another
difficulty with licensing is the lack of market control.
There are similarities between licensing and franchising. The main difference is the
extent to which a marketing programme is assigned to the franchisee. In licensing
agreements, the licensing might well be restricted to the trademark. In franchising,
the agreement often covers the trademark, the logo, the particular method of operation,
and sometimes advertising campaigns. Franchising is particularly used in fast food
operations (for example, Kentucky Fried Chicken (KFC) and Burger King) soft drinks
(for example, Coca-Cola and Pepsi-Cola) and car rental (for example, Hertz and Avis).
Ownership Strategies
Companies will need to decide on the level of direct ownership they desire in entry decisions.
The extreme positions are complete ownership or complete reliance upon other companies,
with the intermediate option of entering into part-ownership schemes.
Ownership decisions will usually be corporate strategic decisions in addition to operational
decisions. The decision will be strongly influenced by the level of political and economic
stability in the chosen country. The higher the level of risk of interference, the more likely it
will be for the company to want others to bear the risks of ownership.
Distribution-channel decisions have important and relatively long-term consequences for
companies. The decision to include company ownership as part of the distribution-channel
decision serves to increase the commitment and results in a major medium- to long-term
view being taken about the market.
The following represent the major alternatives with regard to ownership:
Wholly owned
Here, the alternatives are the setting up or acquisition of a subsidiary in the country
market, or using the companys own sales force. Both these methods have been
outlined above
Partly owned
There are two main possibilities for part ownership of foreign companies:
(i) Joint venture A joint venture is a kind of partly owned subsidiary in which a
multinational enterprise decides to share the management of a company with one
or more collaborating companies. The reasons for entering into a joint venture
are often to reduce political and economic risk. In some countries, joint ventures
might be the only way in which a company can invest in the country (this is
usually called inward foreign investment). Other reasons for using joint ventures
include using the specialist skills and cultural knowledge of a local partner, to gain
access to the distribution channels of a joint venture partner, and as a means of
limiting the capital requirement of international expansion.
(ii) Strategic alliance There are differences between joint ventures and strategic
alliances. In a joint venture, two or more companies contribute specific amounts
of capital to form a new company. In strategic alliances the arrangements
between, usually, two companies are more flexible. The alliance may or may not
result in a new company. The usual purpose of a strategic alliance is to combine
and gain benefits out of each partners skills and resources.
Alliances are a comparatively recent method in international business. It is
possible that the very flexibility of the alliance will result in its eventual transition
into a new company or a more formal joint venture, or the take-over of one
company by the other.
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Alliances are most common in connection with providing access into distribution
channels (entry) and also as a means of gaining research and development
expertise for new product development and manufacturing capability.
Owned by others
Here, the strategy will be to operate through separate companies, the methods
including those considered above such as licensing and franchising, distributors and
agents, and EMCs and piggyback operations.
From this, we can see that the degree of involvement, in terms of ownership and
commitment, in the country can range from high to low:
Figure 8.1: Spectrum of ownership options
High involvement Wholly-owned subsidiary
Partly-owned joint venture
Strategic alliance
Licensing/Franchising
Distributors
Agents
Using the company sales force
Export management companies
Piggyback operations
Low involvement Purchase in domestic market by buyers from other countries
B. SELECTION OF ENTRY ROUTES
A companys selection of entry routes is a key organisational decision and will depend upon a
series of factors. The main factors are:
Potential for sales generation.
Potential for profit earning.
Investment payback period.
Balance of costs between direct and indirect.
Exposure to risk.
Speed of achieving market coverage.
Degree of control.
The match between the requirements of the product/service and services provided
through the particular entry route.
Sources of global finance to support entry strategies.
A company is likely to have different business objectives in different countries. In some
countries there might be significant long-term potential, in which case the company would
wish to follow a key market concentration approach. In other markets, the levels of risk might
be high or the sales potential might be low so the company would be looking for low
commitment methods of entry. Therefore, the preferred entry method will vary from country
to country.
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In the previous section the entry choices were listed in order of involvement in the country
market (Figure 8.1). The entry method with the highest involvement is to set up and run a
wholly owned subsidiary. The company becomes extensively involved in the country
because it is manufacturing and marketing there. The selection of this entry method has
major consequences for the company. The fixed nature of the assets needed to establish the
subsidiary makes the company vulnerable to changes in the political and economic
management of the country.
At the other extreme, the company that sells its products in its own domestic market to
buyers who will sell the product in other country markets has a very low involvement or no
involvement at all in that country market. When looked at from a sales and profit-generation
perspective, the wholly owned subsidiary route offers the possibility of large returns that
could grow substantially. The domestic sale route, on the other hand, provides quick but
comparatively small sales and profit opportunities, with very limited opportunities to expand
the business in the future.
The preferred entry method might also not be available or might be blocked in some markets.
For example, the company might wish to establish a wholly owned subsidiary, but find that
country regulations only allow a joint venture with a local company. Even then, the company
might not be able to find a suitable joint venture or alliance partner. Where the ideal strategy
for a company may be to use an agent as the means of entering a country, it is quite possible
that there will only be a few good quality agents, those with the requisite geographical
coverage, technical knowledge of the product, or customer base. However, the agents that
exist may be already contracted to competitors, in which case the company would need to
find a different strategy to gain entry. In countries with distribution systems that have been
subject to considerable adaptation through cultural influences, such as Japan, it will be
particularly important to select distribution partners who have the right customer contacts.
We will now look at the various selection possibilities for each of the main entry methods.
Sales Generation
Companies will be concerned about the speed with which sales will grow in the country.
Obviously companies would prefer sales to grow rapidly, provided that they have the
production and organisational capability to sustain the growth. The slowest method of
increasing sales will be the wholly owned subsidiary, the company needs to be established
and production levels built up before sales can begin, and this might take a number of years.
The fastest methods of generating sales are to use companies that are already established in
the country and who are regularly selling to the right type of customer. In this way the extra
lines for the new company are added on to the sales list and sales can therefore begin
almost immediately, in more detail:
For the generation of sales, this will be the slowest of all methods, but in the long term
this offers the highest total sales.
Joint venture/strategic alliance
The initial sales generation will be slow because of the need to find, and to negotiate a
suitable agreement with a partner. Once this is completed, sales can develop rapidly,
because one of the normal bases of the agreement is the local knowledge and
distribution capability of the other partner.
Licensing/franchising
Initially sales will be prevented because of the need to find the correct companies for
the licence or franchising deal. Once this has been achieved, sales can take off
rapidly. The extent to which sales grow rapidly will depend upon the qualities of the
licensee or franchisee.
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Agents/distributors
Sales are most likely to develop more quickly through this method than from other
methods. Agents and distributors have already established contacts so sales could
commence at once. In practice, the initial sales levels will be influenced by the
unknown nature of the product and the company in that country.
Own sales force
Sales will start slowly because of the need of the sales force to establish contacts with
suitable customers. To sell successfully, the various linguistic and cultural barriers will
need to be overcome.
Profit Earning Capacity
Organisations are very concerned about profit-earning capacity. This criterion will have a
strong influence upon the final decision about which method to use:
This will be the slowest way to earn profits, but again in the long run it offers the highest
profit potential.
Joint venture/strategic alliance
These have moderate to high profit-earning capabilities. The shared costs and the
input of expertise from the partner organisations give good chances of profits, provided
that the partners have been selected carefully.
Licensing/franchising
Licensing gives a less strong profit payback because of the limited basis on which the
company providing the licence acts in the arrangement. In franchising, the wider range
of marketing mix activities employed and a more proactive approach give a better rate
of profit return.
Agents/distributors
The profitability from these two methods is comparatively modest. Profit flows will start
quickly, but will not grow to the potentially high levels achievable from most other
methods.
Own sales force
Initially the high indirect costs will eliminate the possibility of profits for anything more
than infrequent flying sales visits. If the company establishes a resident sales force in
the country, it will take some time before customer contacts and sales negotiations will
generate a flow of sales revenue sufficient to cover costs. For some very large sales of
capital equipment, for example Rolls Royce aero engines, the high profit potential from
one order will make it worthwhile to base a large team of company personnel in the
country to negotiate the order.
Investment Payback Period
The wholly owned subsidiary route will take a long time before the breakeven point is
reached and even longer until an overall profit point is reached. The shortest payback
periods are for agents and distributors. Here the initial investment costs relate to the costs of
searching for suitable agents and distributors and the costs of training them in the company
products and systems. Costs will include travel expenses and may include visits of the
agent/distributor to the companys headquarters.
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Balance of Direct and Indirect Costs
The agent/distributor costs are primarily based upon direct costs that relate specifically to the
sales of the product. Indirect costs related to training programmes and other non-sales-
related costs will be incurred, but in the main the costs are direct. All other methods have a
higher percentage of indirect costs and these will be at their highest in the wholly owned
subsidiary.
Exposure to Risk
This will be lowest in the case of agents and distributors and highest in the case of wholly
owned subsidiaries. The main risks with agents and distributors are that they will:
Not gain sales.
Underachieve agreed sales targets.
Alter the marketing mix without prior agreement.
It is important that the contract signed allows the company to cancel the agreement without
legal difficulty if the agent/distributor fails to deliver his or her side of the bargain.
Speed of Achieving Market Coverage
For some companies it will be important to gain widespread distribution very quickly. This is
most likely to be the case for consumer products, which will be supported with national
marketing communications programmes. Other companies might wish for a rapid build-up to
beat competitors into the market place.
The fastest methods of gaining market coverage will be through the use of
agents/distributors. However, appropriate companies need to be selected and trained before
sales can commence. This is, though, a much quicker process than the other methods.
Agents/distributors will have an existing customer list that can be activated very quickly.
Usually individual agents/distributors will only cover part of a country. In order to gain
complete national coverage a number of agents/distributors will be required.
Degree of Control
The degree of control relates quite closely to the degree of ownership. The agent/distributor
route offers little control as they are likely to have their own organisational objectives. They
will usually handle the sales of a number of other products and the company will need to plan
and manage agents/distributors to gain the best performance from them. In licensing and
franchising, the ability to control will relate directly to the contract. In joint ventures and
strategic alliances, control has to be balanced between the participants. In some situations
the battle for control can cause the venture to disintegrate. It is only in the company sales
force and the wholly owned subsidiary that the company has complete control.
Match Between the Product and Entry Route
It is sometimes difficult to find the correct blend of services provided by other organisations.
In some countries there may not be a tradition of providing that particular product at the
desired service level. In other countries the organisations may exist, but be contracted
already to competitors. Because of this, companies will often have to accept a less than
ideal situation and rectify the deficits through inputs from their own company. Sometimes, of
course, the solution will be through a wholly owned company operation.
Sources of Global Finance to Support Entry Strategies
A final factor affecting the choice of entry strategy concerns the availability and sources of
finance to support any proposed entry strategy. We have already seen that the different
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entry strategies involve different commitments with regard to the initial levels of investment
required. So, for example, entry via a wholly owned subsidiary will require much higher
levels of investment than, say, using piggyback operations as a method of entry. We can
also see that often a company, which would otherwise prefer to select a more direct entry
strategy, may be forced to use one of the more indirect entry strategies simply because of
lack of capital. The business, therefore, must be aware of the financial investment
implications of the range of entry strategies and also some of the sources of global financial
capital that might be available to support a preferred entry strategy.
Obviously, a company can use its own internally generated funds to fuel overseas expansion
and such funds, of course, are generally cheaper than external sources of finance. Where
internal finance to support a proposed entry strategy is not available, then the company can
turn to conventional external sources of finance such as banks, share issues, etc. However,
when it comes to funding entry strategies, businesses can also draw upon a number of other
potential sources of global finance to support a proposed entry strategy:
Host governments
Sometimes the government of a country that the business wants to enter may be
prepared to offer financial incentives and inducements. So, for example, the United
Kingdom government has, in a variety of ways, provided special financial incentives to
Japanese companies wishing to invest in direct manufacturing facilities in the United
Kingdom. Clearly, there are a number of reasons for such financial incentives, such as
boosting local employment and providing access to new technologies and skills that
would otherwise not be available.
International funding bodies
International organisations such as the World Trade Organisation and the International
Monetary Fund will, under certain circumstances, help companies to build up their
international trading activities.
International venture capital
Increasingly, there is now a global fund of capital available to companies who are
wishing to exploit international business opportunities. These global funds are
operated by venture capital companies sometimes connected to, for example, the
larger world banks. Such global capital funds began to develop in the 1960s and,
some say, have in the past been a major source of international financial instability
inasmuch as they are often operated outside the control of individual governments.
Customers
Particularly in business-to-business markets, customers may help provide finance to
help a valued supplier invest in overseas markets. We have seen that increasingly
business customers are seeking to develop long-term relationships with suppliers to
maximise the potential of all the value chain activities in competitive strategy. Some of
the larger global companies will often help a smaller supplier invest in, say,
manufacturing facilities in a country in order to ensure effective just-in-time delivery.
C. THE ENTRY DECISION
The decision on which entry method to use is, as we have said, one of major strategic
importance. It is a decision that many established businesses have not taken before.
In the domestic market, few established businesses have to make conscious decisions about
which distribution channel to use, in most situations these decisions will have been made
previously. The main activity is based upon improving and enhancing the existing distribution
arrangements and in balancing other activities of the business such as the marketing-mix.
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In international business, the large number of country markets around the world gives rise to
various opportunities to decide upon the best form of entry. It is unusual for companies to
market their products in every country. It is quite common for companies to be restricted to
less than 50 country markets.
The decision approach to entry can be made on subjective or on objective grounds. The
significance of the decision strongly supports approaches that attempt to be systematic and
to use formal evaluative criteria.
Subjective Approaches
Elements of subjectivity are inevitable because of a lack of complete and reliable information.
It is difficult to obtain factually correct data about prospective agents, distributors or joint
venture partners. It is always difficult to forecast future sales. It is particularly difficult to
forecast sales in a new situation. Once the company has been established in the market, it
can use past sales data to help in the forecast of future sales. The company needs to make
judgments about the various information gaps and it is therefore forced to make decisions
which have various amounts of subjectivity contained within them.
The most common subjective approach would be to use a particular entry method because
that is the way that the company has entered other company markets, for example, the
company uses agents in its other markets and therefore automatically looks for agents when
it wishes to enter a new country market.
The most likely entry routes to be the subject of the less rigorous subjective approach are the
use of the company sales force (especially if the sales force remains based in the domestic
market), the use of agents and distributors, and sales that are made domestically. All of
these approaches restrict the risk to the company. If things go wrong, the company will not
suffer major loss. It is worth remembering, of course, that the company could be missing
substantial sales and profit opportunities by selecting inappropriate entry approaches.
Because the lost sales can only be estimated, it is easy for the company to ignore the
missed potential.
It is unlikely that a company will take a subjective approach with distribution methods that
require a lengthy period to pay back the initial investment. Therefore, the wholly owned
subsidiary particularly, but also the joint venture, strategic alliance, licensing and franchising
would normally be evaluated in a formal way.
Objective Approaches
It is advisable for companies to examine the advantages and disadvantages of each entry
method before making a decision. You will see already that it is improbable that any one
approach will have no drawbacks. The final decision will not be easy. Furthermore, the
decision will be based upon imperfect information. It is difficult to estimate what the future
demand patterns will be for each of the entry approaches. Will agents generate more sales
than distributors? How easy will it be to motivate agents? If we set up our own wholly owned
subsidiary, what will the economic and political situation be in five to ten years time? These
and other questions make it very difficult to develop a reliable evaluation of the entry options.
The two main approaches that companies can take are to:
Evaluate entry options through applying scores to the different options.
Carry out a computer simulation to estimate expected revenues and profit paybacks.
The decision between the two will be influenced by the importance of the decision to the
company and its sophistication in using decision-making techniques.
The more the decision is based on reliable information, the more likely it is that the decision
will be successful. Thus, subjective judgment should be minimised and the company needs
to collect the information necessary to make a rational decision. However, the cost and the
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time taken for this is likely to influence the way in which it is approached. The main decision-
making techniques are:
The weighted factor score method
The weighted factor score method can be used in all situations, even if information is
limited, and is preferable to complete subjectivity.
The method works by the company establishing the major factors that it should
consider in making the decision and assigning weights to reflect the relative importance
of each factor. Each option can then be rated against these factors and compared to
identify the best option.
If we take an example in which some of the options have already been eliminated
because the company wishes to gain direct contact with the country market, this leaves
eight options, using the company sales force, agents, distributors, licensing,
franchising, strategic alliance, joint venture and a wholly owned subsidiary. Assuming
that the company wishes to develop its international sales rapidly and in the long term
achieve a substantial global position, the factors that would be relevant and their
weightings might be as shown in Figure 8.2.
Figure 8.2: Factor weightings
Factor Factor
Weight
(A)
Factor
Score
(B)
Rating
(A*B)
The speed of sales growth 0.3
Investment payback period 0.1
Amount of learning about international markets 0.2
Degree of control 0.1
Long-term profit potential 0.3
Total Score
The total scores for each of the options can be calculated. In this way the company will
make a careful evaluation of each option. Subjectivity is still part of the process. There
are elements of subjectivity in deciding which factors to include and which to exclude.
The factor weights and the factor scores both contain elements of subjectivity, but,
nonetheless, it does provide a useful way to make the important entry choice.
Simulation method
A computer simulation could be developed to quantify the profit and sales revenue
positions for each option. The options could then be decided by reviewing the payback
period, the return on capital employed, the market share obtainable and other similar
measures.
To be able to compute the solutions, various estimates would be needed to forecast
sales revenue, profit contributions, business operations expenditures (for example, on
advertising and sales promotion), the capital expenditures and the probability of results
being achieved. The estimation of all this, and other, information would again involve
making subjective judgments about the future. However, the advantage with this
method is that it encourages a comprehensive review of costs, revenues and profits for
each of the options.
131
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Study Unit 9
International Marketing
Contents Page
Introduction 133
A. Product Management 133
Product Mix 133
Country of Origin Effect 134
Techniques and Concepts in Product Management 135
Branding Issues 137
New Product Development (NPD) 137
New Processes 138
Product Adaptation and Standardisation Issues 139
B. Pricing Strategies and International Pricing Policies 141
Considerations in Pricing Strategy Development 141
Options in International Pricing Strategies 143
Transfer Pricing 144
Skimming and Penetration Pricing 144
Countertrade 145
Specific Pricing Methods 147
Quoting Export Prices Incoterms 148
C. International Promotion Policy 150
The Context of International Marketing Communications 150
Marketing Communications Strategies 152
Using Agencies and Consultancies 154
D. International Distribution and Logistics 156
Distribution Channels 156
Intermediaries 158
Distribution Channel Relationships 159
Retailing in Industrially Advanced Countries 160
Retailing in Less Developed Countries 161
Planning and Managing International Channels of Distribution 161
Trends in International Distribution 166
(Continued over)
132 International Marketing
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Distribution Logistics 168
The Total Cost Concept 171
Modes of Transport 171
E. The Extended Marketing Mix 172
Service Product Characteristics 172
The Extended Marketing Mix 175
Relationship Marketing 177
International Marketing 133
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INTRODUCTION
A substantial amount of this unit is concerned with managing the elements of the
international marketing mix, including the extended mix for services. We shall be looking at
the issues in international product management, pricing policy, promotion decisions and
distribution aspects.
Throughout the study encompassing the marketing mix elements, it is important to remember
that many of the concepts, techniques, decision areas and management issues are very
similar to those encountered when considering purely domestic markets and marketing. So,
for example, many of the issues in product decisions, such as how to differentiate the product
and manage the product mix and the product portfolio analysis, etc. are in essence much the
same as we find in domestic marketing. Our focus throughout this study unit will therefore
primarily centre on looking at the additional issues, complexities and management issues
which arise in planning these mix elements for international markets. We shall find
throughout our discussion that the continuing theme of standardisation versus adaptation,
which we have already seen in earlier study units, also runs throughout the issues in
managing the mix elements.
A. PRODUCT MANAGEMENT
The management of products in international business can be thought of as including the
following activities:
Deciding products to be sold throughout the world.
Deciding which products need to be adapted to local conditions and in which country
markets.
Deciding which products need to be modified to keep them up-to-date and in which
country markets.
Deciding which new products should be developed into which country markets.
Deciding which products should be eliminated and in which country markets.
Deciding which brand names to use.
Deciding on packaging.
Deciding on after-sales services that relate to the product, for example warranties.
We can see from this list that, as already mentioned, many of these activities connected with
the management of international products are also found when marketing on a purely
domestic basis. However, the addition of marketing across national frontiers creates several
additional considerations and complexities that are simply not encountered in purely
domestic marketing. We shall start by examining the notion of the product mix and its
management.
Product Mix
A good starting point in our examination of products is the product mix concept developed by
Kotler. The product mix is based upon a number of concepts:
Product qualities
The product operates at three levels:
(i) The core is the basic benefits or services provided.
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(ii) The tangible product is the quality level, the brand name, the packaging, the
styling and product features.
(iii) The augmented product is concerned with warranties, after-sales service,
installation, delivery and credit.
Whilst all three levels of the product will appeal in different degrees to buyers in
different parts of the world, it is noticeable that the augmented product is particularly
vulnerable in export marketing. It is much more difficult for the exporter to provide
delivery and after-sales services than it is in the home market so exporters will usually
rely on other companies to provide these services for them.
Product lines and items
Products can be grouped into product lines. Product lines are products that are
closely related, for example, within the Ford product mix we can identify several
different product lines such as Fiesta, Escort and Mondeo. Each separate product is
an item.
The product mix can be analysed for the coverage of the market by considering the
number of product lines, and the number of items in each line. In the illustration below,
four product lines with their associated product items are identified.
Product line A 16 items
B 4 items
C 26 items
D 10 items
etc.
The width of the product mix shows the number of product lines. The depth is the
average number of different items in each product line. In this example, product line C
has the greatest depth. The overall consistency of the product mix can be evaluated
through the development of specific criteria.
The product mix concept is a useful way to make an analysis of the products offered by a
company in its different country markets. The competitors in each market can be compared
by the different compositions of their product mix. A point to remember is that product mix is
usually easy to obtain via the company list of products or its price list.
We can see that the product mix concepts outlined here are no different from those
considered in domestic markets. However, the greater spread and different types of markets
encountered by the international business often requires it to market a much wider and more
disparate product mix.
Country of Origin Effect
The country of origin of a product can have a positive, neutral or negative effect on the sales
of that product and this effect is not necessarily constant throughout the world. In some
instances the country of origin effect for products made in Germany and Japan may be
consistently good. In Asia, some countries might be perceived to be good producers of
products in other Asian countries, whilst in general Asian products overall might be thought of
in a negative way by US customers.
Some general points, which have emerged from these studies about country of origin,
include:
Consumer buyers in industrially advanced and newly industrialised countries are
influenced by the country of origin in many different classes of products, for example,
cars, clothes, watches and cosmetics.
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Business buyers are also influenced by the country of origin, but generally to a lesser
extent than consumer buyers.
The influence changes over time, for example, many years ago the country of origin
effect for Japan was negative, but over the past years this has changed to be very
positive.
Techniques and Concepts in Product Management
A number of techniques and concepts are appropriate to the international management of
products. Again many of these techniques and concepts can also be used for purely
domestic product management and marketing, so once again we shall consider the special
issues and considerations when applying these techniques and concepts in an international
setting. Three useful techniques and concepts are discussed below.
Positioning and Perceptual Mapping
You should, of course, already be familiar with the concepts of positioning and the
techniques of perceptual mapping in the area of product management.
A number of dimensions or attributes are used by customers to arrive at a perception of
products but a simple two-dimensional map based on just two attributes is shown
below to illustrate the concept of positioning. Figure 9.1 shows a possible
interpretation of the country of origin effect with low/high product quality.
Figure 9.1: Perceptual map
Perceptual mapping is a useful technique for charting the relative positions of many
different issues in international business. For example, it can be used to evaluate the
customers perception in different countries; the Mercedes brand is perceived as being
very high-quality and prestigious in the United Kingdom, but less so in other countries
of the world where it is frequently used as a taxi.
Product Portfolio Analysis
Portfolio approaches have been used for a number of years in marketing and corporate
strategy to help analyse the strategic position of the company and to help identify
options for future actions. They are based on taking a complete view of company
products and comparing their performance in a number of ways, for example, to
compare product performance across country markets, to compare competitor
portfolios, or to compare country markets themselves, on their own or grouped in
Positive Country of Origin Effect
Japan
Negative Country of Origin Effect
High
Product
Quality
Low
Product
Quality
USA
India
Taiwan
Germany
Korea
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various ways to take account of trading blocs or other regional groupings. By doing
this, the company should be able to use its resources in a more strategic way.
The best known of the portfolio approaches is the Boston Consulting Groups growth-
share matrix. The standard BCG matrix can be used as a tool in international business
and marketing strategy.
The example in Figure 9.2 takes one product that a company provides and then plots,
on the portfolio, its relative market share and the rate of market growth in different
country markets. As is normal for the BCG approach, the size of the circle relates to
the amount of sales for the company concerned. The example is based on a UK
company and shows the UK market representing the largest sales of the product. The
lack of Stars would be a strategic concern for the company.
Figure 9.2: BCG analysis across international markets
There are a number of limitations with portfolio analysis, despite its obvious popularity:
(i) It is often difficult to obtain accurate measurements of the total market size, the
growth in the market and the market shares of the main participants in the
market.
(ii) It is very difficult in international business to obtain reliable information that can
be compared accurately across a number of different countries. Therefore, the
positions shown in the portfolio could be influenced more by measurement
differences and errors than by real differences in product performance in different
countries.
The Product Life Cycle
The product life cycle concept, you will recall, is based on the notion that products pass
through a series of stages during their life in the market and that at each of these
stages the appropriate marketing strategies will differ. In international marketing, we
often find that products are at different stages of their life cycles in different countries.
So, for example, in the United States, home computer ownership is towards the end of
the growth period of the life cycle, whereas in the United Kingdom ownership is really
just taking off in terms of growth. Therefore, marketing strategies that are appropriate
Low
High
Low High
Market Share
M
a
r
k
e
t
G
r
o
w
t
h
Problem Children Stars
Dogs Cash Cows
France
Japan
Germany
USA
Australia
South
Africa
UK
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in the United Kingdom to try and promote further growth are different to those that
would be applicable in the United States.
Branding Issues
Branding is particularly crucial in the positioning process for products in international
markets, where often a consumer may be entirely unfamiliar with anything else other than the
international brand name and will therefore tend to rely heavily on that in product choice.
Brand strategies include:
Company brand linked with a generic product description, for example, Heinz Baked
Beans.
Individual brand names which can be used without any major reference to the company
name; for example, Procter and Gamble use Daz without an obvious reference to P
and G, whereas Cadburys Flake shows a branding position in which the brand name
Flake is dependent upon the company name.
It can be the case that a company wishes to develop one international brand that it can
standardise across the world, but that it is frustrated by previous registrations of that name in
some country markets and by unfortunate meanings of the brand name in other markets.
New Product Development (NPD)
New products can be developed in any part of companies, but the most usual place for new
product development to take place is the country of the company headquarters. In major
multinational and transnational companies, research and development capability will exist in
several countries. This means that the larger companies might innovate products from a
number of parts of their organisation.
The particular ways in which the stages take on extra dimensions in international marketing
are as follows:
Idea Generation
Newly industrialised countries are usually economies with high levels of growth, it is
important to take that opportunity into account when developing new products.
Initial Screening and Business Analysis
It is important to view the range of international opportunities, different sales volume
possibilities in different parts of the world, ideas that are more suitable for some parts of
the world than others. In addition, the company should consider adaptation costs for
individual markets and the cost of engineering adaptation for the main (or all) markets
during the NPD stages.
Development
Development is the longest phase of NPD and it needs to include international
perspectives; in many companies, though, this can be a rather narrow, ethnocentrically
dominated activity.
Market Testing
In international marketing, some testing might take place through international trade
fairs. If test marketing is used, it is important to select representative and isolated
markets. In this respect, Australia is sometimes used as quasi-representative of US
and European markets.
Commercialisation
This refers to the needs to co-ordinate activities to beat competitors into the market
place.
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In past years the launch activity took place over a number of years. The present trend
is to carry out co-ordinated launches in a number of countries at the same time, or in
very tightly timed sequence. Such co-ordinated launch programmes require a high
level of organisational capability and considerable resources.
Other aspects to be considered include:
Packaging
This is subject to a wide variety of demands in its twin roles of protection and promotion
in different country markets. In the development of new products a number of
important factors need to be considered:
(i) Protection issues relate to climatic differences. Climate can vary from cold and
dry to very hot and wet. Can the package and the product cope with those
extremes?
(ii) What distribution channels will be used and what modes of transport will be
employed? If the product is sold through open-air markets, extra protection will
be required.
Organisational Structures and New Product Development
A company with a very centralised structure, such as found in the macropyramid
approach, would be likely to have a very rigid new product development process with
new products being developed centrally at headquarters, often for the major domestic
market and then being rolled out to other parts of the world. A decentralised structure,
on the other hand, will tend to give rise to more planned variants of new products. As
always, the new product development programme will need to be a balance between
the financial and control advantages accruing from more centralised/standardised
approaches to the process, with the advantages that accrue from having new products
more closely tailored to individual market needs with the resulting potential for
increased sales.
Financial Implications
New product development is an essential activity, but it is also a risky and expensive
one. However, it is often more risky to do nothing and then it becomes a question of
managing the level of financial risk.
Companies are often attracted to markets that are growing at faster than average rates.
It is probable that many companies, from different countries, will be aware of the
market growth. It is usual for several companies to be going through the NPD stages
hoping to be first to market. Not everyone will win that race.
The escalating costs of research and development mean that NPD costs need to be
spread over a large volume of sales. In many instances the home domestic market will
not be sufficiently large to absorb the large sales volume. This means that companies
have to plan their NPD programmes on an international scale. Some companies limit
their NPD costs by forming joint ventures or entering into strategic alliances. In this
way a company can share some of the development and commercialisation costs.
New Processes
It is important to remember that companies not only compete through developing new
products but also through the development of new processes. So, for example, many
companies have sought to improve their competitive position through the introduction of
improved manufacturing technologies and planning systems, such as just-in-time production,
CAD/CAM systems, and so on. In fact, in many ways, competing through new processes is
more difficult for competitors to copy than new products, and therefore can give a longer
lasting competitive edge to a company.
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Product Adaptation and Standardisation Issues
As with all the elements of the marketing mix in international marketing, the issue of
adaptation versus standardisation is important. In fact, this issue is probably more important
with respect to the product element of the mix than virtually any of the other elements. The
reason for this is that the potential benefits of standardisation are greater in the product area
than in the other areas of the marketing mix. By standardising the product, a company can
gain substantial economies of scale in design, manufacturing and so on.
These forces and factors require the business to consider the adaptation versus
standardisation decision with respect to a wide range of product attributes including:
1. The core product
2. The actual product, including functional features and attributes
3. Product styling and design
4. Quality
5. The augmented product, including warranty, after-sales service and installation
6. Packaging
On balance, the trend is towards increased standardisation of the product in international
markets. A number of factors favouring standardisation are responsible for this:
Economies of scale
Probably no other element of the mix offers a greater potential for cost reduction
through standardisation than the product area.
As already mentioned, by standardising the product, a company can gain substantial
economies of scale resulting therefore in lower costs and potentially (if appropriate)
lower prices.
Improved control
Standardising products offers the business a much greater degree of control over
important elements such as quality, after-sales service, installation and so on.
Reliability and consistency of quality is so important in todays markets that companies
will seek to standardise products and components as much as possible. This also
gives better control over production and facilitates lower stockholding costs.
International standards
Increasingly, international standards with regard to factors such as product design,
safety standards or technical features are becoming similar throughout different
markets. So, for example, all food products sold in the European Union must conform
to stringent, and increasingly uniform, standards with regard to aspects such as
ingredients, testing and so on throughout the member states.
Increasingly homogeneous markets and customer needs
Markets, and particularly consumer needs within these markets, are becoming
increasingly homogeneous across national boundaries. Factors already mentioned,
such as increased travel, improved education and developments in international
communications have all served to facilitate this trend.
Growth of the global company
Finally, the growth of the global company itself has helped hasten the trend towards
more standardised marketing, including standardised products. For example, Pepsi
Cola, Levi Strauss and IBM are all global companies trying to market their products on
a similar basis in all parts of the world.
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Although the trend has been towards an increased standardisation of products in
international markets, a number of factors serve to constrain the extent to which product
standardisation can be achieved. Amongst some of the most important of these factors are
the macro-environmental factors, composed of social/cultural, technological, economic, and
legal/regulatory factors and therefore tend to favour product adaptation:
Social/cultural factors
Some of the strongest forces that may require the business to adapt products for other
markets are social or cultural factors. Many products simply could not be sold in some
markets if they were not adapted to local needs in this respect. So, for example, many
food products cannot be sold in other countries because of religious or social reasons.
Technological factors
Technological factors often require the business to adapt products for different markets.
An example would be the requirement to adapt electrical products in different parts of
the world because of the different voltages in use in different countries. Even in the
European Union, voltages on which appliances operate are different between the
member countries.
Economic factors
Economic factors, too, may be important in requiring adaptations to products between
different countries. So, for example, in lesser-developed countries the business may
have to modify product quality levels or the features and design of a product in order to
make the product more affordable to the consumers of a particular country.
Legal/regulatory factors
Obviously, the business needs to adapt products to meet different regulatory and legal
requirements in different markets.
One of the major problems experienced by the European Union in its attempts to move
towards a single market has been the differing legal and regulatory standards for
products in different member countries. Even seemingly simple products such as
cheese, food colourings and chocolate have been subject to major differences between
different countries with regard to regulations concerning how they are made, the
ingredients used and even what they are called.
Clearly, many factors have to be considered, researched and evaluated with regard to the
degree of product standardisation or adaptation and which specific aspects of the product
this decision pertains to. A number of frameworks have been developed with a view to
delineating the broad alternative strategies available to the business with respect to
international product standardisation/adaptation.
For example, Mesdag identified three NPD strategies as follows:
SWYG (sell what you have got)
As the name implies this strategy is based on simply selling the same product that we
are selling in the home market. In one sense, then, we could argue that this is
adopting an entirely standardised approach inasmuch as the product is not adapted for
different markets.
SWAB (sell what people actually buy)
Essentially, this strategy involves adapting the product to meet local needs in each
market. As such, it is very customer oriented, but can be costly and complex. It is
essentially a strategy of differentiation.
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GLOB (sell the same thing globally, ignoring national frontiers)
This, too, is a standardised approach, where products and brands are essentially the
same irrespective of where they are being sold. Unlike the SWYG strategy, however,
this approach to standardisation is a considered one with a marketer making a
conscious planning effort to develop global strategies that enable the marketing of
standardised products and brands.
Obviously, the most appropriate strategy will depend on the forces and factors already
considered. Essentially, though, overall the marketer must determine the most cost-effective
strategy for the company.
B. PRICING STRATEGIES AND INTERNATIONAL PRICING
POLICIES
Before we look at a number of specific pricing strategies, we need to consider the factors that
influence decisions on those strategies.
Considerations in Pricing Strategy Development
Pricing strategies need to be based on many of the same considerations in international
markets as they are in domestic markets. This will include the costs of production and
marketing, the nature of competition and the prices of competitor, and the reactions of
customer demand to different pricing levels. In addition, the objectives of the company will
be a significant factor.
All of these have an additional dimension arising from the nature of international business,
particularly in terms of the conditions in the country itself and the nature of the market in
specific countries. The use of the SLEPT and C factors can help identify particular
difficulties:
Company and products
What is the company position regarding the speed of profit returns and relative costs?
It is common for UK and US companies to need a quick payback on market entry and
on new product launches, this being dictated by stock market pressures. Japanese
companies, on the other hand, often have a much slower requirement for initial profits.
What is the company position regarding relative costs? Does it have cost advantages
over competitors? If it does, are those cost advantages sustainable in the future? If
the company has the lowest cost position in the world, it has more pricing options than
a company with higher than average costs.
What are the extra costs to the company say that are incurred by marketing to other
countries? The extra distribution logistics costs are one obvious area. There might
also be extra marketing research costs, extra organisational costs and so on.
Markets
The ability of customers to pay in different country markets needs to be investigated.
What is cheap in some markets might be too expensive in other country markets. Soft
drinks are an impulse buy in industrially advanced countries, but in lesser-developed
countries the same soft drink might be an extravagant luxury, unless the company has
a different, lower pricing strategy for LDCs.
Distribution channel arrangements also vary from country to country. In some
countries, a multi-layered system with its extra layers of profit margins and
commissions will cause the end consumer price to be much higher than in countries in
which fewer distribution channel intermediaries are necessary.
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The strength of competitors and the level of aggressiveness of their pricing policies can
be a major influence on long-term strategic pricing and on short-term tactical pricing. In
international markets, some competitors can be global. Some of these might be using
standardised pricing strategies. Others might be multinational enterprises operating
different pricing strategies in different markets. Other competitors will be local ones
who, in some countries, for example in Asia, will have low costs and be able to
undercut most competitors on the basis of price.
SLEPT and C factors
Different countries will have different rates of inflation, as we have seen in Brazil, which
has suffered from high rates of inflation for many years. Pricing strategies in
economies with very high and fluctuating rates of inflation are very difficult to develop
and implement.
Government imposed conditions, particularly price controls and varying tariffs and VAT
or sales taxes also impact on pricing. The differences in these, country to country,
make the standardisation of pricing very difficult.
In some situations, services such as credit, leasing arrangements or countertrade
(which we shall discuss later in the study unit) might change the importance of the price
as a central point in the value of the product.
Currencies also fluctuate considerably. Over the past few years the Japanese yen has
increased in value against many currencies, including the US dollar. In this situation
Japanese companies have had to take steps to move production away from Japan,
because it has now become a very high cost country. The high cost has been
influenced considerably by the rising value of the yen.
Company objectives
Various company objectives may influence the suitability of different pricing strategies:
(i) A typical objective is the specification of a particular rate of return on capital
employed, so prices would have to be calculated to achieve this return. This can
cause very high prices to be charged when new products are launched that have
emerged from a high cost R and D and new product development process.
(ii) Another objective is the achievement of a particular market share. Japanese
companies appear to follow an international expansion plan in which the
achievement of substantial market shares after a number of years is a key
objective. If this is the case, the company will probably make big losses in the
first few years after market entry.
(iii) A further objective is early cash recovery. Companies that are starved of cash
may stipulate that market entry has to be made to achieve a break-even position
in the first year.
(iv) Other objectives relate to competition. One objective might be to avoid the
outbreak of a price war. Another objective might be to discourage competitors
from entering a particular country market.
Price escalation in the value chain
A facet of pricing in international marketing is the phenomenon of price escalation in
the value chain. Compared to purely domestic marketing, there are a number of
potential additional costs involved when marketing products across international
boundaries, such as additional transportation and insurance costs or more
intermediaries involved in the channels of distribution. There are also additional
charges for elements such as export documentation and the requirement for more
specialised packaging and import duties.
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With a longer chain of value activities in international markets, the result is that costs
and, therefore, prices are often escalated. This means that, for example, a product that
is price competitive in the domestic market may be totally uncompetitive with regard to
price in international markets.
In appraising the viability and potential of international markets, therefore, the business
must carefully consider what the extent of price escalation is likely to be and the
potential impact of this on demand. Of course, it may well be that the business can
seek to minimise price escalation by cutting costs as far as possible. Alternatively, it
may decide to, for example, modify the product to make it cheaper. More direct
channels of distribution may also help to minimise costs and therefore price escalation.
Options in International Pricing Strategies
There are several options open to a company. These can be grouped under standardised,
geocentric and adaptation pricing. In summary these options are:
Standardised pricing
This involves setting a price that is only changed by the specific costs of transporting
goods to the country.
Some companies take this position as a deliberate strategy to prevent the development
of grey or parallel markets. Grey markets develop when a product is moved, by other
companies, from one country to another to take advantage of price differences between
the two countries. The grey market often undermines the company position and that of
its distribution channel intermediaries in that country market. The company suffers
because the product, being sold purely on price, loses corporate and brand values and
its distribution channel members.
If a company uses a deliberate standardised pricing policy, there is no price differential
to be exploited by potential grey marketers.
Another form of standardised pricing is that related to companies following an
ethnocentric orientation. The price is the price charged in the home market plus all the
extra costs that are directly associated with that order. The end effect might be broadly
similar to the deliberate strategy but the reasons are quite different. One is a deliberate
and explicit strategy. The other is an implicit strategy. No formal strategic planning is
used in its formulation.
The weakness of the standardised pricing strategy approach is that it fails to take
account of customer, market and competition differences in different country markets.
Geocentric pricing
This aims to develop a pricing strategy that, taking all country markets, will be coherent.
The coherence might be based upon competition policy, it might be calculated to
minimise the possibility of grey markets developing, or it might be based on different
world region groupings.
Geocentric pricing is concerned with developing a broad and consistent strategy within
which different country managements can make appropriate adjustments.
Adaptation pricing
This can be part of the typical MNE with its polycentric orientation. If this is the case,
each subsidiary will calculate its price based on factors that are adapted to the host
country.
Companies other than MNEs can follow another version of adaptation pricing. These
companies would adapt the price according to their understanding of opportunity,
market demand, distribution channel influences and competitive pressures.
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Transfer Pricing
When a company expands into operations in other countries, it becomes involved in selling
semi-finished or finished products from one subsidiary to another. The price at which goods
are exchanged internally is called the transfer price.
Transfer pricing is an issue both for individual subsidiaries, because the level of the transfer
price affects the profits made by the subsidiary, and for host governments, because the level
of profits made by the MNE subsidiaries in their own country influences the amount of tax
receipts for the country concerned. For LDCs, tax revenue from MNEs can have a significant
effect on total national income.
There are great opportunities to discuss and dispute transfer prices. The usual approach is
to transfer at cost plus some element for profit contribution. The amount of the profit
contribution can be changed to give the MNE the best overall international position, both in
terms of minimising tax returns and in terms of its international competitive position.
Skimming and Penetration Pricing
In addition to the international pricing strategies of standardised, geocentric and adaptation
pricing, companies can also use skimming or penetration pricing.
The market skimming strategy involves the company setting a high price when it enters the
market to try to segment the market on the basis of price. This approach can be effective in
gaining a fast recovery of cash to pay for high new product development costs, providing the
market can be segmented by price. To do this, the product in question must be special in
some way; for example, it might have patent protection that prevents competitors from
copying the product. In countries in which intellectual property rights are not protected, it
might be impossible to develop a market-skimming strategy because counterfeit competition
would erode the market segment too quickly.
A company using market skimming can gradually drop the price, over time, to exploit other
market segments with a different price responsiveness to the initial market segment.
However, the high price set in this strategy can also encourage competitors to enter the
market, lured by high profits.
The market penetration strategy is designed to build sales volume quickly. It is a strategy
that has been adopted by many Japanese companies in consumer durable and industrial
durable markets. The customer response to market penetration pricing can be to build more
sales demand. The effect, therefore, of this strategy can be to allow further price cuts
because the new cost structures, resulting from the high sales levels, permit further
reductions in price.
An attraction of the market penetration pricing strategy is that the low price discourages
competitors. If competitors are deterred for long enough, the company can build a powerful
market-share position, one from which it can only be dislodged with difficulty. Its strengths
are in its customer franchise and in its low cost position based on a strong relative market-
share position.
Both strategies are medium term; aiming to last for at least one year or longer. Market
skimming can be the shorter of the two strategies. The reason for this is that the strategy is
open to more competitive reaction. In addition, the company might cascade down through a
series of market segments as it reaches the extent of the buying potential at a particular price
level. Market-penetration strategies are set up as longer-term strategies. The objective is to
build a strong market-share position and a low cost of production, which are strong
defendable positions.
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Countertrade
Countertrade is a general term used to describe transactions in which all or part of the
payment is made in kind rather than in money. Instead of using money as a unit of account,
one product is swapped for another; for example, machine tools might be countertraded for
wire.
Note that, although money does not necessarily change hands as part of countertrade, price
will still be a feature of the transaction. This is because the relative values of the products
traded need to be established and they also need to be sold, at some point, for cash. Thus,
the market value of the goods, through the normal mechanisms of supply and demand, will
continue to be important.
There are a number of reasons for engaging in countertrade and it offers attractions to
various interests in the arena of international business:
Governments promote countertrade as a means to encourage companies to buy
products or services from their country. In this way, convertible currency (or hard
currency) will be conserved and the balance of trade will have more exports to offset
some or all of the imports.
Companies will use countertrading as a means of negotiating the sales of products or
services. The use of countertrade influences the pricing approach taken by the
company. In some situations the money price may completely disappear, the
transaction will be based on a calculation of the value of the different elements in the
countertrade. In other situations, a money price will exist, but various combinations of
negotiated countertrade deal will influence the level of the price.
It is also attractive to companies as a way of avoiding issues directly connected with
currency exchange. There are various risks associated with fluctuations in exchange
rates which may mean that value may be lost in changing currencies received or
payable as a result of international transactions. We shall examine this in detail later in
the course, but here we can note that countertrading, by not using money to effect the
transaction, can be an effective means of removing these risks.
Countertrading is also used in selling to buyers in developing countries as a means of
minimising currency difficulties and as a way to finance the transaction on behalf of the
buyer. It is particularly related to the sale of military equipment and capital equipment,
but may be used in the sale of many different types of product and service.
For buyers in countries in which the availability of convertible currency is limited, the
ability to establish an exchange value through offering other goods or services is a
useful method of pricing.
There are a number of ways in which countertrade deals may be effected:
Barter
Through history, goods have been bartered and, at its simplest, countertrade will be a
barter deal. This happens when one product is exchanged for another product without
the use of a price calculated in money. One product is valued in relation to the other
product.
Parallel barter
This form of barter takes place when the deal is made in two distinct phases. In
addition, the deal is quite likely to be made with the use of currency.
The parallel barter is a counterpurchase or a reciprocal purchase. The contract will
stipulate that the first purchase is dependent upon the subsequent purchase of other
products. The process is illustrated in figure 9.3.
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Figure 9.3: Parallel barter
Sells products
Stage 1 Company A in Country X Company B in Country Z
Receives cash or
perhaps goods
Sells products
Stage 2 Company A in Country X Company B in Country Z
Receives cash or
perhaps goods
The Stage 2 deal is often dependent upon the Stage 1 deal. Sometimes the reciprocal
purchase is to the same value as that at the Stage 1 level. More frequently there will
be differences in the value of the two stages of the parallel barter.
Buy-back
This type of countertrade is associated with the sale of capital equipment. It is a way in
which the price of the product is linked with sale back to the exporter of some or all of
the output of the capital equipment. For example, a company might sell a cement
factory to a buyer in a developing country. As part of the price negotiations, the
exporting company will agree to take certain amounts of cement over so many years.
The advantage to the buyer is that part of the output of the cement plant over so many
years will have a guaranteed sale. To the exporter the buy-back is a way of
rearranging the value of the price.
Offset deals
These deals are particularly associated with transactions in which governments are
involved. As such, they are likely to be concerned with expensive items of military
equipment or major civil engineering contracts.
As part of the overall negotiation, the exporter agrees to arrangements in which part of
the contract is produced in the local economy. For example, some of the components
might be sourced locally, the assembly might take place locally or commitments about
the local labour content of the civil engineering contract might be made. Offset deals
are, therefore, linked to the final price. Without the offset arrangements, the local
government will not agree to pay the price of the main contract.
Switch trading
This approach is one in which third-party companies or trading houses are used by the
exporter to trade the goods received, in order to release the value in the countertraded
goods. For a fee, the trading houses will arrange the sale of the goods taken in
exchange for the exported goods. For the exporter, the trading house is useful
because the risks of receiving unfamiliar goods are taken away. However, the fees
taken by the trading house reduce the profits that can be made from the countertrade.
In some countries and with some customers, countertrade might be the only way in which a
sale can be made. These deals are most likely in LDCs, but reciprocal, buy-back and offset
deals can happen in the sale of capital equipment and military equipment in many different
situations.
Countertrade deals force companies to trade in ways in which they are not particularly
efficient. The core expertise of the company will be in the products or services in which the
company is a specialist. The receipt of other, often totally unrelated, goods faces the
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company with the need to extract the best value from the unfamiliar goods. The company
either needs to develop in-house expertise in handling countertrade deals, or it needs to use
third-party companies who specialise in arranging countertrade deals. The problem with
using the specialist trader is the fee charged, which will reduce the available profit margin to
the exporter.
Specific Pricing Methods
You are doubtless already aware of the major alternative methods of setting prices. In fact,
essentially these methods do not differ when considering international business, even though
there are a number of additional considerations and complexities to be taken into account
when pricing across national boundaries. To remind you, however, of the three major
alternative methods of setting prices, we have outlined each of these below, together with the
relative advantages and disadvantages of each.
Cost-Based Methods
As the term implies, cost-based methods set prices primarily using information on
costs. There are several alternatives with regard to setting specific cost-based prices,
but the major ones are as follows:
(i) Full cost/cost-plus pricing This is one of the simplest methods of pricing and
usually involves adding a predetermined percentage based on required margin
levels to the total costs of producing and marketing a product. Proponents of this
approach argue that it is simple to administer and ensures that prices cover all
costs.
However, it effectively ignores demand and can therefore result in lost marketing
opportunities because it is not customer-oriented enough. Given the increased
costs that are often incurred in marketing a product across national boundaries
cost-plus pricing can also render a product totally price-uncompetitive in an
export market.
(ii) Marginal cost pricing With marginal cost pricing, although costs are still the
major basis for setting prices, a distinction is made between variable and fixed
costs in order to assess whether or not a contribution can be earned. Under this
approach, sometimes the business may set prices at less than full cost, provided
some contribution to fixed costs is being earned. As such, it is much more
flexible than the full cost method and can be used where a business is trying to
penetrate an export market for the first time based on lower prices.
Competitor-Based Methods
Again, as the term implies, competitor-based pricing methods involve using competition
as a benchmark for fixing prices. Prices set can be more or less than other competitors
in the market, but often a competitor-based approach will use the industry price leader
as a reference point for setting prices.
Competitor-based methods are useful in that they acknowledge the importance of
competitive factors in the pricing decision and enable a company to consider how the
company can differentiate its offer in the competitive range. They may also be used as
a way of creating barriers to prevent competitive entry to a companys markets.
However, competitor-based pricing may result in a company ignoring differences
between its own and competitors cost structures, resources and marketing objectives
and strategies.
Demand/Market-Based Methods
These are the most marketing-oriented methods of pricing because they are customer
oriented. Essentially, this approach sets prices on the basis of the customers
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willingness and ability to pay and the market structure prevailing. Obviously, this
requires a detailed understanding of customer demand schedules and may require
market research.
Both market skimming and market penetration pricing are examples of demand/market-
based pricing and serve to illustrate how this approach to setting prices reflects a much
wider range of demand and customer and competitor considerations than do the other
approaches to pricing.
Quoting Export Prices Incoterms
As in domestic markets, interested customers will often ask a supplier for a price quotation.
Unlike domestic markets, however, export price quotations take on an added significance in
that different methods of quoting have different legal and cost implications with regard to the
responsibilities of the buyer and seller.
Export sales prices can be quoted in different ways according to the different responsibilities
to be borne by the supplier and the customer with regard to the transfer of ownership,
payment of freight, and responsibility for such areas as insurance, documentation, export
duties and taxes. So, for example, when a customer asks for a price quote, the supplier may
quote the price that involves the goods being delivered to the customers warehouses with
the supplier being responsible for all freight, insurance costs, and any tariffs and duties up to
the point when the goods are delivered to the customers warehouse.
At the other extreme, a suppliers price quote may be only on an ex-factory basis, which
means that the customer will be responsible for all insurance, documentation and transport
costs. Clearly, these are very different price quotes, so the customer and supplier must
understand and agree exactly what each partys liabilities and responsibilities are in terms of
the quote.
Because of the importance of price quotes in international markets, and in particular the need
for both buyer and seller to understand the trade terms encompassed by a particular price
quote, the International Chamber of Commerce (ICC) has established a set of internationally
recognised trade terms to cover international trade and price quotations. These are known
as Incoterms.
Incoterms are essential in international trade because they reduce the uncertainties
connected with the buyers and sellers liabilities and responsibilities. Using Incoterms
means that the same terms can be used around the world. In the case of a dispute about a
particular order and its delivery, the dispute can be minimised because Incoterms provide a
standard definition of trade terms.
With regard to price quotations in international markets, the following Incoterms are used
according to which stage export prices are being quoted:
Ex (point of origin) This price quote involves the supplier transferring the product and
its title at a specified point of origin and is often based on an ex-works price (EXW).
FOB (Free On Board) This is where the customer is provided with additional services
(such as logistics).
FAS (Free AlongSide) This is where the supplier is responsible for delivering the
product to the purchasers shipped harbour.
C & F (Cost and Freight).
CIF (Cost, Insurance and Freight).
DDP (Direct Destination Point) This is where the supplier takes responsibility for all
the costs associated with delivering the item(s) to the destination specified by the
purchaser.
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Needless to say, generally speaking, customers would prefer the supplier to shoulder as
much of the liability and costs as possible, and would therefore prefer a price quote based on
CIF or DDP. On the other hand, of course, a supplier can quote a lower price where liabilities
and costs are the responsibility of the customer at an earlier stage of the delivery process,
and so will often prefer to quote an Ex, FOB or FAS price. Whichever approach is used,
however, it is important to understand that the different Incoterms are legal trade terms and
therefore must be agreed and understood by both parties.
As we can see, there are very many different Incoterms, but unless you are directly involved
in export administration, there is probably no need for you to know all of these in great detail.
However, we will consider three of the most commonly used Incoterms in agreeing trade
terms and quoting prices as follows:
Ex-Works (EXW) As already suggested, this method of quoting prices and trade
terms implies the most basic of the levels of service that an exporter could provide for a
customer. Under this contract, the exporter makes the goods available at his premises.
This is obviously not a very customer-friendly approach, but it does provide the
customer with the opportunity to buy the goods at the lowest possible price. Some
customers might prefer this arrangement.
The benefits of EXW will be strongest for customers who are knowledgeable about
export distribution logistics and procedures and those that are seeking to reduce the
amounts of foreign currency required to finance the transaction.
Free on Board (FOB) FOB price quotes and contracts provide the customer with
extra services. Under this contract the exporter arranges and pays for all the logistics
services involved in moving the product from the ex-works position to a ship in a
named port.
The customer benefits from the extra services that the exporter can probably handle
more efficiently. The exporter, after all, should be familiar with the local domestic
distribution facilities, whereas customers from other countries will often lack such local
knowledge. The customer may also lack buying power compared to the supplier with
regard to the purchase of local logistics services. The customer can benefit from FOB
terms by specifying the customers own national carrier and by using national suppliers
of other logistics services (such as insurance). In this way, the customer can reduce
the foreign currency requirements of the order.
An FOB contract steers a middle ground between the lower cost ex-works type
contracts and the higher cost CIF and DDP contracts. Thus, a customer might insist on
an FOB price quote because the level of service provided would be higher than that
offered with an ex-works price but would not be as expensive as a CIF price
Cost, Insurance and Freight (CIF) CIF terms provide the customer with a much
higher level of service than EXW or FOB terms. CIF price quotes and contracts
provide the customer with all the costs arranged and risks paid for by the exporter to a
specified port of destination in the customers own country. The CIF contract can
enable efficient exporters to use exporting services to contribute to product profitability.
The CIF contract is also a way in which the exporter can provide a higher level of
service to the customer. Clearly these customer advantages of the CIF contract need
to be balanced against the inevitably higher prices to the customer of such a quote.
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C. INTERNATIONAL PROMOTION POLICY
The Context of International Marketing Communications
The key differences between domestic and international marketing communications lie in the
availability of different media and the cultural norms and legal rules applying in a particular
country. Before considering in detail the ways in these influence marketing communications,
it will be useful to consider the internal context of the general communications process and
the difficulties that arise in this process when we consider the international context.
The main ones relate to the lack of a common understanding between the message sender
and the message receiver. This results in encoding problems and decoding problems.
Encoding problems centre upon the co-ordination of extra salespeople, agencies and
consultancies in the message creation and transmission process and the difficulties in
translating messages into different languages. Decoding problems result primarily from
differences in the cultural context of the message receiver compared with the message
sender. A number of factors here can result in misinterpretation of the message. In addition,
the high context/low context culture gap and the simple need to translate between different
languages can cause problems.
Encoding/decoding problems may be compounded by different conditions applying to the
channel in different countries. We discuss the issue of availability below, but other issues
arise through the level of competitive activity and hence the amount of competing and
conflicting information provided in a country.
The basic resources used for marketing communications, information, sales people and
processes, and the mass media, will vary in their availability through the international arena.
The effect will be felt differently in the different elements used:
Personal selling
The sales force will be influenced by the decisions taken at the market-entry stage. If
the company decided to use agents or distributors, this will reduce the direct control
that the company has over personal selling. If the company uses its own sales force,
the availability of this will be limited by the normal commercial decisions about how
many salespeople are to be used and how much time they can spend in each country
market.
Advertising
Whilst the advertising media used for used for marketing communications, press,
television, cinema, radio, outdoor and poster, will be available in virtually every country
market, the extent to which they reach target audiences and, thus, their relative
importance will differ from country to country. However, the constraints applying to
what can be said and how it may be said are of more significance in this area.
Sales promotion
Here, the issues will be similar to advertising. However, in the international context,
advance planning is crucial in order to take advantage of opportunities that become
available. For example, some international trade fairs and exhibitions are only held
every two years and floor space is limited, which means that companies need to book
in advance to secure space in the more important ones.
Public relations
Again, since the media used will be the same as those used for advertising, general
availability will not be a problem, but the context of social, cultural and legal applying in
a particular country can be a significant constraint.
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Direct marketing
The issue here relates primarily to the availability or otherwise of appropriate
databases. In some countries the databases on which effective direct marketing is so
reliant simply do not exist. Another availability problem for this particular marketing
communications tool relates to the effectiveness and efficiency or otherwise of the
postal system itself, which obviously varies from country to country.
The Internet
Differential access to, and hence use of the Internet is the key factor here. Obviously,
the first requirement here is access to a suitable PC and the appropriate software. PC
ownership differs considerably still between different parts of the world with the highest
incidence of ownership being in the United States. In addition, there are differences in
costs of actually accessing the Internet. So, for example, compared to the United
Kingdom, where telephone call rates to access the Internet are still relatively high, in
the United States where E-commerce is most developed, telephone charges for
accessing the Net are amongst the lowest in the world.
The factors that constrain the development of marketing communications are primarily social
and cultural, although the legal rules applying in different countries can be significant. Again
the way in which they apply will vary with the different forms of communication.
These constraints are generally far more important to marketing communications than the
factors affecting availability. It is rare for an element of marketing communications to be
completely unavailable.
It is much more likely that what is available is constrained by country rules and regulations,
by cost, by coverage and by the qualitative differences in the persuasiveness that can be
obtained using different methods.
Advertising
The main constraints on advertising arise in the following areas:
(i) Legal and voluntary controls Different countries have different rules and
regulations about what advertising messages can be transmitted. Control of
advertising is usually strongest for TV advertising and is usually restrictive for
products such as tobacco and alcoholic beverages. These and other differences
cause constraints upon the ability of companies to develop standardised
advertising.
(ii) Different audience levels There are considerable variations in the potential
audience for different forms of media in different countries; levels of readership
for different forms of print media, and the size of viewer and listener audiences
vary widely. The national press is particularly strong in the UK and it is possible
to cover most markets through a few titles in the press. In many other countries,
the press is weak in terms of national readership levels, even though it is widely
available, but the regional press is often strong. In many developing countries
the ownership of televisions is quite low which means that it has a limited
coverage of the mass market. However, it is important to use media research
information because in some countries low ownership can be compensated for by
multiple household viewing of television sets or by communal viewing in places
such as bars.
(iii) Different coverage possibilities In some countries, such as Germany, the
amount of television time available for transmitting advertisements may be
constrained by a specified number of minutes per hour allowed for advertising. If
this happens in a country, then the amount of advertising on TV will be limited,
and the other advertising media will be increased to compensate for the TV
weakness.
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(iv) Different costs The cost of advertising is usually measured on the basis of
cost per 1,000 people reached. The cost is influenced by the price of advertising
space in the various media and the number of people who are in the potential
market of the media exposure. Differences in the pricing of advertising space will
clearly change the overall cost. Equally, though, if the media prices remain the
same but fewer people read a particular newspaper or listen to a radio station
then the cost per 1,000 will increase. Because media prices and media
audiences vary from country to country, the choice of advertising media can be
constrained because of a high cost per 1,000 in some country markets.
Sales promotion
This will be constrained primarily by legal and voluntary control differences and by
differences in what is acceptable to members of the distribution channel in different
countries.
Different countries restrict different types of sales promotions in different ways and
these can even influence the market for certain products and services. For example,
competitions are restricted in various ways in most countries, usually some skill
element will be required, and whilst coupons are permitted in many markets, but they
are not in some (such as Germany and Austria).
The strength of retailers in some countries, particularly in the industrially advanced
countries, provides a powerful constraint in terms of what they will accept. The more
powerful the retailers become, the more their particular demands for tailored
promotions and specific types of promotion will be imposed upon manufacturers.
Public relations
In public relations there are considerable constraints caused by the lack of knowledge
of the media, the journalists employed by the media and the various publics (for
example, politicians) in different countries. This means that public relations is
frequently localised to particular countries because of the limitations imposed by the
detailed and up-to-date knowledge required to be successful in public relations.
Direct marketing
In many countries various aspects of direct marketing are covered by legislation and
the international business must be familiar with the relevant rules and regulations that
apply. So, for example, access to, and use of, databases are often constrained by
legal factors and voluntary codes of practice. There are also constraints with regard to
the content and use of unsolicited telephone and direct mail campaigns.
Cyberspace communications
To the concern of at least some, marketing communications using the Internet are,
currently, remarkably free of constraints. In part, this is because of the relative
newness of these so-called cyberspace communications, but also because they are
proving difficult to regulate and control. However, in using these tools of modern
marketing communication, the business must be careful not to violate regulatory or
social and ethical customs that would normally pertain in a particular country. So, for
example, it would be unwise, say, to advertise alcoholic products through the Internet in
countries where alcoholic consumption is prohibited. Perhaps the biggest concern at
the moment with regard to cyberspace communications and controls, or rather the lack
of them, relates to the promotion of pornography.
Marketing Communications Strategies
Developing suitable campaigns using marketing communications is a major strategic
demand. Suitability has to be justified in the context of the company and the international
marketing environment. The diversity of country markets and the constraints and
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opportunities that exist within them give rise to the need to develop different solutions, for
example, taking account of cultural and linguistic differences, and using an appropriate mix of
communications in light of the availability and constraints applying. These solutions must
also take account of cost pressures and the resources that the company has to support its
marketing communications.
As we have seen before, a major strategic decision revolves around the issues of
standardisation and adaptation.
It is difficult to standardise most elements of marketing communications to any great extent.
Personal selling, direct marketing, public relations and sales promotion all interface very
closely with the country and its culture. The main opportunities for standardisation lie in
common social and cultural elements between countries and even globally.
Thus, it is possible to standardise some sales promotions through the linkage with major
world sporting events, and public relations activities can adopt a common approach to, say,
political lobbying or crisis management throughout the companys facilities around the world.
The greatest possibilities for standardisation arise in advertising. The main reasons for this
are as follows:
To save money The standardisation of advertising reduces the associated
production costs. To take an example, a company such as Levi might spend several
million pounds to produce one TV commercial. This commercial, with minor
adaptations for language, can be used on a worldwide basis. If the company, on the
other hand, produces a TV commercial for each of its major markets, say 20 markets at
a cost of 500,000 per commercial, the total production cost will be far higher. The end
effect, with 20 different commercials produced at low cost with less technical
sophistication, is likely to have less impact in each country whilst at the same time
being more expensive in total for Levi.
To present the same image In the Levi example it enables the company to develop
a standard advertising message and promote the concept of a global brand. This can
be very valuable if buying motivations are similar in different countries.
To communicate with a geographically mobile market If consumers move from
one country to another, it is important that message confusion does not spoil sales
because of conflicting and confusing messages from one country to another.
To concentrate on one big excellent idea There are few excellent creative ideas. If
such an idea is developed and if it has transferability across country markets, there is
great commercial value in exploiting this idea to the full.
It is easier to see how marketing communications that are adapted to each market will gain
better returns than standardised communications. The locally adapted or specially prepared
country approach has a better chance than the standardised approach to be appropriate for
the local market. In particular, marketing communications that are specifically prepared for a
country can be made to have a high degree of suitability through attention to the detailed
requirements of:
Customer benefits and market segments.
The distribution channel.
The needs of the sales force.
The tactical strategy for the product in its local competitive environment.
Table 9.1 shows the potential appropriateness of the three main positions in respect of
standardisation/adaptation.
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Table 9.1: Degree of appropriateness for local country
Form of marketing communications Appropriateness
Specifically prepared for the country Highest
Prepared centrally but adapted for the
country
Can be high, but depends on whether the main
standardised approach is appropriate to the
requirement of the country
Standardised with minimal adaptation
and prepared centrally
This can work very well for developing
familiarity, particularly for global brands, but
risks the lowest common denominator effect
with bland communications that lack
distinctiveness in any one market
Any strategy for marketing communications must take account of the resources of a
company, its objectives and its target markets. Thus, any campaign must be carefully
planned to cover the target market, with an appropriate creative message and with sufficient
opportunities to cause people to act in the ways that enable the achievement of
organisational objectives (usually sales revenue or profits). It is also important to match the
costs of marketing communications with the required and forecast returns of sales and
profits.
Note that it is not the case that all companies involved in international businesses marketing
will necessarily always have the resources to pay for, or even need, large mass-market
campaigns. Such expensive approaches (particularly in respect of the production costs for
TV commercials) are only appropriate if the company has the resources and can use the
right mass media in an appropriate way to reach its mass target market in an efficient way.
Companies marketing business products do not usually use mass media campaigns. Their
campaigns are targeted to specific business markets and the associated decision-making
units (DMUs) within the buyer company. The most likely approaches are specialised
business publications, trade fairs and exhibitions, print through brochures and technical data
sheets (in the appropriate languages) and direct mail. Sales promotion and public relations
can be used in specialised ways.
Using Agencies and Consultancies
For many companies, marketing communications are a key means by which their products
and services can be differentiated from their competitors. In particular, they need to develop
communications that are appropriate both to the product and company image, and to the
needs of customers in the particular market or markets served. It is seldom the case that,
apart from the very large or the very small company, few will have the in-house knowledge
and skills to bring to bear on this. As a result, there are a great many agencies and
consultancies operating in the fields of marketing communications that offer specialist
expertise.
In the international arena, local agencies are able to offer detailed local knowledge of country
conditions, in particular, the local media, buyer behaviour and cultural issues. They should,
then, be able to develop better, more appropriate campaigns for their country market.
Also, they can provide savings through paying for services and staff only as and when they
are needed, rather than a company having a permanent commitment to maintain the
necessary functions in-house. The problems for the client relate to the co-ordination of many
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different local agencies, the difficulties of communicating with them, the likelihood of different
campaigns without a uniform message, and extra cost.
There are many different ways in which companies can use agencies in their international
marketing. The precise arrangements should be determined by the contribution that the
agencies and consultancies can make and the costs and benefits that relate to the different
combinations and arrangements.
The use of agencies and consultancies was examined when we looked at external resources
earlier in the course. From this you will recall that the benefits of agencies are as follows:
Financial They can provide savings through paying for services and staff only as and
when they are needed, rather than a company having a permanent commitment to
maintain the necessary functions in-house.
Specialist knowledge This is particularly important when we bear in mind the range
of different types of specialist knowledge in international marketing.
Creative input Companies rarely employ people for their creative talents, although
this is a useful adjunct to most marketing and business activities. Agencies and
consultancies can be used to find good creative ideas in advertising, public relations
and sales promotions.
External perspective This will be particularly helpful for international businesses.
Agencies offer a way in which cultural differences can be handled and the customer
perspective in each country can be applied, although it may result in campaigns that
are too localised. The company needs to find a balance between extensive localisation
and a blind, ethnocentric extension of its home country marketing communications or
a bland geocentric standardisation in which the communication does not offend, but
neither does it work.
The selection of agencies and consultancies should be carried out in a systematic way.
Initially, the need for, and extent of the use of, external resources needs to be established
through a careful consideration of overall marketing objectives:
Establish whether marketing communications should be handled in-house or whether
agencies and consultancies will be used.
Establish the balance that is desired between standardisation and adaptation.
Establish the geographic boundaries of the international communications, which
countries should be covered, which are the most important markets and which will be
important in the future?
Establish the balance required in the communications mix; so, if agencies are to be
used, are agencies required with particular expertise in advertising, sales promotion or
public relations, and will they understand the requirements of the sales force?
Establish the budget for the total marketing communications and this may be factor in
attracting the right type of agencies and consultancies.
Consider whether all the needs can be met by one agency or several are required with
different expertise.
In selecting particular agencies or consultancies to meet the defined needs, the following
process identifies the key stages and concerns.
Initial screening
This should aim to identify a small number of agencies who should be capable of
undertaking the work. It needs to be based on a list of criteria that can be used to
assess whether an agency is broadly suitable or whether it is unsuitable. The criteria
should include:
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(i) Experience in the appropriate international markets.
(ii) Experience in the type of product or service.
(iii) Experience in handling and co-ordinating international standardised campaigns.
(iv) Experience in the appropriate media and elements of marketing communications.
(v) Ease of communication between the client company and the agency.
(vi) Degree of favourable testimonial support from other clients, etc.
(vii) Whether the agency has competing or conflicting accounts.
(viii) A review of their marketing communications output.
It is probable that the company will be able to carry out this initial screening much more
effectively in its home market and its major international markets than it will on a
completely comprehensive worldwide basis.
Detailed screening
The next stage is fine or detailed screening to select the best two or three agencies
who will then be given a precise brief and asked to prepare marketing communications
solutions to the problems posed in the brief. This detailed screening will be undertaken
by a more thorough assessment of the shortlist of agencies, using the criteria list,
augmented by meeting(s).
Final selection
The client will select the preferred agency based upon the quality of the presentation
and the solutions proposed, the quality of the people (this is a service business) at the
agency, and the price for the agencys services. The importance of international
marketing communications for the company will be a strong influence upon the amount
of time that the company will spend on this selection process.
The range of possibilities for the use of agencies and consultancies is almost endless. The
main arrangements are:
(i) One global marketing communications company
(ii) One global advertising agency
One global public relations agency
One global sales promotion agency
(iii) As (ii) but agencies operate at a trading bloc/world region level
(iv) As (ii) but agencies operate at a country level
(v) As (iv) but using a local national agency which has a network arrangement in each
country. Therefore the agency handles the co-ordination problems rather than the
client
D. INTERNATIONAL DISTRIBUTION AND LOGISTICS
Distribution Channels
The international distribution channels for consumer and business goods show a number of
similarities, and we have considered some of the channels in our previous discussion of
market entry routes. In both, there is a choice between direct and indirect export channels:
Indirect exporting is where distribution is undertaken by distribution channel members
based in the home country;
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Direct exporting uses distribution channel members based abroad, usually in the
country market itself. This invariably involves the use of intermediaries, although direct
contact with customers is an important aspect for business goods.
We can illustrate the typical pattern of the distribution channel arrangements for both indirect
and direct exporting by considering them in relation to consumer goods. This is set out in
Figure 9.5.
Figure 9.5: Distribution channels for consumer goods
Manufacturer of Consumer Goods
Indirect Export channels Direct Export
channels
Domestic
Purchasing
Piggyback
Operations
Trading
Companies
Export Houses/
Export
Management
Companies
The indirect exporting distribution channel members, if used, will sell to
the final customers via the direct exporting distribution channel members
Wholesalers Agents/Brokers Mail Order Direct to
Customer
Retailers
Customers
The direct channel to the customer is not very important. The main routes to the final
customer are through wholesalers and retailers and also through mail order.
For business goods, the same indirect exporting channel members can be used, domestic
purchasing, piggyback operations, export houses or export management companies and
trading companies. However, the direct exporting channel is usually of far greater
importance in providing a direct route to the business buyer and the using local agents and
distributors.
Business buyers buy in larger quantities than consumer buyers. The volume of sales may
well be such that the costs of selling direct to the customer can be covered, but the
manufacturer, in selling direct, has to cover all the costs from the one order. An agent,
retailer or distributor will be selling a number of different products and can, therefore, share
the selling costs across a number of companies. A second significant point is that the
business buyer will usually want to negotiate changes to the technical specification of the
product, to agree delivery times and to negotiate the price. Direct contact is of value to the
business manufacturer because it enables this adjustment/negotiation process to take place.
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The typical pattern of direct export distribution in relation to business goods is set out in
Figure 9.6.
Figure 9.6: Distribution channels for business goods
Manufacturer of business goods
Direct export channels
Direct to Customer Distributor Agent
Business Customers
Intermediaries
Intermediaries between the manufacturer and the end user of the product provide a number
of useful services for the manufacturer. They help the process of finding customers and of
promoting the sales of the product. Many also help the manufacturer by putting capital into
the system by buying the product.
The changing nature of distribution means that it is more useful to consider the activities
performed by channel intermediaries, rather than simply their place in the distribution chain.
The roles performed by distribution channel intermediaries can be defined by the range and
extent of the activities that they perform, for example:
The assortment of products that they stock.
The numbers of customers that they have direct access to.
The amount of marketing communications support that they provide.
The extent to which they buy in bulk and then sell in smaller quantities.
The amount of capital that they provide. In the case of cash-and-carry types of
operation, other channel members will provide the capital. Manufacturers might supply
goods on 30 or 60 days payment terms. If the cash-and-carry, on average, sells the
product for cash to retailers within five days, then the manufacturer and the retailer
(who might hold stock on average for, say, 10 days) will each add working capital to the
system.
The amount of distribution logistics services that they perform, e.g. local delivery.
Thus, wholesalers and distributors are expected to buy in large quantities, to stock a wide
range or assortment of products, to provide capital and local delivery, and to promote the
sale of the product. Because of this range of activities, the wholesaler/distributor would
typically expect a higher profit margin than an agent.
Note that an agent does not buy the product but acts on behalf of the manufacturer. The
agent searches for customers and if the sale is made, it is referred back to the manufacturer.
One consequence of international business is that the number of levels of intermediaries is
usually greater than in domestic markets. In some countries, for example Japan and Italy,
there are a number of different national, regional and local wholesalers who handle the
product before it reaches the retailer level. The extra levels make it difficult for the
manufacturer to get close to the end customer. This means that it is difficult to use sales
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promotions and it is difficult to learn very much about the retailer or the final consumer,
because the contact and knowledge are contained within this multiplicity of wholesalers. In
addition, each extra level in the distribution channel adds to the final price through the extra
profit margins
The retailer is in a strong position regarding information. He or she is in contact with the
customer and is in a position to build knowledge about customers and buying behaviour.
Even if the retailer does not formally evaluate the customers, he or she is in close contact
with the culture of the area in which he or she trades.
Retailers generally operate in much smaller quantities than wholesalers, in LDCs in
particular, they might exist on very low levels of sale, with a small assortment of products and
with very modest stock or inventory levels. However, retailers in some countries will perform
quite different activities. These differences are most marked between major retailers in
industrially advanced countries and retailers in rural parts of LDCs.
Distribution Channel Relationships
In an ideal world, manufacturers would expect that distribution intermediaries would provide
100% support for their products. In turn intermediaries would expect that manufacturers
would provide them with products that customers were anxious to buy and, in selling these
products, would make high profits. The real world is, of course, rather different.
Manufacturers have to work hard to gain the support of intermediaries and intermediaries
have to battle hard to be successful in the competitive hurly-burly of the market place.
In order to illustrate the nature of distribution channel relationships and the ways in which
these can be influenced by cultural factors, we will look at the Keiretsu in Japan and retailing
in advanced and lesser-developed economies.
The Keiretsu is a distinctive type of business organisation found in Japan. The Keiretsu are
linked together through a whole series of financial arrangements, interlocking directorships
and social and historical links, based on Japanese values of personal service, that form a
very powerful, cohesive relationship between the constituent parts of the Keiretsu.
There are three types of Keiretsu, financial, production and sales distribution. The sales
distribution Keiretsu are distribution channel arrangements that link manufacturers with
wholesalers at varying levels and with retailers.
An important element of the Keiretsu is the importance attached to high quality personal
service. As viewed from some perspectives, this would make the channel inefficient because
of its high costs. However, in the Japanese context it is efficient because customers are
prepared to pay the extra price for the services that they value.
In contrast, throughout the country, high levels of service are an intrinsic part of Japanese
culture. Similarly, an important expectation within the Japanese distribution system is that of
high quality and personal service. Whilst it is also true that high levels of service are
important in the US, the way in which service is expected is rather different. In Japan,
service means:
Easy availability through long opening hours.
Easy availability by physical closeness.
Good delivery services.
Good credit terms.
A ready acceptance of the return of goods even if there is no reason for the goods to
be rejected, for example they were not damaged in transit.
In the US, the expectation of service is characterised by attention to low price efficiency. US
distribution is based on large size, substantial mechanisation and computerisation. The
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people component of the US is much less important within the perception of what is good
service.
To facilitate the level of service which links the Keiretsu, it is necessary to have large
numbers of retailers and wholesalers and this is true in the distribution channel where many
companies are very small, usually employing just a few people
It is extremely difficult for non-Japanese companies to gain entry into the Keiretsu distribution
system. Non-Japanese companies cannot deliver a Japanese service because of obvious
linguistic and cultural differences. It is this reason that is at the heart of the inability of non-
Japanese companies to build successful levels of sales in Japan. In order to enter the
Japanese distribution system, non-Japanese companies will need to find ways of obtaining a
joint venture or an alliance with a Japanese partner, or to persuade a Japanese trading
company to sell their products. These trading companies, called Sogo Shosha, provide a
culturally adapted interface into the Keiretsu. If this is done, the Japanese values expected
with the Keiretsu system will be capable of being delivered.
Retailing in Industrially Advanced Countries
Retailers in industrially advanced countries develop aggressive approaches to
manufacturers. In many instances it is the very large retailers that control the distribution
channel. They perform the functions of wholesalers by buying in bulk, by distributing to their
retail branches and by adding capital to the system. They even take on some of the activities
of manufacturers through the development of own-label products and by specifying the types
of products that they will stock and the price lines that they will sell them at.
In such countries, the expectation of the retailer and the wholesaler is undergoing change.
As retailers become more powerful, they express that power in the form of:
More own-label products.
The development of strong retailer images.
The use of strong dedicated marketing communications programmes.
The insistence on manufacturers contributing to the costs of retailer promotions in
which their products are featured.
The use of central head office buying with the help of specialised computer packages,
forcing the manufacturer to deal through head office.
Very specific requirements about delivery times, quantities and frequency of delivery.
Aggressive bargaining about price and their profit margin.
Difficulty in granting the listing for new products (without the necessary listing, new
products cannot be stocked).
Manufacturers are currently engaged in battles with retailers. From the manufacturers
perspective they are fighting to protect:
Their profit margin.
Their rights to develop new products and to be the innovators of products in the
distribution channel.
Their rights to maintain strong brand images.
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Retailing in Less Developed Countries
Retailers in less developed countries show a number of differences from retailers in more
advanced countries:
The level of concentration of retail power will be much less. This means that
manufacturers are relatively more important in the distribution channel.
Retailers are often local, are comparatively unsophisticated in their use of site selection
techniques, and will make limited use of technology in retailing.
The size of retail outlets and the range of product assortment will be small.
Retail stores will be based on the name and personality of the owner, or on the types of
product that are sold in the shop. In industrially advanced countries, retailing concepts
such as Toys R Us or the Early Learning Centre are commercially successful.
Retailers are mainly reactive to manufacturer marketing communications. The latters
promotions are welcomed because they help sell products for the retailer. In addition,
they make the retail shop more interesting.
Manufacturers have more power in retailing systems in which there are such low
concentration ratios. The retailer is too small and too fragmented to build power, and the
manufacturer and wholesaler will have control in the distribution channel. On the other hand,
the cost of distributing products to many small outlets can be very high.
In the future, these retailers (more particularly in the main urban centres) will become more
like the retailers in more industrially advanced countries. Another influence will be felt
through the moves of retailers to increase the international scope of their operations. As the
internationalism expands, these retailers might enter LDCs. In this way, some of the more
advanced retailing practices will be diffused into the less advanced retailing of the LDCs. As
retailing changes in LDCs, manufacturers expectations will need to change also.
Planning and Managing International Channels of Distribution
The key elements and considerations in planning and managing international channels of
distribution are similar to those encountered in planning and managing channels of
distribution in domestic markets. You should therefore already be familiar with the nature of
these decisions, but it would be useful to remind ourselves of the key elements, and in
particular any additional issues and complexities, which arise when planning these elements
of distribution in international markets.
The following represent the key decision areas in planning and managing channels of
distribution together with any special considerations with regard to these key decision areas
when planning international channels of distribution:
Channel length
The first decision for the channel planner is to determine the number of levels between
the producer/business and the final customer in the channel of distribution (the channel
length). The shortest channels are those where the business sells direct to the final
customer with no intermediaries being involved. This is sometimes referred to as a
zero level channel and essentially involves the business in direct marketing. Zero
level channels are often used in business-to-business markets, particularly where
products are expensive or highly technical in nature, as well as in direct marketing in
consumer product markets.
This type of channel arrangement affords the business a much greater degree of
control over how the product or service is marketed and obviously has the advantage
of enabling direct contact with a companys customers, with all the attendant
advantages that this gives rise to.
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Perhaps the biggest disadvantage of the zero level channel in international markets is
that it requires the business to have the necessary expertise to be able to deal with
foreign customers often across a wide range of different geographical areas of the
world. Remember that businesses use intermediaries for a variety of reasons, but
essentially they are used where they can perform marketing activities and functions
more effectively than the businesses themselves. Because of the often wide disparity
between different markets and customers when considering international, as opposed
to purely domestic, markets, very often the business has little choice other than to use
intermediaries in the channel. In addition, zero level channels with no intermediaries
often involve the business in exposure to much higher levels of investment and risk. As
a result, much international business is characterised by the use of a variety of
intermediaries by the business.
One stage up from the zero level channel is the one-level channel, where the business
uses one type of intermediary to reach consumers. As the business adds different
types of intermediaries to the channel, so the channel length increases. So, for
example, if a business sells through a wholesaler and then through an international
selling agent, two levels are introduced into the channel and the channel subsequently
becomes longer.
Remember that, generally speaking, the longer the channel, the further the business is
from the final customer and therefore the less control they will have. In addition, longer
channels of distribution will tend to lead to the phenomenon of price escalation in
international markets, as each intermediary obviously requires a share of the profit.
Again, the reasons why the business might use different intermediaries in the channel,
therefore, are that the use of such intermediaries gives rise to superior effectiveness in
performing the required channel functions and flows.
If anything, in recent years there has been a trend towards shorter channels with a
growth of more direct marketing and the increased control and customer contact that
this gives rise to.
Types of intermediaries
The second decision area in channel design relates to the nature and types of
intermediaries to be used in the channel. Obviously, to a great extent, this aspect of
channel design is related to the decision about channel levels. The usual types of
intermediaries used in domestic channel arrangements such as wholesalers, retailers,
agents and brokers, are all available to the international marketing channel planner.
However, over and above these normal domestic channel intermediaries, the
international business has in fact an almost bewildering array of types of intermediaries
when it comes to the international channel arrangement. So, for example, the business
can choose between domestic purchasing agents, export houses, trading companies,
licensees, overseas agents, export consortia, international trading companies,
overseas buying offices, confirming houses and so on. Quite simply, then, identifying
and selecting the most effective types of intermediaries can be much more difficult and
complex compared to the selection process for domestic channels. Once again,
though, the business is looking for the most cost-effective combination of types of
intermediaries to achieve their given marketing objectives.
Channel/market coverage (number of intermediaries)
Sometimes also referred to as distribution density, this decision regarding channel
design relates to the number of intermediaries to be used at each level that in turn, of
course, affects the nature and extent of market coverage.
In some markets, customers require products to be available in a wide range of
locations and types of intermediaries. Many consumer goods fall into this category. In
this situation, large numbers of intermediaries are required, giving wide-ranging market
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coverage and hence a distribution density which is intensive. At the other extreme,
the market may be one where only a small number of customers are required to be
reached and therefore perhaps only one or two specially selected intermediaries will be
used, giving exclusive distribution. In between these two extremes is selective
distribution, where a relatively small number of intermediaries are used at each level,
but more than the one or two found in exclusive distribution.
Tasks, responsibilities and terms
This element of channel design and decision-making relates to what is required to be
performed in the channel of distribution with regard to tasks and responsibilities and
who is to perform these. So, for example, someone in the channel of distribution may
have to take responsibility for credit or after-sales service. The channel design
decision must consider these tasks and responsibilities in advance and determine the
most cost-effective way of performing them. Moreover, it is important to ensure that
these tasks are allocated and agreed between channel members as part of the
channels design decision.
Distribution logistics and service levels
Overall, distribution channels should be designed to get the right products, to the right
customers, in the right place at the right time and in the right condition. In achieving
this, distribution is about the planning, implementation and control of physical flows of
materials, services, and information from the business to customers. In recent years,
these flows and their management have been referred to as physical distribution
logistics. The business must therefore design channels based on the flows required to
get products from the businesss organisation to final customers. Moreover, physical
flows in channels of distribution need to be managed so as to deliver predetermined
levels of service to customers.
We shall be looking at elements of service levels from the design of the logistical
system later in the unit, but examples of service levels affected by the design of the
logistics system are:
(i) Delivery response times.
(ii) Consistency and reliability of delivery.
(iii) Flexibility of delivery and ordering systems.
(iv) After-sales support.
The increased recognition of the importance of this element has led to the growth of a
whole new area of the management of distribution, usually referred to as logistics or
logistical planning. The importance of planning the logistics element of channels is
heightened in international markets for a number of reasons.
(i) Distributing across national boundaries to often geographically disparate areas of
the world can substantially increase distribution costs, and hence the potential
pay-off from designing systems which minimise these costs.
(ii) Developments in production and manufacturing systems such as just-in-time and
zero defects or Kanban systems (which are systems of manufacturing based on
purchasing in small but frequent batches) place an increasing premium on
effective distribution and delivery systems to customers.
(iii) Customers are much more demanding with regard to what they expect from the
business with regard to distribution. Not only do customers expect their products
and services to be delivered more quickly, but also with additional levels of
service and in perfect condition.
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These then are some of the key decision areas in selecting channels of distribution, but what
are some of the considerations in making these decisions, how can the business choose
between alternative channel arrangements? We shall now turn our attention to the key
influences on this choice.
As so often with marketing mix decisions, a very wide range of factors have the potential to
affect the design and selection of appropriate channels. A number of writers on distribution
have used the notion of identifying certain C factors to help explore and explain the key
factors affecting the design and selection of distribution channels. The main Cs are:
Cost
Two kinds of cost need to be considered. The first cost is that involved in setting up the
channel in the first place. The second kind of cost is that of maintaining the distribution
channel. The main costs in this area are the total profit margins paid to distribution
intermediaries that make up the difference (excluding tariff and other government-
imposed duties) between ex-factory cost and the final price paid by the end user. The
other cost element is the company selling costs associated with the distribution
channel.
Capital requirement
This C carries on from above. It reminds us of the different capital requirements of
different channel arrangements. All arrangements will require capital; however, when
the company establishes its own internal channels (for example its own distribution
depot or its own direct sales force in a country), its need for capital will be greatest.
Control
It is difficult to exert direct control in international marketing. It is often too expensive to
establish the companys own sales force. It is therefore usual, particularly in export
marketing, to use distribution channel intermediaries. Because of this, it is important to
select intermediaries over whom the company can exert some measure of control.
Coverage
Most companies seek to cover all, or at least the most important parts, of each country
market. The performance of the distribution channel will be assessed by the amount of
the market that is covered. Market coverage can be measured in:
(i) Geographic coverage of the country. In some countries this might not be
essential, because the majority of the market might be contained within a small
part of the country. For example, over half of the population of Japan lives in the
Tokyo-Nagoya-Osaka market area.
(ii) Market coverage. For most companies, market coverage will be more important
than geographic coverage.
Character
The distribution channel selected must fit the existing and the evolving requirements of
the product and the company. Food products have perishability as an important
characteristic. Business products are characterised by a customer need for high levels
of after-sales service. If the distribution channel does not fit the character
requirements, it will not have the required level of performance.
Continuity
Distribution channels need to continue to perform over long periods of time. It is
difficult to change from one type of distribution channel to another. However, within
one type of channel it is quite possible to lose channel members and with them
continuity between channel members. If agents are used in a country, it is quite
possible for the agent to retire or to decide to move to a different type of business. It
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might be difficult to replace the agent if no similar agent exists to cover the same
geographic or market area.
Company
This C encompasses a number of factors. To begin with, company objectives influence
the choice of channels of distribution. Where a company is wishing to grow, for
example, it may wish to secure intensive channel coverage. Another company factor is
company resources. Where a company lacks sufficient resources, it may have to use
more levels of intermediaries. Finally, a companys organisational structure, and in
particular its selected methods of market entry will have a direct effect on the channels
of distribution used.
Competition
Competition, of course, affects every facet of a companys marketing strategy and mix,
and channels are no different in this respect. A company will therefore need to
consider the sort of channel arrangements used by competitors in a given country. A
company may choose to use similar channel arrangements to key competitors or
perhaps may instead seek to develop different, and possibly innovative, channels
compared to their competitors.
Culture
Culture, too, affects every facet of a companys marketing strategy and mix as we have
already seen. With regard to channels of distribution, certain products in a country
may only be available through certain distribution outlets due to cultural practices. So,
for example, in some countries certain foodstuffs are only available through specialised
retailers. Culture may also affect specific distribution practices, such as opening hours
for retail outlets, etc.
Customers
Finally, though in some ways most importantly, customers also affect channel
decisions. Obviously channel arrangements must fit with target market customers and
their needs and wants.
Working effectively with intermediaries means that the processes of selecting, managing,
motivating and controlling them must be effective:
Selection
Selecting individual intermediaries in the channel is crucially important. Obviously the
choice of intermediaries depends on many factors including the overall channel
configuration. The fortunate business has a number of intermediaries to choose
between, all of which are able and willing to take on and complete the necessary
distribution tasks. All too often, however, the business is faced with little choice and
must take what is available.
Where the business is able to select between alternative individual intermediaries, the
following are likely to be key factors in choice:
(i) Skills, expertise and experience of the intermediary.
(ii) Enthusiasm and commitment of the intermediary.
(iii) Fit with/coverage of target market.
(iv) Financial stability.
(v) Sales potential.
(vi) Reputation.
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Often the selection criteria are weighted heavily in favour of sales volume potential.
The performance of specific intermediaries can be measured against the target levels
of sales that the intermediary will be expected to provide. This precise form of
performance measurement is most useful when the company is using a small number
of agents or distributors. It is not practical if the company is using retailers, because
the company will have less information about the sales levels of individual retailers.
The most important element that companies are concerned about in the long term will
be the profit contribution that the distribution channel and individual intermediaries
can make to the company. Companies that focus on short-term profit return will place
great emphasis on profit contribution, even in the first year of the operation of a
particular distribution channel arrangement. Companies with a long-term view of profit
importance will view the performance criteria of sales growth, market coverage and
market share as much more important in the long term. They will view the short-term
success as the foundation for long-term profitability.
Management and motivation
Obviously companies, having selected individual channel members, need to manage
and motivate them. The tasks, responsibilities and roles of individual channel members
determined earlier as part of the overall channel configuration decision should be
communicated and agreed with those individuals. It is vital that channel members
know exactly what is involved in terms of their agreement with a company. Specific
arrangements, such as responsibilities for joint promotions, pricing and discounts, need
to be formalised.
Companies should use the range of management and motivational methods that they
would use with their own domestic sales force. Motivation can be influenced by good
quality marketing communications and Western companies have considerable
experience in providing various types of sales incentive schemes and psychological
rewards. The effectiveness of different methods will vary.
The important influence of cultural difference should be considered. In some situations,
personal and group esteem and honour will be more important than individual
competitive pressure to hit sales targets.
Control
Finally, the business must ensure that there are adequate systems for evaluating and
controlling intermediaries. Very often, when dealing with intermediaries in international
markets, control is more difficult to achieve because the business is working at a
distance.
Obviously, control and measures of performance will need to be agreed in advance,
together with actions that can be taken in the event of either party being dissatisfied.
Wherever possible, the business and individual intermediaries should draw up
contractual agreements with regard to, for example, standards of performance, terms,
conditions and roles, methods and bases of payment, and conditions for the ending of
a contract by either party.
It is important to note that it can sometimes be very difficult, and therefore very costly,
to withdraw from contractual arrangements with intermediaries in international markets.
Needless to say this heightens the importance of getting it right in the first place.
Trends in International Distribution
Like all areas of marketing, distribution channels and arrangements are constantly evolving
and changing. If anything, however, international distribution is one of the most dynamic
areas of contemporary marketing. Distribution patterns, channel arrangements, techniques
and systems of management have all undergone major changes over the last ten years and
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will continue to do so. The international business needs to be at the cutting edge of these
changes and their implications for the design and management of effective international and
global channels of distribution. It is fair to say that distribution and logistics are increasingly
becoming the new battleground in international marketing as companies seek to gain the
competitive edge. Amongst the most important developments that are taking place with
regard to international channels of distribution, are the following:
The rise of the global retailer
Increasingly, retailing is becoming global in nature. For example, the American
supermarket retailer, Walmart, has recently acquired the British supermarket retailer,
Asda, in order to expand its operations in Europe. IKEA, Benetton and Aldi, are all
examples of companies with international and global perspectives and operations.
The increased power and size of retailers
In virtually all parts of the world, smaller retailers are losing out to large organisations.
Not only is this true of individual outlets, such as the growth of the hypermarket, but it is
also true of the retail organisations themselves, who have increasingly become large-
scale multiples across a wide range of different product markets.
The growth of vertical marketing channels
Vertical marketing channels are channels where the different levels in the channel are
co-ordinated to act almost as a single organisation. In part the growth of vertical
marketing channels is due to the increased size of certain channel members, and in
particular the retailers already mentioned. The large retailers can, because of their
huge buying and market power, effectively control other members of the channel in
order to achieve co-ordinated marketing.
The growth of direct marketing
We have already mentioned the trend towards more direct channel arrangements. This
has been facilitated by improved technology and marketing infrastructures, such as
improved databases available to businesses. The growth of direct marketing and
channels also reflects changing lifestyles, with customers having less time and
inclination to leave their homes in order to do their shopping.
Information technology and the Internet
Related to the growth of direct marketing, once again the ubiquitous Internet is
changing channels of distribution. Mobile phones, the expanded ownership of PCs and
the growth in teleshopping will obviously serve to fuel this growth further. At the
moment, in most parts of the world, Internet shopping is restricted to just a few product
categories but some of the most successful uses to date of the Internet as a channel of
distribution have been the purchasing of books and holidays and certain specialised
areas such as auctions. There is no doubt, however, that once again this will be one of
the fastest growing types of distribution in the future.
The growth in importance of physical distribution and logistics
We have already touched on the importance of physical distribution and logistics in
planning distribution and will be going on to explore it detail in the next section. At this
stage it is sufficient to note, however, that the high costs of physical distribution,
together with the potential savings for businesses in this area, have served to focus
businesss attention increasingly on this aspect of distribution.
Another major reason, however, for the growth of effective physical distribution and
logistics has been the recognition by customers of the importance for companies to
manage the whole of the supply value chain. Companies have realised that a key
factor in competitive success is the effective management of these supply chain
activities.
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Distribution Logistics
Distribution logistics is the term used to cover all those activities in moving and facilitating the
movement of products from the production point to the customer. In international marketing
this will usually involve longer journeys, more types (or modes) of transport and considerable
amounts of documentation.
It is an area that in the past has had a low profile in the marketing departments list of
priorities. Businesses often think that completion of marketing plans and a product ready for
despatch means their job is complete. It is, however, becoming increasingly recognised that
distribution is an integral part of the product offering and a tool that can be used to win
competitive advantage.
Logistics is an area in which the tight fit of detail is essential. Documents need to be 100%
correct and time schedules need to be met accurately. In addition to this requirement at an
implementation level, it is important to note the strategy decisions about what is the best
balance between service levels to customers and the costs incurred by the company.
We have looked in detail in earlier study units at the complexities of marketing in an
international arena, the need for informed strategic planning and an organisation that is
capable of being customer-focused, often in subtly different ways. It is, therefore, very short-
sighted for a company to assume that once the product has left the factory, so to speak, their
job is at an end. It is, of course, only when the customer is in possession of a product that is
meeting the need/want for which it was purchased that customer satisfaction can be
achieved.
The importance of this element of the process is changing for a number of reasons:
The costs associated with distribution can frequently account for up to 50% of the
product cost, possibly more for exported products.
Availability and delivery are being utilised by the manufacturer to win competitive
advantage.
Across the world, customers are demanding more convenience and using distribution
to evaluate potential suppliers, for example, in telebanking and TV shopping.
The growth of just-in-time systems and material management.
There have been changes in the balance of power between distributors and
manufacturers, which has resulted in the squeezing of margins and refusal of access to
customers, for example Kellogs and UK supermarkets.
As we have mentioned previously, there has been an increased recognition of the
importance of managing all the elements of the value chain, and in this case, all the
supply aspects of this chain.
Once again, developments in information technology are also facilitating a more
strategic approach to the management of this part of the business. Perhaps the best
example of a development in this area is the growth of Electronic Data Interchange
(EDI) systems. EDI systems essentially link suppliers and customers in the value chain
through on-line computer systems.
This means that customers and suppliers are directly linked and immediate responses can
be made where customers require further supplies. The customers own stock system will
sense when an order needs to be placed and this will be relayed automatically to a pre-
determined supplier through a computer link. The order will be raised automatically and dealt
with at the other end in the same way by the suppliers computer. Instructions will be sent to
the suppliers warehouse and delivery systems to forward the order without delay and all the
accompanying paperwork, such as invoices, etc. will be raised and dealt with at the same
time. Obviously, systems like these require close co-operation between the different
members of the value chain and above all require effective logistics systems to be in place.
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We have considered throughout this course the requirements of successful international
trade and distribution is clearly an integral aspect of the strategic planning process. The
management process and opportunities for control may be limited because of political,
financial, geographical or cultural considerations, but the planning of distribution must be
undertaken only on the basis of a detailed understanding of the market and its
characteristics.
The start of distribution logistics planning must be with the customer. As we shall see below,
there is a need to identify both the level and elements of service that customers require, what
they value and, most importantly, what they will pay for. It is also necessary to be aware of
what the competition is offering and at what price. Companies will then be in a position to
translate requirements into costs (for the company) and benefits (to the customer).
It has now become increasingly evident that distribution logistics strategy can strongly
influence the quality of customer care, the potential for increases in profitability and even
change a products positioning.
At one time, most organisations would have considered that physical distribution was
concerned primarily with order processing and delivery systems. The growth of the notion of
logistics has led to a much wider, and more realistic, view of the key elements of the physical
distribution and logistics system. It is now recognised that there are many interrelated facets
to the logistics system and that each of these facets must be managed in an integrated way.
The following are now recognised as being the key elements of a logistics system:
Inventory management.
Order processing and documentation.
Facilities and storage, e.g. warehousing.
Transport management.
Materials handling.
Packaging.
These elements of the logistics system are no different for the international business.
Needless to say, however, distance and geographical and cultural dispersion make the
management of this area and these elements potentially much more complex for the
international business. So, for example, in considering inventory management, the
international business must consider the potential delays in the system with regard to
delivery of stocks due to greater distances. Similarly, the modes of transport for the
international business will involve consideration of those modes that are used to transport
products over long distances and often across large bodies of land or water. Put simply, the
international business is likely to use a much wider range of transport types than the purely
domestic business.
Materials handling and packaging must also reflect the fact that products destined for
international markets are likely to be handled much more frequently during the distribution
process and are therefore more likely to be damaged. Similarly, packaging and delivery
systems may need to reflect, for example, differences in climate and environmental
conditions between different markets. The costs of distribution are likely to be much higher
for the international business, underlining the importance of this aspect of the marketing
process.
Finally, we know that the output of the physical distribution and logistics system, such as
delivery times, is a major factor in supplier choice in international markets. If a company or a
country develops a reputation for poor and unreliable delivery, it will quickly begin to lose
market share in international markets.
Associated with these key elements of the logistics system, the business must decide on the
following aspects:
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Stock levels.
Order cycle times and ordering systems.
Methods of transport.
Warehousing and storage, handling and packaging systems.
You should remember that all of these decisions must be made in conjunction with the actual
channel decisions such as mode of entry, types of distributors, distributor coverage, etc. We
can see that designing the physical distribution/logistics systems is a complex and difficult
process. What then are the major factors influencing these decisions, and what should serve
to shape the design of the logistics system?
The most important thing to remember about the logistics system is that it has a major
influence on levels of customer service. In designing the physical distribution/logistics
system, therefore, the start point should be what we want the output of the system to provide.
Specifically, we need to determine the required service levels from the system, for example, it
is likely that delivery time reliability, goods arriving with zero defects and a high level of
responsiveness to customer requirements will be significant customer requirements.
The following represent the key elements of customer service which stem from the design of
an operation of the logistics system:
Delivery response time.
Minimum/maximum order size.
Flexibility, e.g. ability to handle special or rush orders.
Consistency and reliability of delivery.
Order status information.
Ease of ordering, including paperwork and documentation.
Condition of delivered goods.
After-sales support.
We can immediately see from this list of service elements why distribution and logistics is so
important to customers and therefore to a companys competitive success. In looking at
these elements of customer service, one might be tempted to think that ideally the logistics
system should be designed so as to give the maximum level of service to every customer.
So, for example, one should aim to have the shortest possible delivery times, the simplest
procedures for handling orders, maximum flexibility and so on. At the very least, it might be
argued, a company should be better in all of these areas than its competitors if it is to
succeed.
However, although customers are increasingly demanding higher and higher levels of service
from their suppliers, we have to remember that the other half of the decision about the design
of the logistics system is concerned with costs. Quite simply, higher service levels in any of
these areas increases costs for a company. Put another way, by offering near perfect service
levels a company may be generating sales and business, but not making any profits.
Alternatively if the company tries to recoup these costs of improved service levels it may find
its prices are simply too high. The business therefore has to balance increased costs with
improved service levels.
We should therefore design the system with regard to service levels around an identification
of customers requirements and in particular what constitutes value in terms of service levels
to the customers. So, for example, we need to assess if the customer would value smaller
minimum orders or the ability to deal with special orders, and whether the customer is
prepared to pay for these additional levels of service. The physical distribution and logistics
system should be designed so as to provide pre-specified levels of customer service at
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minimum cost. When this has been decided, the logistics system can then be designed as a
system considering total costs.
The Total Cost Concept
The total cost concept of distribution is concerned with identifying all the costs involved in
distribution as a total system cost. This is particularly important because of the higher cost
levels in international marketing. Of particular significance is the inclusion in the system of
the costs associated with lost sales caused by failures in service levels, such as making the
customer wait for delivery.
It is quite easy to reduce costs of individual parts of the distribution logistics system. Using
slower and less frequent deliveries can cut transport costs. Holding lower levels of stock can
reduce inventory costs. Less stockholding can reduce warehouse operating costs. However,
the consequence of smaller stocks can be to increase the likelihood that products will be out
of stock. If products are out of stock, customers will have to wait for new stock to arrive.
Some customers will not wait. They will cancel their order and buy from the competition. It
should be remembered, therefore, that the big picture and the overall impact of these
decisions must always be taken into consideration before taking action for short-term gain.
Thus, the total cost concept involves:
Identifying all the costs incurred.
Taking account of the influence of changes in one activity on the rest of the system, this
causes trade-offs between one activity and another.
Taking account of the ways in which the customer is affected by changes in distribution.
The main costs in distribution logistics are transport, warehouse, inventory, order processing
and documentation, packing and packaging and the costs of lost sales.
Remember that in international marketing most of these elements will cost more than in
domestic marketing. For example, product packaging will need to change to take account of
the requirements of different distribution channels and cultural conditions, the extra bumping,
jolting and need to cope with climatic change mean that international packing has to be more
substantial and will, therefore, be more expensive.
Modes of Transport
We can illustrate many of the concepts and concerns in distribution logistics by considering
the decision about modes of transport. Transport, through its five modes, provides many
options, each of which has specific requirements and implications.
The five main modes of transport are road, water, pipeline, rail and air. In international
distribution logistics, goods might use several modes before they reach their final destination.
The use of containers makes the switching costs from one mode to another much lower than
they used to be in the days of loose cargo and high labour involvement. The differences
between the sophisticated capital-intensive distribution logistics in industrially advanced
countries and the low-tech labour-intensive methods used in some LDCs can impose
considerable strains on the development of efficient logistics.
Again, the SLEPT factors, and particularly, culture, will considerably influence the whole
process and its efficiency.
The final choice of which mode of transport to use will be influenced strongly by price. Other
factors in the decision are:
The requirements of the product, for example, strawberries will perish and the best
market prices will be lost if the delivery is not quick and reliable.
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The time taken for the particular mode and the overall transport time taking account of
all the interconnections and waiting times.
The specification of the customer, who may wish to specify the use of the national
carrier of his or her country, for example, the state airline or ships sailing under the
national flag.
Both the availability and the costs of different modes of transport can vary considerably from
one country to another, particularly when considering industrially advanced countries
compared to lesser-developed countries. Clearly, cost is a key consideration in the choice of
transport modes, but once again total costs should be used to examine trade-offs between
various parts of the system.
The interconnections between transport costs and the other parts of the distribution logistics
system need to be considered. It would be wrong to identify airfreight as high-cost and
therefore only suitable for a narrow range of products. If the trade-offs between various parts
of the system are considered, we will find that the high cost per mile or per kilometre
travelled by air can be offset (sometimes only partially) by:
Lower inventory requirements because of the faster delivery.
Less packing requirements because of the comparative smoothness of air travel.
Less insurance cost because of shorter transit times and lower damage risk.
A lower cost of lost sales, the greater responsiveness of airfreight to customer
requirements will encourage customer demand to increase.
Thus, we can see that water transport is comparatively slow, but it has a low cost per
tonne/kilometre, which makes it particularly appealing for long journey requirements for bulky
goods. The low cost of the journey can be traded off against:
The long transit time.
The need for extra inventory to cover the long transit time.
Extra packing to withstand ocean travel.
Extra insurance to cover the damage risk and the longer transit time.
The need for interconnections with other transport modes, increasing administration
and documentation.
The influence on lost sales, this can be minimised if water transport achieves regular
and reliable delivery schedules.
E. THE EXTENDED MARKETING MIX
Service Product Characteristics
Earlier in the course we discussed the product element of the marketing mix. Increasingly,
businesses are making a distinction between two major types of products in markets, namely
the distinction between physical products and service products.
Physical products include cars, computers, clothing, components, raw materials and so on
and, as the term implies, all those products which are essentially tangible. Service products,
however, are essentially intangible and include products such as financial services,
insurance, consultancy, holidays, entertainment and leisure, and so on.
In part, the need to distinguish between these two types of products and markets has been
prompted by the fact that in many parts of the world, and especially in developed economies,
service industries have been amongst the fastest growing sectors whereas physical product
markets, and especially those involving manufactured products, have been in decline. In
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fact, many developed economies, such as the United Kingdom, France, Germany and the
United States, are now classified as service economies.
In the context of international business, the growth of the global company, which initially
began with the manufacturing companies, has now spread to the service sectors to the
extent that some of the largest multinational companies are service product organisations
such as McDonalds, Hertz, American Express, Federal Express, Holiday Inns and so on.
Service products have a number of special characteristics compared to their physical product
counterparts and, consequently, require a somewhat different approach to marketing. In
particular, these characteristics give rise to the need to consider the additional marketing mix
elements. There are four such key characteristics, as discussed below.
Intangibility
This is probably the easiest of the special distinguishing characteristics of service
products to understand. With physical products we can touch, see, and often smell the
product. This means that we can pick the product off the supermarket shelf and
examine and assess its weight, handle, finish and so on. With a service product,
however, the product is essentially intangible and therefore the customer cannot
handle, touch and assess the product in the same way. This may seem rather obvious,
but it has important marketing implications:
(i) Consumers often find the evaluation of new service products and concepts very
difficult, which in turn may place an increased emphasis on aspects such as word
of mouth recommendation, company and brand reputation, the help and advice of
the salesperson, etc.
(ii) Intangibility makes it difficult for the business to find ways of making the product
stand out from competitor products. Service products can, therefore, be difficult
to differentiate.
(iii) It can be more difficult to patent and protect new service products compared to
physical products.
As we shall see when we consider the extended marketing mix for service products,
the service provider may seek to make the product appear more tangible by drawing
attention to any tangible attributes of the product or company that surround the
purchase and consumption of the service product. This may include aspects such as
the premises in which the product is produced and marketed, the appearance of the
staff delivering the service and so on.
Perishability
Compared to intangibility, the notion of service products being characterised as highly
perishable, and indeed more perishable than their physical product counterparts,
seems strange. After all, what could be more perishable than, say, fresh fruit and how
can a service product decay?
In fact, many service products are amongst the most perishable in the market place.
Essentially this high degree of perishability derives from the fact that, unlike physical
products, service products cannot be stored. If they are unsold, therefore, they cannot
be put into stock and brought out and sold again at a later date. A good example of this
is the service product of an airline seat. If a seat is unfilled on an aircraft at the time of
take off, then the revenue generating capacity of this seat is lost for ever. Admittedly,
this is a different view of the notion of perishability compared to, say, food products, or
even fashion products, but it is nonetheless the same effect in so far as the business is
concerned.
The highly perishable nature of service products places an increased onus on the
business to synchronise, and as far as possible, match demand with supply. This, in
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turn, has implications for many facets of planning, for example, substantial use is made
in service product marketing of aspects such as off peak pricing, special promotional
offers and so on.
As we shall see, the element of the extended marketing mix for service products most
affected by the perishability characteristic is that of process.
Heterogeneity
Unlike many physical products which can be manufactured to predetermined and
uniform standards, service products are often much more difficult to standardise.
Essentially, this is because service products involve a much higher degree of people
content. Service exchanges are characterised by a high degree of interaction between
both service provider and service receiver and as we all know, people are much less
predictable and more variable than production and manufacturing processes.
Even where the service product has been standardised as much as possible, through,
for example, standardised service elements, staff training and so on, individual
customers may still experience the service offer in different ways. The result of all this
is that it is much more difficult to control the marketing transaction and customer
experiences, and from the customers perspective, the experience of the service
product encounter may be much less predictable.
Again, as we shall see when we consider the extended elements of the mix,
businesses can attempt to remove some of this uncertainty and increase the
standardisation of the service product through the design and management of each of
the extended marketing mix elements for services.
Inseparability
For many service products, consumption and production occur simultaneously, often on
the suppliers own premises. So, for example, when we visit a hairdresser, the service
product is produced and consumed there and then on the service providers premises.
There are several implications of this inseparability of service products for the marketer.
For example, it can severely restrict the potential size of the market that the service
provider is able to cope with, and hence may severely limit, say, economies of scale.
Perhaps the most obvious implication of this characteristic of services, however, is the
increased emphasis it places on the people element of the service providers marketing
mix and the physical/tangible attributes of where the service is produced and
consumed. In addition, it means that the business must pay careful attention to
managing any direct interactions between the company and its consumers, and so
again, has implications for aspects such as staff training and appearances.
It is these characteristics that have implications for the marketing of service products.
Clearly, the precise implications of each of these characteristics differ from product to
product, but using the example hotel accommodation we can explore the way they affect the
marketing of a service product.
Although there are many tangible attributes to a hotel and its accommodation, the core
product is essentially intangible in that the customer is buying a pleasurable experience.
This essentially intangible nature of the product can make it difficult for the customer to
assess whether any particular hotel is likely to be satisfactory. Marketing hotel
accommodation, therefore, must attempt to resolve this dilemma for the customer. Things
like brochures and photographs are likely to be very important together with perhaps
testimonials from satisfied customers. It would also help in marketing this intangible product
to, for example, allow prospective customers to view the accommodation and the facilities
before making a decision.
The perishability of the product is high. This means that the hotel management must
carefully try to synchronise demand and supply so that hotel rooms are not left empty. This
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may involve, for example, off-peak pricing, special weekend packages, discounts for regular
bookings from company representatives, etc.
Heterogeneity and inseparability mean that substantial attention should be paid to aspects
such as staff training, staff appearance, and processes such as booking and reservation
systems, etc.
The Extended Marketing Mix
The growth of services marketing, together with the special characteristics of service
products, which we have already outlined, have in turn led to the acceptance that the
conventional four Ps of the marketing mix now need to be extended to include a further three
Ps. Each of these three additional Ps therefore, is outlined and discussed below. Needless
to say we shall consider each of these extra marketing mix elements in the context of
international marketing:
People
This is the first additional marketing mix element in the extended marketing mix.
Remember, with service products, the supplier and customer often meet face to face.
Furthermore, in fact, with many service products, the product is the person(s) providing
the service. So, for example, we often choose a particular service provider because of
the skills, personality and so on of the person(s) providing the service. Even when the
person is not central to the actual service product, the people element of the service
provider can still be important in affecting a customers experience of the service and
any subsequent satisfaction or dissatisfaction.
Take the situation, say, of a meal at a restaurant. The actual meal may be excellent
and the dcor and the atmosphere of the restaurant exciting. The consumers
experience of a meal in this restaurant, however, may be ruined if the service is poor or
the staff rude. It is vital that the people involved in providing the service, and especially
those in direct contact with actual customers, are carefully selected, trained, motivated
and presented. In short, the people element of the marketing mix is an essential
ingredient in determining the degree of marketing effectiveness and success.
For the international marketer, managing the people element of the marketing mix may
be more problematic than for purely domestic marketing. For a start, what works in
one culture with regard to the people element of the mix may not be appropriate in
another. For example, Americans demand a high degree of service and to some extent
servility when purchasing and consuming. In a food establishment, therefore, the
American customer often prefers waiters to be constantly at hand and to attend
immediately to every requirement. This contrasts with the United Kingdom where many
customers do not like this degree of attention when they are ordering or eating their
meals. Similarly, staff in different cultures may object to, resist, or simply find it difficult
to adapt to a foreign approach regarding how they operate and deal with customers.
The people element of the mix is the factor that gives rise to variability and lack of
control in the service product offering and is therefore probably the most difficult to
manage in the context of international marketing. There is no simple answer to the
extent to which it is best to try and standardise the people element across different
international markets through, for example, staff training, agreed procedures, etc. The
international business must carefully assess the advantages and disadvantages of
attempting a standardised approach depending on customer, competitor and company
considerations.
Having said this, as we have seen for the other more conventional elements of the
marketing mix, the move is towards greater uniformity and standardisation. Some
companies, therefore, place considerable emphasis and effort on selection, training
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and motivation of staff so as to ensure greater uniformity in this element of the
marketing mix.
Process
Process refers to how the service product is provided and delivered. For example,
walk into McDonalds and they have a predetermined ordering and queuing system,
standardised methods and procedures for cooking and delivering the food to tables and
predetermined systems for seating, clearing and tidying tables. Process systems,
therefore, can include aspects such as ordering systems, quality systems, queuing and
delivery systems, customer support systems and so on.
Like people, the process elements of the marketing mix can substantially affect levels
of customer satisfaction. These systems, therefore, should be carefully thought
through and planned in advance as part of the total marketing effort. In the context of
international marketing, standardising processes serves to increase the consistency of
service and can therefore enhance the customers experience. In fact, McDonalds is
an excellent example of a company that has standardised its process systems
throughout the world.
Once again, however, we need to be careful about such standardisation and in
particular ensure that process procedures do not conflict with the cultural habits in a
particular country. So, for example, in the United Kingdom, orderly queuing is the norm
and therefore quite acceptable, whereas in other countries such queuing is alien to
their cultural practices.
Physical Evidence
This third and final element of the extended marketing mix for services relates to those
elements of the companys service offering which are more tangible even though they
may be ancillary to the service itself. There is a range of types of such physical
evidence, including such examples as the design and dcor of the service premises,
the writing paper, pens, entertainment information, and so on in a hotel bedroom and
the appearance of service personnel, including uniforms, etc.
Many companies now spend considerable time, money and effort on the physical
evidence of their marketing. This is important because, in effect, physical evidence can
be used to make more tangible an otherwise intangible service, therefore helping to
convey images and perceptions of, say, quality, to a customer. Physical evidence also
helps in customer brand recognition and as such helps the company to differentiate
itself from competitors.
Once again, international service companies are increasingly standardising elements of
their physical evidence, so, for example, the dcor of an international hotel group may
be similar throughout the world. In the same way, the appearance of staff may be
standardised through the use of company uniforms. As with people and process
elements however, care should be taken to ensure that any physical evidence elements
do not conflict with local customs and tastes.
Standardising any of the elements of the marketing mix usually gives rise to two potential
major advantages. The first advantage to be gained from standardisation of the international
marketing mix elements is the opportunity for cost reduction and economies of scale. The
second major advantage is increased consistency and control over the marketing effort.
Both of these major reasons for standardisation apply to the additional marketing mix
elements for services, but it is particularly the second of these that is most relevant, namely
the potential for increased consistency and control over marketing programmes. Service
products are very much people-based and therefore suffer from high degrees of variability.
Standardising the marketing mix elements of people, process and physical evidence can help
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to reduce this problem. Furthermore, by standardising these elements, the international
service provider can build a worldwide presence and image.
Whilst the process and physical evidence elements can be standardised relatively easily, it is
not always appropriate. Different cultures will give rise to different ideas and approaches to
managing the people element of the marketing mix, so, for example, the use of working
practices and procedures which are acceptable in one culture may not be in another and
some have argued that the very American approach to be found in all McDonalds outlets is
not really appropriate in some cultures and can give rise to antagonism.
Relationship Marketing
As we have seen, the growth of service industries has prompted businesses to extend the
marketing mix to include people, process and physical evidence. Accompanying, and in part,
reflecting, this development has been the move towards a new way of looking at the nature
of the exchange processes between a company and its customers. The essence of this new
way of looking at customer/market exchanges has been the notion that it is increasingly more
effective to look at it as a long-term series of mutually beneficial interactions between buyers
and sellers rather than simply looking at each as a one-off transaction. A relationship
marketing approach seeks to try to shift to maximising beneficial relationships with other
parties rather than trying to maximise the gain of each individual transaction.
This new way of looking at the exchange process, together with the attendant changes in
marketing practice and the strategies which have accompanied it, is referred to as a
relationship marketing approach.
Relationship marketing questions the classic marketing theory and the traditional four Ps
marketing approach, highlighting the importance of co-operation rather than competition.
The contemporary business, it is suggested, should try to build long-term, trusting
relationships with customers, distributors, dealers and suppliers. In other words, relationship
marketing stresses the importance of looking at and managing the total set of value chain
activities involved in the supply and marketing of a companys products.
The development of a relationship marketing approach can only be accomplished by
promising and delivering reliable and consistent service underpinned by fair prices and
agreed procedures between the various organisations in the value chain.
The idea is that with a relationship marketing approach, the respective parties in the value
chain, including customers, become more trusting and more interested in helping each other
rather than adopting the conventional approach of trying to outdo each other. The ultimate
outcome of a relationship marketing approach is the building of a unique company asset,
often referred to as a marketing network, which comprises a set of relationships between the
company and its customers and the rest of the value chain. Increasingly, the company seeks
to try to shift to maximising beneficial relationships with other parties rather than trying to
maximise the gain of each individual transaction.
There are a number of reasons why transaction marketing has appeared as a new marketing
paradigm:
The growth of services marketing, with its emphasis on the people elements of the
marketing mix.
The recognition of the sheer common-sense notion of the benefits and advantages of
working together with customers and other members of the value chain instead of
trying to fight each other.
The recognition of the cost of acquiring customers and the sense, therefore, of trying to
retain those customers that the company currently has. Related to this, is the
undoubted value of customer loyalty. Some research suggests that it can cost anything
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up to ten times as much to gain a new customer as to retain an existing one. Similarly,
the lifetime sales value of a loyal customer can be enormous.
Developments in manufacturing and supply and purchasing procedures such as just-in-
time management, zero defects and electronic data interchange systems require a
move towards closer relationships and even strategic partnerships between
manufacturers and their suppliers.
All of these factors mean that not only business-to-business marketers, where relationship
marketing first began to emerge, but also consumer goods marketers are increasingly
moving towards a relationship marketing approach.
Developing and implementing a relationship as opposed to the conventional transaction
marketing approach requires several changes to be made in an organisation and its
marketing approach and strategies.
Perhaps most important in developing and implementing a relationship marketing approach
is the need for a fundamentally different perspective on the marketing process. This change
in perspective is characterised by the need to consider customers and other members of the
value chain as valuable partners who need to be co-operated with rather than protagonists
who need to be beaten. In fact, in order for this perspective and approach to work, it is
important to recognise that all parties must adopt this perspective, together with the view that
all parties can benefit from a set of mutually beneficial long-term relationships rather than a
series of one-off transactions.
Another key factor in developing and implementing a successful relationship marketing
approach is the need for everyone in the company, and not just marketing personnel, to be
concerned with, and accept some responsibility for, creating customer satisfaction. In turn,
this may require changes in organisational structure, staff training and new approaches to
evaluating departmental performance. Above all, it requires a change in organisational
culture to support the notion of developing long-term relationships with customers.
The implementation of relationship marketing requires effective and two-way communication
with the different members of the value chain, including customers. Developments such as
improved electronic on-line interaction between companies and their customers and the use
of database systems help to facilitate this.
In some companies, relationship management has developed to the extent that they are
using relationship managers to manage the relationship between a company and each key
customer or customer group.
Finally, developing and implementing relationship marketing above all requires trust and co-
operation between the organisation and its customers. Needless to say, this can only be
developed over a long period of time and is easily lost if the relationship is abused.
In essence, the requirements for developing and implementing a relationship marketing
approach are no different for international as opposed to purely domestic customers and
markets. However, once more, the sheer diversity and differences between international
markets can make the development of relationship marketing that much more difficult for the
Once again, cultural differences may serve to hinder the development of a relationship
marketing approach. For example, in some cultures, sales negotiations are expected to be a
confrontational process with winners and losers as the outcome. Similarly, the sheer size of
many multinational companies may serve to make it difficult to develop open and close
relationships with customers who may be much smaller and hence suspicious of any
attempts to deal with them as equal partners.
Another factor that may make relationship marketing more difficult might be problems of
communication between the business and different customers. These communication
problems may be simply due to physical distance from customers, the fact that there may be
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several intermediaries and therefore little direct contact with the customer, or simply the fact
that language and other cultural barriers serve to impede the communication process.
The international business may need to put special effort into developing effective
relationships with international customers. Every effort must be made to ensure effective
two-way communication with customers. Again this is increasingly being facilitated by
improvements in electronic communication. One approach to developing long-term effective
relationships is the development of strategic alliances between the different members of the
value chain. This approach formalises relationships between the different parties, although
again such formal arrangements are no substitute for the more informal but equally important
relationships of trust, developed by giving and fulfilling promises between different parties.
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Study Unit 10
International Manufacturing
Contents Page
Introduction 182
A. Manufacturing Management 182
Objectives and Strategy 182
Materials Management 183
B. Manufacturing Location 183
Key Factors Affecting Location Decisions 183
Concentration vs. Decentralisation 184
Future Trends 185
C. Make or Buy 185
Key Considerations 185
Vertical Integration 186
Strategic Role of Foreign Production Plant 186
D. Co-ordination of International Manufacturing 187
Need for Co-ordination 187
Just in Time (JIT) 187
Application of Information Technology 188
182 International Manufacturing
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INTRODUCTION
Manufacturing systems, in contrast to the 'nuts and bolts' image of ten years ago, have
become a really strategic issue for competitiveness. They play a major role in business
process re-structuring/engineering and strategic capability development. Nevertheless
manufacturing systems are facing increasing challenges brought about by:
Global market emerging without national market differentiation.
Regionalisation of free trade and economic co-operations.
Emerging regional markets from some developing countries.
Global competition forces its players to compete on all fronts, cost, quality, delivery,
flexibility, innovation, and service.
The challenges are causing manufacturing managers and engineers to face increasingly
difficult manufacturing system design and operational management. The critical issues are
these:
How to leverage its capabilities around the world so that the company as a whole is
greater than the sum of its parts.
Trade offs between wider dispersion for local responsiveness and higher integration for
efficiency.
Options for effective configuration of systems to satisfy strategic requirements.
How can a system for international manufacturing be structured to create a proactive
competitive influence rather than a reactive responsiveness?
Besides the issues of production location, logistics, global sourcing and strategic
alliances, how can a company rationalise its existing manufacturing networks?
In general, how can manufacturing systems best support a company's international
development?
Globalisation requires the movement of goods and people at ever-greater volume and speed
and at lower cost.
Diffusion of the supporting manufacturing technology to an ever-growing range of processes,
along with advances in telecommunication have had far-reaching consequences, from the
shop-floor to the global structure of industries. We are seeing fundamental change in such
basic elements of production as company size, the nature and form of product and process
specifications, transaction processing, and labour.
A. MANUFACTURING MANAGEMENT
Objectives and Strategy
The objectives of manufacturing and materials management are to lower the costs of value
creation and add value by better serving customer needs. Lowering costs and increase
product quality can do this. These two aspects are related.
There are three ways in which improved quality control reduces costs. First, productivity
increases because time is not wasted manufacturing poor quality products that cannot be
sold. This saving leads to a direct reduction in unit costs. Second, increased product quality
means lower re-work and scrap costs. Third, greater product quality means lower warranty
and re-work costs. The net effect is to lower the costs of value creation by reducing both
manufacturing and service costs.
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Added to the objectives of lowering costs and improving quality are two further objectives of
manufacturing and materials management that take on particular importance for international
businesses. First, manufacturing and materials management must be able to accommodate
demands for local responsiveness. Second, manufacturing and materials management must
be able to respond quickly to shifts in customer demand.
For a company to establish a good materials management function it needs to legitimise
materials management within the organisation. It can do this by putting materials
management on an equal footing with other functions in the company.
Materials Management
Materials management encompasses the activities necessary to get materials to a
manufacturing facility, through the manufacturing process, and out through a distribution
system to the end user. The materials management function is complicated in an
international business by distance, time, exchange rates, customs barriers, and the like.
Efficient materials management can have a major impact upon a company's bottom line.
The strategic objectives include:
Lower costs
Simultaneously, increase product quality.
Accommodate demands for local responsiveness.
Respond quickly to shifts in customer demand.
B. MANUFACTURING LOCATION
Key Factors Affecting Location Decisions
For the company that considers international production to a feasible option, certain factors
need to be considered when making a location decision, country factors, technological
factors, and product factors:
Country factors suggest that a company should locate its various manufacturing
activities in those locations where economic, political, and cultural conditions, including
relative factor costs, are most conducive to the performance of that activity. However,
regulations affecting FDI and trade can significantly affect the appropriateness of
specific countries, as can expectations about future exchange rate changes.
Technological factors include the fixed costs of setting up manufacturing facilities, the
minimum efficient scale of production, and the availability of flexible manufacturing
technologies.
The adoption of flexible manufacturing technologies can help improve the competitive
position of companies. Most importantly, from the perspective of an international
business, flexible manufacturing technologies can assist in the process of customising
products to different national markets in accordance with demands for local
responsiveness.
When fixed costs are substantial, the minimum efficient scale of production is high,
and/or flexible manufacturing technologies are available, the arguments for
concentrating production at a few choice locations are strong. Alternatively, when both
fixed costs and the minimum efficient scale of production are relatively low, and when
appropriate flexible manufacturing technologies are not available, the arguments for
concentrating production at a few choice locations are not as compelling.
Product factors include the value to weight ratio of the product and whether or not the
product serves universal needs.
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Concentration vs. Decentralisation
Two location strategies are possible:
Concentration of manufacturing.
Decentralisation of manufacturing.
The choice between these two strategies should be made in light of country, technological,
and product factors. The main considerations are summarised as follows:
Single or few locations:
Fixed costs are substantial.
Minimum efficient scale is high.
Flexible manufacturing technologies available.
Major market locations if it better meets local demands:
Fixed costs are low.
Minimum efficient scale is low.
Flexible manufacturing technologies unavailable.
Trade barriers and transportation costs remain major impediments.
Two product features affect location decisions:
Value to weight ratio.
Product serves universal needs.
The following table summarises the key country and technological impacts on manufacturing
strategy choice.
Table 10.1 Location and Manufacturing Choice Impact
Preferred Strategy:
Concentrated Decentralised
Country Factors
Differences in political economy Substantial Few
Differences in culture Substantial Few
Trade barriers Few Many
Technological Factors
Fixed costs High Low
Minimum efficient scale High Low
Flexible manufacturing technology Available Not Available
The Case of Shell Chemicals
At the beginning of the 21st century, about 25% of Shell's chemicals assets were located in
Asia Pacific and the Middle East. By 2010, this proportion was expected to rise to more than
one third, ensuring that Shell is well positioned to meet the region's growing demand for
petrochemicals.
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A $4.3 billion CSPCL Nanhai joint venture between CNOOC and Shell Nanhai BV opened in
2006, while a new integrated petrochemical facility, the Shell Eastern Petrochemicals
Complex, was due to start up in 2009.
In recent years, the focus of the petrochemicals industry has been steadily shifting towards
Asia Pacific and the Middle East. Asia Pacific, and particularly China, is driving
petrochemicals demand growth.
On the production side, the major capacity expansions are in the Middle East, based on
large-scale and advantaged oil and gas feedstock, and in Asia Pacific. Between them, the
Middle Eastern countries and China could add around 25-30 million tonnes of ethylene
capacity between 2005 and 2010.
While China will undoubtedly require significant imports to meet domestic demand, the
growing consensus suggests China is unlikely to absorb all of this additional capacity. This
will have important implications for global operating rates, competitiveness and
petrochemical trade flows.
The strength of the Shell chemicals companies lies in the integration and world-scale
economics of their global manufacturing assets, together with the high standards that are set
to make sure that the CARADOL name is synonymous with quality and consistency.
CARADOL polyols are made at various locations and then transported to a worldwide
network of storage tanks to make sure that CARADOL polyols are always close to customers
and their markets. For example, CSPCL Nahani in China, Pernis in the Netherlands and
Jurong Island (Shell Chemicals Seraya Pte Ltd) in Singapore.
Future Trends
Research by Deloitte Touche Tohmatsu (2007) points to three critical trends that pull apart
manufacturer's supply chains and make them more complex and difficult to manage,
continuous pressure to drive down supply chain costs, the pursuit of new lucrative markets
and channels, and the quickening pace of product innovation.
Recent trends in the global trading environment, new production systems, and new
technologies suggest that global corporations of the future will develop a manufacturing
network of decentralised plants based in large, sophisticated, regional markets. Each plant
will be smaller and more flexible than is typical today. The location of such plants will be
based more on regional infrastructure and local skill levels than on purely cost-based factors.
C. MAKE OR BUY
Key Considerations
A key issue in many international businesses is identifying which component parts should be
manufactured in-house, and which should be out-sourced to independent suppliers.
The advantages of making components in-house are that it facilitates investments in
specialised assets, helps the company protect its proprietary technology, and improves
scheduling between adjacent stages in the value chain. Cost is obviously also an important,
and not independent factor.
When substantial investments in specialised assets are required to manufacture a
component part, the company will prefer to make that component internally rather than
contract out to an independent supplier. In order to maintain control over its technology, a
company might prefer to make component parts that contain proprietary technology in-house,
rather than have them made by independent suppliers.
When a company needs to tightly control scheduling, planning, and coordination of adjacent
production processes, vertical integration can be preferable to being dependent on
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independent suppliers. The advantages of buying components from independent suppliers
are that it helps preserve strategic flexibility and it helps the company to avoid many of the
organisational problems associated with extensive vertical integration.
The great advantage of buying component parts from independent suppliers is that the
company can maintain its flexibility, switching orders between suppliers as circumstances
dictate. This is particularly important in the international context where changes in exchange
rates and trade barriers might alter the attractiveness of various supply sources over time.
The following list summarises some key advantages of each decision.
Advantages of Make:
Lower costs
Facilitating specialised investments.
Proprietary product production technology protection.
Improved scheduling.
Advantages of Buy:
Strategic flexibility
Lower costs.
Offsets.
Vertical Integration
Vertical integration into the manufacture of component parts involves an increase in the
scope of the organisation. The resulting increase in organisational complexity can be costly.
There are three reasons for this:
1. The greater the number of sub-units within an organisation, the greater the problems of
coordinating and controlling those units.
2. The company that vertically integrates into component part manufacture may find that
because its internal suppliers have a captive customer in the company, internal
suppliers lack an incentive to reduce costs.
3. Leading directly on from the previous point, vertically integrated companies have to
determine the appropriate price for goods transferred between sub-units within the
company. Setting appropriate transfer prices is a problem in any company.
The company that buys its components from independent suppliers can avoid all of these
problems.
Several companies have tried to capture some of the benefits of vertical integration, without
encountering the associated organisational problems, by entering into long-term strategic
alliances with key suppliers.
Although alliances with suppliers can help the company to capture the benefits associated
with vertical integration without dispensing entirely with the benefits of a market relationship,
alliances do have their drawbacks. The company that enters into a strategic alliance may
find its strategic flexibility limited by commitments to alliance partners.
Strategic Role of Foreign Production Plant
The strategic role of foreign plant can change over time. A factory originally set up to make a
standard product to serve a local market, or to take advantage of low cost inputs, can evolve
into a facility with advanced design capabilities.
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The strategic advantage of a particular location can change as well, as governmental
regulations change and/or countries upgrade their factors of production.
As the strategic role of an overseas factory is upgraded and a company develops centres of
excellence in different locations worldwide, it supports the development of a transnational
strategy.
In summary, the evolution process is initially established where labour costs are low and later
become important centres for design and final assembly. Upward migration is caused by:
Pressure to improve cost structure.
Pressure to customise product to meet customer demand.
Increasing abundance of advanced factors of production.
D. CO-ORDINATION OF INTERNATIONAL
MANUFACTURING
Need for Co-ordination
Co-ordination of the materials management function is complicated in an international
business due to differences in distance, time, exchange rates, customs barriers, and the like.
Efficient materials management throughout the supply chain can have a major impact upon a
company's competitiveness and thus its profitability.
A supply chain includes all of the organisations involved in the extraction, manufacture and
distribution of raw materials, components and commodities. The organisation and
coordination of the various functions is the business of supply chain management (SCM).
SCM is a strategic and operational process that directs the materials flow through the supply
chain to the end user.
Processes such as just-in-time (JIT) systems generate major cost savings from reduced
warehousing and inventory holding costs. Likewise, information technology and particularly
electronic data interchange (EDI) play a major role in materials management.
Just in Time (JIT)
Just-in-time (JIT) production is the method of supplying what is needed, when it is needed
and in the quantity required. JIT has increased the need for tight control of the logistical
process. It can be argued that JIT production is responsible for the change in capitalist
production from a push economy to a pull economy. That is that commodities are pulled
through the supply chain by actual demand rather than being pushed through by forecasted
demand.
JIT systems generate major cost savings from reduced warehousing and inventory holding
costs. In addition, JIT systems help the company to spot defective parts and take them out of
the manufacturing process, thereby boosting product quality.
The case of Leoni
Ashton (2007) explains as the subsidiary of a large German car part supplier, Leoni Tunisie
S. A. produces cable and electronic components for Daimler Chrysler and other European
car manufacturers. It was established around 1982, employs 2400 employees (including 170
in research and development).
The just-in-time supply chains put extremely high demands on logistics systems. Leoni has
outsourced all logistics needs to an international forwarder, which has a local subsidiary in
Tunisia. As an example of the long-term relationship with its logistics provider, Leoni has
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developed a tailor-made stacking system that is specifically fitted to the trucks of the
forwarder and permits for a capacity utilisation of between 95 and 98 percent.
A full production and logistics cycle lasts about nine days. Raw materials and intermediate
products are sourced from across Europe, Asia and the United States. They are
consolidated at Leonis headquarters in Germany and shipped to about a dozen different
factory locations in various countries. Seven trucks leave Germany for Tunisia each week.
Application of Information Technology
Information technology, and particularly electronic data interchange (EDI), play a major role
in materials management. EDI facilitates the tracking of inputs, allows the company to
optimise its production schedule, allows the company and its suppliers to communicate in
real time, and eliminates the flow of paperwork between a company and its suppliers.
Key benefits of IT include:
Production acceleration, when necessary.
Support links between a company and its suppliers and shippers.
Communications without time delay.
Paperwork minimized.
Tracking of component parts to assembly plant.
Production scheduling optimisation.
The Case of Perfect Plant
Tata Consultancy Services, a global IT services, business solutions and outsourcing
company, announced in September 2007 that it had teamed with SAP AG the world's leading
provider of business software, on the launch of the Perfect Plant centre of excellence at
SAPs facility located in Newtown Square, PA in the US.
The system is designed to help manufacturers combine global manufacturing coordination
with local execution to improve end-to-end manufacturing operations and financial
performance. The initiative focuses on helping manufacturers reduce manufacturing costs,
optimise asset utilisation, deliver to customer requirements, and surpass quality and
compliance objectives. It provides manufacturers with enhanced operations intelligence and
tight integration between planning, execution and business processes for cost-effective,
efficient and coordinated sense and response to customer demands.
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Study Unit 11
International Human Resource Management
Contents Page
Introduction 190
A. The Strategic Role of International HRM 190
HR Contribution 190
International Drivers and HR Delivery 190
B. Staffing 191
Human Resource and Staffing Policy 191
Main Staffing Approaches 191
Staffing and the International Business 192
In-House and External Resources 192
The Expatriate and the National Manager 194
C. Developing The Global Approach 196
Developing Specialist Centres 196
Developing the International Manager 197
The Concept of the Equidistant Manager 198
D. Labour Relations 198
Major Concerns 198
Organising for Competitive Advantage 199
The Development of a More Global Approach 199
190 International Human Resource Management
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INTRODUCTION
In general, Human Resource Management (HRM) refers to those activities undertaken by an
organisation to effectively utilise its human resources. These activities include human
resource strategy, staffing, performance evaluation, management development,
compensation and labour relations.
The effect of international operations and activities on HRM is enormous. Equally, effective
international HRM, which focuses on managing an internationally mobile workforce and
global HRM, which is concerned with managing international HRM activities through the
application of global rule-sets, can make a major contribution to the success of an
organisation's international dealings.
One of the challenges that face organisations as they globalise their operations is the
adaptation of their HR practices to the new set of cultures in which the organisation is
operating and the creation of a manner of operation that is both comfortable to the
organisation, and appropriate for those cultures. This market challenge is true for companies
all over the globe.
As organisations become more global and begin to do business in greater numbers of areas,
the number and variety of cultures represented in their workforce also changes. As this
number increases and as organisations attempt to treat each different culture with respect,
practical issues can arise that may make doing business increasingly more difficult.
In this unit, we shall be looking, therefore, at the management and control of human
resources in international business and in particular, some of the issues which arise when
choosing between and managing local, expatriate and global staff.
A. THE STRATEGIC ROLE OF INTERNATIONAL HRM
HR Contribution
According to the British Chartered Institute for Personnel and Development (CIPD) (2007)
when:
The organisational drivers for internationalisation are well understood
The key delivery mechanisms are in place, coherent and consistent
The organisational drivers and delivery mechanisms mesh with the global HRM
activities
then global HRM can make a significant contribution to organisational success. Where any
one of these factors is absent, there may be problems.
In particular, HR professionals have to ensure that the activities they engage in move them
away from more transactional types of work towards those concerned with developing
organisational capability and business development.
A critical aspect of creating global HR strategies is the ability to judge the extent to which an
organisation should implement similar practices across the world or adapt them to suit local
conditions.
International Drivers and HR Delivery
The key drivers for international operations will generally include:
Maximising shareholder value whether implicitly or explicitly stated.
Forging strategic partnerships with similar organisations, groups or suppliers.
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Creating core business processes driven by business needs.
Building global presence to be visible in the market place.
Organisations may exhibit several of these drivers at the same time.
The key delivery mechanisms for HRM would normally comprise:
e-enabling HRM, using new information and communications technology.
Knowledge management, to exploit the internal knowledge stock.
Cost-reduction/HR affordability, offering cost-effective solutions.
Creating centres of excellence, avoiding replication and duplication of effort.
For a company to undertake any of the basic strategies outlined above, and have their
organisation fit with this strategy, the staffing and other HRM functions must also fit with and
complement the strategy and organisation.
Slogans like think globally and act locally sound good, but it requires effective HRM policies
for these slogans to be put into action.
B. STAFFING
Human Resource and Staffing Policy
With the concern for being global and the concern about the transfer of learning and being
multidomestic and, therefore, simultaneously being sensitive to local conditions several
strategic concerns relevant to international HRM arise. For example, can and how do MNEs
link their globally dispersed units through human resource policies and practices? Can and
how do MNEs facilitate a multidomestic response that is simultaneously consistent with the
need for global coordination and the transfer of learning and innovation across units through
human resource policies and practices?
Staffing policy is concerned with the selection of employees who have the skills required to
perform a particular job. Staffing policy can be viewed as a major tool for developing and
promoting a corporate culture.
In companies pursuing transnational and global strategies we might expect the HRM function
to pay significant attention to selecting individuals who not only have the skills required to
perform a particular job, but who also fit with the prevailing culture of the company.
Main Staffing Approaches
There are three main approaches to staffing policy within international businesses. These
have been characterized as an ethnocentric approach, a polycentric approach and a
geocentric approach.
An ethnocentric approach to staffing policy is one in which all key management
positions in an international business are filled by parent-country nationals. The policy
makes most sense for companies pursuing an international strategy.
A polycentric staffing policy is one in which host country nationals are recruited to
manage subsidiaries in their own country, while parent country nationals occupy the
key positions at corporate head quarters. While this approach may minimize the
dangers of cultural myopia, it may also help create a gap between home and host
country operations. The policy is best suited to companies pursuing a multidomestic
strategy.
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A geocentric staffing policy is one in which the best people are sought for key jobs
throughout the organisation, regardless of nationality. This approach is consistent with
building a strong unifying culture and informal management network.
Staffing and the International Business
As companies grow and become more dependent upon international business to contribute
to their total sales revenue and profits, they will employ more and more people
internationally. The ways in which staff are deployed is of great importance and we shall
examine three aspects of this in this section.
The capability of an organisation to manage its tasks effectively is both an in-house and
an external resources decision. Whilst lower cost is an important factor in the decision
to use external resources, there are important cultural benefits to be gained from using
locally based agencies and consultancies.
Expatriates have been used by many multinational organisations to inject unavailable
local expertise. They have also been used to provide glue for the organisation. The
movement of expatriates from corporate headquarters to subsidiaries around the world
provides the means to diffuse the culture of the company.
Whilst expatriates can help the control and co-ordination of the company, they can
block the development of local managers. A challenge facing management in the
future is how to develop local management and to develop multicultural management
teams. These times will be based on talent rather than on headquarters country
citizenship. For the worlds largest companies the equidistant manager will be the very
difficult goal.
In-House and External Resources
The general trend in many businesses is use direct employment of people within the
organisation to concentrate on the main activities of the business. For activities that are
undertaken less frequently or are less central to the company, the organisation will buy-in
agencies, consultancies and people on short-term contracts, that is it will use external
resources.
For example, in the marketing area, many functions can be bought-in from outside. It is
common to use advertising agencies, their use being based primarily on the cost-saving
advantages derived through the commission system. In areas such as logistics, the use of
external resources will be justified partly through cost savings and partly through the need to
buy-in specialist expertise that is not available in-house, for example, freight forwarders can
use their considerable knowledge of freight handling and international transport systems to
make cost-saving, efficient decisions. The infrequent exporter, on the other hand, will lack
information about the best possible routes and price deals available. Because of a lack of
consistent throughput of export orders, the infrequent exporter will not need to employ people
on a full-time basis. This then becomes a vicious circle because without full-time specialist
people working in-house, the company will not develop experience of the rapidly changing
world of international logistics.
In Table 11.1 we set out some of the possibilities of employing external resources in respect
of the marketing mix.
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Table 11.1: Use of in-house and external resources in marketing
Marketing
Mix Factor
In-House Resources External Resources
Product Because of the central position of
products to the organisation,
product management is usually
handled in-house.
Some new product development
specialist expertise might be used.
Price Handled in-house. Services for technical details of
documentation and foreign
currency exchange which influence
the final price are often bought-in.
Distribution-
Channels
Some distribution methods will be
handled by the company.
Smaller companies often use
distribution channel intermediaries
such as agents and distributors.
Distribution-
Logistics
Some distribution methods will be
handled by the company.
Many companies use external
transport companies for sea or air
freight.
Large companies often use in-
house expertise for export
documentation.
Smaller companies may use freight
forwarders or transport companies
to handle export documentation.
Most companies use banks to help
finance international orders and to
arrange foreign exchange.
Promotion Selling is usually handled in-
house. Face-to-face selling in
external country markets may be
carried out in-house (especially
through the use of subsidiaries).
Advertising, public relations, sales
promotion and design are usually
bought-in from outside specialist
companies.
Selling activities by agents and
distributors will be part of the
selling/distribution channel
interface.
Marketing
Research
Large companies will have in-
house MR specialists, but will
usually buy-in MR as well.
Smaller companies often rely on
Government-sponsored marketing
research schemes.
International
Marketing
Planning
Most companies will regard this as
an in-house activity but will
sometimes employ consultants to
give an external perspective.
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The overall position is that it is unlikely that a company will possess, in-house, all the
knowledge and specialist expertise that is necessary in international business. It will,
therefore, be necessary to buy-in external resources. The balance between in-house and
external resources will vary considerably from company to company. Some companies will
have a policy of handling most activities in-house. This is likely to be the case if confidential
information is an important part of company success. If the knowledge required for the
product or service is very specialised, this will limit the chances of finding suitable outside
people with the appropriate levels of knowledge.
The main reasons for using outside specialists are:
Outside specialists may have more specialist knowledgeable than in-house personnel.
For example, in foreign exchange dealing or in handling marketing research surveys
across a number of countries with widely different cultural behaviour.
It is cheaper to use outside specialists. This is likely to be the case if the amount of
work in-house is insufficient to justify full-time direct employment.
To manage a temporary need for extra people to handle a particular issue. For
example, the need for interpreters for the duration of an international trade fair.
Outside specialists have the appropriate language and cultural fluency for particular
markets.
In addition to these four factors, companies will, sometimes, need to undertake a step-
change in their approach to international business. For example, a large multinational
company may wish to develop a more global approach. If this is the case, specialists will be
useful to help define appropriate strategic directions and to devise ways in which the
corporate culture can be changed to a more geocentric orientation.
The Expatriate and the National Manager
In this section we will look at the reasons for using company personnel working in their own
country and compare these with the reasons for using company personnel, but basing them
in another country. Company personnel based in a different country are often referred to as
expatriates. Expatriates may exist at any level or functional specialism within the company,
but the main area of concern is at management level.
To look at the strategies for using expatriate and local managers we must first look at the
main types of manager employed by international companies:
Locals Managers who are citizens of the countries in which they are working.
Home-country expatriates Managers who are citizens of the country in which
company headquarters are based.
Third-country expatriates Managers who are citizens of a different country from the
company headquarters and the country where they are working.
We could posit that most companies will want to use local managers to fill the positions in
both the company headquarters and the companys various subsidiaries around the world.
Thus the typical company would have something of an ethnocentric bias in its headquarters
and polycentric influences in its subsidiaries, because of the proportions of nationalities and
cultures that it employs in its various countries of operation.
However, the position is likely to be more complicated depending on a number of different
factors. Figure 11.1 sets out some of the strategies applicable in varying conditions.
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Figure 11.1: Different strategies for employing local and expatriate managers
Country A Subsidiary Country B Subsidiary
Mainly locals Mainly locals
A few expatriates from
company headquarters.
In this case more expatriates
are used because of a
shortage of suitably skilled
local candidates. Home-
country and third-country
expatriates will be used.
Headquarters of
the Company
Mainly locals
Country D Subsidiary Country C Subsidiary
Almost all locals Almost all locals
In this country the rules
governing employment
make it very difficult to
employ expatriates.
This subsidiary is very
successful and long
established. It has little
obvious need for expatriates.
The position illustrated for Country A Subsidiary shows how companies will usually wish to
use a number of expatriates in their subsidiaries to control the organisation and to ensure
compatibility in the way in which systems are developed and implemented. Country B
Subsidiary shows an example of situations in which a large number of expatriates might be
needed, for example, if there are few local marketing specialists in a company, expatriates
will be needed to fill the gap. Country C Subsidiary illustrates the situation found when a
subsidiary earns a high degree of independence from company headquarters because of its
consistent ability to meet its objectives. The example of Country D Subsidiary is one in which
the company may wish to employ expatriates, but is prevented from doing so by rules,
regulations and laws established by the country concerned. Many countries in Africa have
considerably restricted the numbers of expatriates that multi-national companies can employ.
The main reasons why companies use expatriates can be summarised as follows:
To provide immediate technical competence. Expatriates often have the required
knowledge and skills (for example, in the use of marketing research), which do not
exist in the local workforce.
To facilitate co-ordination and control between the subsidiary and the complete
organisation. Expatriates familiarity with communications and the culture of the
company provides a basis for developing similar systems and culture in the subsidiary.
To enhance the (expatriate) managers development in the international arena.
There are problems with using expatriates, however. For many people the difficulties caused
by geographic mobility are too great, the move affects not only the manager, but also the
managers family. There are also difficulties in career progression at the conclusion of the
expatriate assignment. If the company does not manage the return of expatriates so that
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managers are able to enhance their career prospects, they will resist attempts at expatriate
assignments.
Cost is another important factor. The relocation costs, housing and costs such as the
education of the children from expatriate families, are often surprisingly high. In addition,
costs of living in other countries, particularly major cities, can be higher than the expatriates
domestic residence. In a survey of the cost of living in the worlds biggest cities by the
Economist Intelligence Unit, Tokyo was by far the most expensive city. Using New York as
the base, rated at 100, Tokyo was just over 200. The next city was Zurich at 125; Paris,
Seoul, Hong Kong, Moscow, Singapore, Frankfurt and London ranged between 125 and 100
in descending order. Bombay and Belgrade at about 50 represented the cities surveyed with
the lowest living costs.
A further problem with the use of expatriates is the way in which it can inhibit the
development of local managers. If all senior appointments are made to expatriates, not only
does this prevent local managers from developing the experience necessary to operate at
higher levels in the international organisation, but it is also a serious demotivating force
discouraging people with the potential to be high flyers. Their reaction might well be to seek
employment in other organisations in which their talents will be more aptly rewarded.
C. DEVELOPING THE GLOBAL APPROACH
Figure 11.1 represents the type of approach taken by many multinational enterprises in the
past. However, companies are now developing ways in which they can be more flexible and
more attuned to the cultural requirements of the market place. One way in which this
flexibility is being sought is through approaches being propounded by gurus such as Tom
Peters. They propose breaking down typical organisational hierarchies to enable companies
to be disorganised, to allow them to cope with the disorganisation and change they face in
their environment and in their markets.
The other main development is the borderless world view of Kenichi Ohmae and the need to
build management teams and managers to cope with the new complexity of international
marketing. One strong view propounded by Ohmae is the need to develop equidistant
managers. Equidistant managers would have the knowledge, experience and cultural
flexibility to operate on a global basis without their decisions being flawed through self-
reference criteria. This is obviously very difficult to achieve.
Developing Specialist Centres
Figure 11.2 represents a more global company. This company still has the major
headquarters based in the country in which the company was originally founded. However,
the company aims to use specialist centres based in different parts of the world and uses
managers more on the basis of merit than the fact that they are nationals of the company
headquarters.
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Figure 11.2: Strategies for building the global company
Country A Subsidiary Country B Subsidiary
Developed into a centre for
worldwide IT development
and support.
This subsidiary is in the
development phase. It will
be developed into a
specialist centre for
production.
Headquarters of the
Company
Provides all functions.
Uses locals as well as
extensive use of third-
country expatriates.
Country D Subsidiary Country C Subsidiary
This subsidiary is still in the
development phase.
Country restrictions prevent
major development.
Developed into a centre
for worldwide marketing.
In all subsidiaries, except the restricted case of Subsidiary D, the company employs a
number of home-country and third-country expatriates. It aims to develop managers from
each subsidiary, some of whom will be moved to company headquarters, others to other
subsidiaries.
Developing the International Manager
The important issues in the development of the international manager centre on building
personal competence in respect of management and business skills in general, and in the
particular requirements of the international arena, including developing cultural flexibility and
language skills.
Companies will face the process of management development in a number of ways, but the
main aspects will centre on planned experience and training programmes:
Developing experience
Experience needs to be developed in a progressive way. Managers will be exposed to
jobs in various countries with progressive difficulty, success at one level being the
normal prerequisite for progression to the next level. Experience needs to be
developed in various countries. Each country will pose different cultural challenges. In
particular, it will be the ability to apply management solutions successfully in different
countries that will be crucial. Progression beyond the country management level to the
grouping of countries level needs to take place.
Training and development
In most instances, managers will be given in-house training and training from external
providers. This training will be used to develop managers general and international
management expertise. In addition to specific management courses, though, the
manager should attend courses for cultural preparation and inter-cultural analysis and
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to improve language skills. For managers operating in many different countries, it will
be impossible to learn every language to a high level, such as is required for
negotiating or presentation purposes. However, he/she should possess high-level
language skills in at least one other language and social survival language skills in all
the important languages that relate to his or her geographic responsibilities.
The Concept of the Equidistant Manager
In the major companies of the world, the imperative of global management is strong. These
companies market and compete in global markets. In order to do this, they need to develop
managers who avoid continual reference to constricting experience and values. Kenichi
Ohmaes concept of the equidistant manager provides the basis of this.
The equidistant manager develops strategy and implements plans based on the importance
of the customer or market, not on geographic proximity or home-country cultural terms.
He/she avoids:
A vision dominated by home-country customers.
A vision dominated by specific company subsidiaries.
A view that everything outside the company and the country is part of the rest of the
world.
The words overseas, subsidiaries and affiliates because these serve to separate the
home domestic operation from the rest of the world.
The whole process is, of course, very difficult. The main issue for those businesses who
need to operate globally is that they must develop values and attitudes amongst their
managers that are global.
The UK is regarded as part of Europe. Some people in the UK regard the UK as an essential
component of Europe. They regard the integration of the UK into Europe as crucial for the
future prosperity of the UK. Others in the UK wish to retain a traditional country
independence. From the more limited perspective of the UK and Europe we can see how
difficult it is to develop a reliable, equidistant view within Europe. When this is attempted on
a global scale, the whole process is exceedingly difficult.
D. LABOUR RELATIONS
Major Concerns
Main concerns of organised labour include fears that the global company may counter union
bargaining power by threatening to shift production elsewhere, or will try to import and
impose unfamiliar labour practices from other countries.
In contrast, a company's ability to pursue a transnational or global strategy can be
significantly constrained by the actions of labour unions. A key issue in international labour
relations is the degree to which organised labour is able to limit the choices available to an
According to Hill (2001) organised labour has responded to the increased influence of
international companies through:
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Trying to set-up their own international organisations.
Lobbying for national legislation to restrict multinationals.
Trying to achieve regulation of multinationals through international organisations such
as the United Nations.
However, it would appear that none of these efforts have been that successful to date.
Organising for Competitive Advantage
Traditional labour relations have been decentralised to individual subsidiaries within
multinationals. Recently the trend is moving towards greater centralisation. This enhances
the bargaining power of the multinational vis--vis organised labour.
There is a growing realisation that the way in which work is organised within a plant can be a
major source of competitive advantage.
None the less, national differences remain a significant problem, for example:
The structure of unions & their influence over organisations vary.
These areas of differences influence operations worldwide.
Labour laws are virtually unique to every nation.
Levels of employee participation in setting HRM policies also vary.
Government regulation of business differs across borders.
The Development of a More Global Approach
Companies are now developing ways in which they can be more flexible and more attuned to
the cultural requirements of the market place. One way in which this flexibility is being
sought is through approaches being propounded by gurus such as Tom Peters. They
propose breaking down typical organisational hierarchies to enable companies to be
disorganised, to allow them to cope with the disorganisation and change they face in their
environment and in their markets. The other main development is the borderless world view
of Kenichi Ohmae and the need to build management teams and managers to cope with the
new complexity of international business. One strong view propounded by Ohmae is the
need to develop equidistant managers. These managers would have the knowledge,
experience and cultural flexibility to operate on a global basis without their decisions being
flawed through self-reference criteria. This is obviously very difficult to achieve.
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201
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Study Unit 12
Implementation, Evaluation and Control
Contents Page
Introduction 202
A. Individual Country Annual Plans 202
Elements of the Annual Business Plan 203
B. Managing the Implementation Process 206
C. Performance Evaluation and Control 207
Difficulties in Measuring Performance 207
Evaluation Criteria 209
Control Systems 209
Methods of Evaluation and Control 210
D. Planning for the Future 213
What if? Questions 213
What Changes will be Necessary? 214
202 Implementation, Evaluation and Control
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INTRODUCTION
This study unit covers the implementation of the specific tasks required to meet the
objectives of international business strategy, and the evaluation and control of those tasks.
To date, we have been concerned with examining the broader, macro or strategic activities
involved in international business. So, for example, we have been concerned with the
analysis and implementation of broad long-term strategies for international business
including such areas as methods of entry, target market selection, the implementation of the
overall strategy and standardisation versus adaptation issues.
Obviously, these aspects are important inasmuch as they determine the broad overall
framework within which the more detailed and tactical aspects of business decisions in each
individual country are made. Within this broader framework, the international business must
meet the needs of customers in their local environment, and within the overall strategic
context of the adaptation/standardisation decision, decide the extent to which the elements of
the business will be adapted to meet the specific demands of each market under
consideration.
In short, a detailed implementation plan for the business activities over the year must be
developed, relating to each individual market in which the business operates. We start the
unit with a consideration of the way in which such plans are built up and the issues involved.
We then go on to examine the key aspects of managing the implementation of the plans and
their evaluation and control.
In developing and implementing plans, companies make a series of assumptions about what
they expect to happen. Evaluation and control are concerned with measuring and checking
to assess what the results are from the implementation of the plans. They are also
concerned with the remedial action that the company should take when, as so often
happens, the performance differs from the promise of the plan.
We conclude by considering some consequences for international business strategy of
changes in the environment.
A. INDIVIDUAL COUNTRY ANNUAL PLANS
A companys overall corporate plan sets the broad objectives and strategies for a companys
international business operations. At the corporate level, strategic decisions regarding
international business encompass areas such as the degree of commitment to international
markets in the context of the overall business, the selection of regions or countries, the
methods of entry and broad decisions regarding the shape of the international business mix,
including issues such as the extent of standardisation versus adaptation. Within this context,
the annual plan prepared for each country in which a company operates provides the
mechanism for implementing overall corporate strategies, whilst at the same time reflecting
and accommodating the needs of different countries and situations.
Because the annual plan considers the local environment and customer needs of specific
markets, it enables the business to develop business programmes that reflect these local
environments and customer needs. Essentially, the annual plan enables the management to
adapt the business to meet the specific demands of each market under consideration,
including tasks of essentially a more tactical nature compared to those found in the overall
corporate international plan. So, for example, within the general framework of a policy set at
corporate level encompassing, say, the promotional element of the business mix, we wouldnt
expect the details of media scheduling to be exactly the same in every market in which the
business operated. Effective implementation requires these more detailed aspects to be
considered and incorporated within plans for each country.
Implementation, Evaluation and Control 203
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The business plan helps analyse each individual countrys specific requirements and the
competitive environment before translating these into specific action programs. Developing a
plan for each country ensures that the business has anticipated and understood the
following:
Individual market needs and market trends.
Competitive market structure and competitive strengths and weaknesses in the market.
The specific business objectives, strategies and tactics that would be most effective in
a particular market.
The required structure and balance of the business operations to be used in each
particular market.
The required budget and resource implications.
The key issues in the implementation process.
Without an annual business plan for each market, the business is unable to control and co-
ordinate activities across markets, and the overall business strategy is unlikely to be
implemented effectively.
Elements of the Annual Business Plan
Remembering that the organisation should have already established overall corporate and
business objectives and strategies, a detailed annual business plan is required for each
market. The main elements of this detailed plan should include the following:
Analysis
For each individual country market, the business should start with a detailed analysis.
This analysis should encompass the following:
(i) Market size and trends.
(ii) Business environment and trends, political, economic, social/cultural,
technological (SLEPT analysis).
(iii) Competitor and competitive market structure analysis.
(iv) Internal analysis, product portfolio, market share, strengths and weaknesses and
current performance levels.
(v) Customer analysis including needs and motives, segmentation, purchasing
patterns and processes, purchasing timings, customs and practices.
All of these elements are important in developing the plan for a particular country
market inasmuch as the analysis will highlight the local issues, and in particular, the
needs of customers in their local environment. Ultimately, the business will possibly be
seeing and dealing with customers as individuals and therefore will need to adapt the
elements of the business and program to meet the specific demands of the individual
markets under consideration.
Based on this analysis stage, and again against the framework of overall corporate and
business strategies, the business can now proceed to the next element of the annual
business plan, namely the production of a detailed SWOT analysis for each market in
question.
SWOT analysis
For each market, the business must prepare a detailed SWOT appraisal. You should
be familiar with the meaning and use of SWOT analyses and indeed we have
discussed this in previous study units. In the context of the annual business plan, the
SWOT analysis should identify those opportunities and threats that will affect decisions
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about business objectives and programmes in a particular market over the planning
horizon of the forthcoming year.
Business objectives and strategies
Once again, remember that the objectives and strategies are those that would be
pursued over the forthcoming year in each market. This element of the annual
business plan should encompass:
(i) The specific objectives and sub-objectives relating to specific products, segments
and customers. These objectives should be specific, measurable, actionable,
realistic and timed (SMART) and should include objectives for sales, profits and
market share.
(ii) The selection of specific market segments and targets.
(iii) The strategies for competing, i.e. the basis of differential advantage to be used.
(iv) The desired product and brand positioning.
Programmes for implementation of the Business Plan
This element of the plan should include detailed programmes for the implementation of
business activities in a country and, again, should relate to specific products, segments
and customers.
Unlike the corporate plan which is concerned with broad thrusts of strategy and
decision-making (such as the selection of country markets, methods of entry and
issues concerning the degree of standardisation or adaptation of the business
elements), at the individual country level, the annual plan will include much more
detailed programmes for each element of the business operations.
You should remember that individual country annual plans represent an opportunity to
meet the needs of customers in their local environment and therefore to adapt the
elements of the business operations in a more tactical manner to meet the specific
demands of each market under consideration.
The implementation element of the annual business plan should encompass each of
the elements of the business operations including, where appropriate, the extended
business operation elements for services. For example, the sort of detail included in
the annual marketing plan can be illustrated if we consider what the plan might contain
with regard to, say, promotional elements. The plan might encompass the following
aspects with regard to the promotional programme:
(i) Detailed promotional objectives for each product/market/customer, for example,
to increase brand awareness of our brand amongst target customers from its
current 10% to 20% within 12 months.
(ii) Detailed advertising and promotional programmes, for example, details of
advertising campaigns, (advertising platforms, media selection and planning,
including timing and frequency), advertising research, point of sale material
programmes, details of PR and publicity activities (including planned press
conferences, press releases, etc.) and details of sales promotion campaigns
(including consumer distributor programmes).
(iii) Detailed budgeting requirements and spend patterns for the elements of the
promotional campaign.
(vi) Detailed timing and scheduling activities for the program over the year including,
for example, agency briefings, timings of press conferences, the distribution of
point of sale and other promotional material, etc.
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(v) Detailed evaluation and control activities for the different elements of the
promotional mix, for example, advertisement pre-testing research, recognition
and awareness tests, etc.
If we take into account the fact that these detailed programmes would be required to be
planned for each element of the business operations and, where appropriate, for each
product, market segment and/or customer, you will appreciate how much more detailed
the annual country marketing programme is compared to the overall corporate and
marketing strategy plans. Again, we should also remember that this amount of detail is
necessary in order to ensure that the needs of customers in their local environment are
met, together with the specific demands of each market.
Specification of tasks, responsibilities, costs and budgets
This element of the business plan should include detailed outlines of the specific tasks
to be performed together with the allocation of these tasks to functions and, ultimately,
individuals. Weaknesses in this area of task allocation are, in fact, among the major
reasons for ineffective implementation of business programmes. Examples of
weaknesses in implementation include a failure to communicate with, and, as
importantly, agree the responsibilities of, those individuals charged with ensuring that
the required business tasks are performed.
It is important that those charged with these responsibilities understand what they are,
and moreover, have the resources and skills to achieve them. Failure to communicate
and agree responsibilities may mean that no one takes responsibility for the actions
outlined in the business plan, with the obvious consequences that are likely to result.
In addition to ensuring that tasks and responsibilities are allocated and agreed, it is
also important to ensure that costs and budgets have been assessed. In particular, it
must be ensured that the required financial resources are available at the right time to
implement the marketing plans.
Control and evaluation
The annual business plan should include details of expected operating results including
sales, profit, financial ratios and other softer elements of business performance, such
as customer service levels, brand awareness, etc. It is against these expected
operating results that the business can establish and implement key control standards
together with any details of actions required where operating results are not being
achieved.
Again, at this level of the business planning process, control mechanisms and actions
should be detailed, specifying exactly what action will be taken, under what
circumstances, and by whom. In the measurement of the annual business plan, it is
best to have at least quarterly, and preferably monthly, reviews to ensure that plans are
on course and also that plans can embody the most up-to-date information on any
changes that have occurred.
These, then, are the key elements of the annual business planning process and again we
can see the need to break down broad overall corporate and business strategies into detailed
business programmes for each country, encompassing specific programmes and activities.
As we have also seen, however, implementation means working through, and with, others.
Because of this an important aspect is the people element of implementation. We shall
consider this aspect of implementation together with several other facets that affect the
implementation process and which are in fact related to the people aspect in the next
section of this study unit.
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B. MANAGING THE IMPLEMENTATION PROCESS
Good planning requires different skills from good implementation. Many otherwise excellent
international business plans come to nothing because they are not effectively implemented.
Effective implementation requires several aspects to be managed effectively and we shall
consider four key aspects here.
People management
As mentioned earlier, the implementation of business strategies and plans takes place
through people. Because of this, the international business must have the necessary
skills in managing people. One key skill in this area is the ability to empathise with the
views and problems of other individuals. All business activities are fraught with
uncertainty and risk and can therefore be very stressful, particularly where change is
involved as a result of implementing new strategies.
The international business must be aware of these issues and be able to see and
anticipate problems as others see them, able to direct individuals whilst at the same
time being fair in dealings with staff and allowing those members of staff to feel
comfortable in approaching management.
Incentives and rewards
Our second factor affecting the implementation of international business strategies
could also be said to be a people management issue, in so much as it relates to
systems for rewarding, and therefore encouraging or motivating, staff charged with
implementation activities.
It is essential that incentive and reward systems in an organisation be geared to key
performance standards in a business plan. So, for example, if the business plan
requires a long-term perspective in terms of, say, increasing market share in a country,
it is important not to have incentives and reward systems which are geared to short-
term success.
Sometimes, because the development of international business is essentially a team
effort, incentives should be group-based rather than individual-based. Incentives
should be seen to be fair by all those affected by them and should seek to encourage
extra performance.
Communications
Again, related to the people aspects, effective implementation depends on good
communications throughout an organisation. Staff must be kept informed of objectives
and plans and any changes that affect these. Communications should be both
horizontal and vertical and should make maximum use of both formal and informal
channels.
Problems of communication can be exacerbated in international business due to, for
example, geographically distant operations or sometimes an insular headquarters.
Regular meetings, status reports, newsletters and so on should be used to
communicate. Increasingly, computerised information and decision support systems
are helping to facilitate improved organisational communication in international
business.
Organisational structures and design
Organisational structures for international business were covered earlier in the course.
We saw there that there are several different types of organisational structure for
international business and considered their relative advantages and disadvantages.
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Different organisational structures have different implications for implementation, with
some structures being more effective in this respect. So, for example, more
decentralised and flexible organisational structures tend to increase the effectiveness
of implementation as they tend to result in more functional communication and
teamwork. Sometimes a company may require special organisational structures
specifically to implement new international ventures. Such tasks teams may be
composed of individuals from different functions of the organisation who are brought
together to facilitate implementation.
These, then, are some of the important considerations for the marketer when trying to
implement international business plans. Failure to manage these aspects effectively can
give rise to several problems including, for example:
Decision making being delayed or deferred.
A lack of speed in responding to changing business and environmental circumstances.
Poor motivation and high staff turnover.
Increased conflict and lack of co-operation.
Increased costs and inefficiency.
C. PERFORMANCE EVALUATION AND CONTROL
In this section, we start by considering the process evaluating business performance and in
particular some of the more conventional approaches to, and difficulties of, evaluating.
Difficulties in Measuring Performance
It is difficult to arrive at reliable and fair ways to measure performance in the international
arena. The reasons for this are as follows:
Markets are not equal between one country and another. Markets vary considerably in
size, in potential, in the variety of competitive forces that exist in the market and in the
ways that potential buyers react to changes in business strategies.
The strength of the company in different markets is not consistent. The company will
usually have some markets in which it has established a long-term presence. In some
markets the company will have used a disproportionate amount of resources. It is,
therefore, difficult to disentangle the measurement of current performance from what
has happened in the past.
Performance by the company in a particular market is influenced by various
interactions at different levels in the company. This is not a problem for companies with
modest levels of sales. However, for large companies with extensive international
operations, the interactions are considerable. For some companies there are three or
more layers within the company, as shown in Figure 12.1.
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Figure 12.1: Layers of the company
We have examined important strategic decisions that relate to country selection, the
mode of market entry, and standardisation and adaptation. If we apply these at the
three levels, we can imagine that sometimes the managers at a country level might
argue strongly for an adapted approach, but that the corporate and regional level might
impose a global standard or a regional standard with very little country modification
being permitted.
The evaluation of international performance is significantly influenced by changes in
foreign exchange rates. If evaluation is proposed on sales revenue or profit
contribution, it is certain that some of the figures that are calculated will merely reflect
exchange rates. Obviously, in evaluation it is important to measure the right things.
The company has no control over changes in exchange rates. What the company
needs to find is a measure that can be used to compare cross-country performance
that is largely independent of currency changes.
We can illustrate some of these problems by reference to market share. This is often
recommended as a basis for evaluating performance, particularly as it has been used by
many companies as an objective of long-term strategic planning in international markets and,
indeed, forms the basis of a number of strategy formulation models (for example the Boston
Consulting Group Growth-Share Matrix). However, there are problems in measuring market
share accurately, including the following difficulties.
Within country markets it is difficult to find a 100% accurate method. Most markets are
measured through marketing research techniques and thus suffer statistical errors. In
international business there are further problems that relate to the variability of
marketing research techniques used in different countries. This will result in different
statistical errors.
Business statistics based on government data might be influenced by incorrect
reporting to minimise tax returns, by unhelpful ways in which information is classified in
sub-groupings, or by unreliable import/export data. This is likely to be the case if cross-
border smuggling takes place.
Market valuations will be influenced by the foreign exchange problem. This does not
affect the size of the market share but it does affect the value of that market share.
World Region
level, e.g.
Europe,
America, Asia
Country level
Company at
the
headquarters
corporate level
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Growth-share matrices are dependent on market growth rate and relative market share
data. It might be possible to estimate growth rates without necessarily having reliable
data for market size or relative market share.
Evaluation Criteria
It is most unlikely that a company will be able to develop evaluation methods that do not have
problems. It is equally certain that relying on just one form of evaluation will provide an
incomplete picture of company performance. For example, it is quite usual for short-term
sales to increase but for short-term profits to decline, or even become losses, when a new
product is introduced, whereas over the longer term, the company hopes to show good profit
increases. Thus, companies will vary in the number and range of evaluation criteria used.
The most likely ways in which performance will be evaluated are:
Comparing performance against the agreed business objectives.
Comparing performance against industry averages and against competitors, including
(despite all the above comments) market share.
Profitability. This is the basis that most companies use, at least as one measure of
performance, since it is the key measure of performance at corporate level. There are,
though, obvious problems in using profitability in a comparative way, foreign exchange
variations, the way in which transfer prices have been calculated and different country
taxation structures all interfere with accurate inter-company profit performance across
country boundaries.
At a subsidiary company level, companies will use profit return on capital employed,
profit return on sales and similar criteria. It is usual for this to be assessed at a pre-tax
level, because after-tax includes the tax element over which the local manager has no
control.
Measurements of quality, customer satisfaction and shareholder value. The first two of
these are of particular interest to business as both quality issues and customer service
and satisfaction levels have become more and more important in recent years, both in
domestic markets and internationally.
Most measurements will be on a quantitative basis and ratio analysis is frequently employed,
for example, in the ratio of marketing costs to sales revenue for each of the different
elements of the marketing mix.
Performance criteria that relate to sales and profitability will be communicated through the
company accounting and financial control systems. Those that relate specifically to
measures obtained through marketing research and marketing will be communicated through
reporting systems based on reports that might be monthly, quarterly or half-yearly.
Control Systems
The analysis of performance against the above types of criteria is, as we have seen, more
difficult in the international context for a variety of reasons. This is also true of control
systems. Of particular importance here are the extra problems that result from geographic
distance that reduces the amount of face-to-face contact and gives rise to extra
communication difficulty. Furthermore, there are cultural differences that affect the
usefulness of control systems. Managers from low context cultures will have more difficulty
in interfacing with managers from high context cultures than with managers from similar
types of cultural background. This will be further influenced by the local manager/expatriate
balance and by the extent to which a real international manager culture has been achieved.
In addition, country-related differences might influence performance to a greater degree in
some countries than others. These differences are difficult to isolate.
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Control systems are essentially concerned with isolating the causes of performance
problems and taking corrective action.
At the simplest level, corrective action may be just making an extra effort in implementation,
for example, motivating agents or distributors to better levels of sales performance. At
another level, more resources might be required. For example, a larger marketing
communications budget might be needed, or an extra budget to fund price reductions, or to
prevent price increases, which could be necessary if there are unfavourable currency
fluctuations. In the short term it might be advisable to reduce the level of profit contribution in
an attempt to reduce the price rise impact. At another level it could be that the strategy
chosen was incorrect. This would mean that a complete review of the process of analysis,
the identification of strategic options, the selection of the preferred strategy and the
implementation of the strategy would have to be undertaken.
It has been suggested that strategic control needs to take account of a number of key
elements:
Selecting the right evaluative criteria These need to be as measurable as possible
and should be limited to the most important criteria. The criteria need to have short-
term and long-term measures and to be benchmarked against key competitors.
Achieving good strategic performance It must be seen that top management is
concerned with performance that directly relates to the achievement of the key criteria.
There must be regular reviews of progress against the criteria. It is essential that
balance is discussed between:
(i) Achievement against different criteria; there might need to be a trade-off between
the various criteria.
(ii) Achievement of short-term and progress towards the long-term strategic targets;
if attention is focused on the short-term, the end result will be a failure at the
strategic level.
Achieving good strategic control It is important to achieve a high level of strategic
planning. If the strategic plan is fundamentally flawed, the control mechanisms will not
be able to correct under-performance, and the strategic planning process will need to
be repeated. Control needs to take place both through formal and informal appraisals.
If things appear to be going wrong, then top management involvement is signalled
through rapid intervention.
Methods of Evaluation and Control
As we have seen throughout the different elements of international business, this is a very
dynamic and fast changing area. Organisations are constantly looking for ways to improve
the effectiveness and efficiency of their activities and this is just as true in the area of
evaluation and control as in any other area of business planning. In fact, as we shall see,
approaches to evaluation and control in international business are changing dramatically.
There are a large number of specific developments in the techniques of evaluation and
control, but the main thrust of change in this area has been two-fold:
1. The development of more outward-looking and much broader approaches to evaluation
and control which seek to take greater account of both customer and competitor
considerations in the evaluation of business performance and include more qualitative
aspects than the more traditional evaluation and control techniques.
2. The use of new technology, and in particular information technology that has enabled
much more sophisticated techniques of control to be introduced.
Some of the more important approaches in these areas are considered below.
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Self-assessment/business audits
Increasingly, companies are undertaking full business audits. A business audit
examines every facet of a companys operations with regard to both efficiency and
effectiveness. In doing so, the audit acts as both a control and an input to planning
activities based on a comprehensive and wide-ranging review of a companys total
business efforts.
The audit therefore covers responses to changes in the business environment and the
implications for future opportunities and threats and assesses how valid and relevant
the companys objectives and strategies are. Obviously, an audit is a very wide-
ranging assessment of a companys business performance and needs to be done on a
regular, perhaps annual, basis using objective appraisals carried out by the audit team.
Benchmarking
Benchmarking is essentially comparing a companys business performance against the
best in class competitors. There are a number of approaches to benchmarking:
(i) Truly competitive benchmarking compares a companys business performance
against the best direct competitors.
(ii) Functional benchmarking compares a particular aspect of a companys business
activities, such as procedures for dealing with customer complaints, against those
organisations that are considered best in this area.
(iii) Generic benchmarking is based on comparing business practices with the best
companies in the world, irrespective of whether or not they are direct competitors.
For the international business, the benchmarking exercise should be done by
comparing a companys performance with other international businesses rather than
purely domestic ones.
Benchmarking has the advantage of ensuring that a company does not become insular
in evaluating its own performance, perhaps judging that it is doing well in terms of its
business when in fact, compared to the best companies, it is performing badly. So, for
example, a company might consider that it is effective in developing and launching new
products until it considers its best-in-class competitor who can bring a new product to
market twice as fast and at 15% lower cost. Needless to say, many companies that
have embarked on benchmarking exercises and have compared their performance
against their best-in-class competitors have experienced a nasty shock.
Since its introduction, the use of benchmarking to evaluate performance has become
widespread. The first step in a benchmarking exercise is to determine what constitutes
the important measures of business performance. In establishing these measures, it is
important to look at customer perspectives as to what constitutes effective market
performance rather than internal measures of performance such as profits, etc. This
understanding of customers wants and needs is vital to an effective benchmarking
exercise. A company can then establish the key factors for success and proceed to
measure its performance with regard to these factors against the best practices.
Benchmarking should extend to every facet of the value chain and we should always
be looking for ways to improve competitive market performance. For benchmarking to
be effective, it is important to have the right attitude towards this process. In particular,
it should not be seen and used to expose individual weaknesses in performance in
order to punish those responsible. Nevertheless there is no doubt that the use of
international benchmarking has helped sometimes insular organisations and marketers
to realise that they need much better levels of performance if they are to compete in
world markets against the best.
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Best practice
The American consulting company, Arthur Andersen, is credited with the notion of
evaluating performance on the basis of best practice. In fact, several studies and
techniques use this notion of best practice to evaluate and control business activities.
The approach is very similar to benchmarking inasmuch as the approach seeks to
ascertain those practices that are most influential in determining company success.
So, for example, research into best practice has indicated that companies that are
marketing oriented, that have good quality and quality control procedures and who
provide good levels of customer service tend to have the highest growth and profit
rates.
The so-called Profit Impact of Marketing Strategies (PIMS) study by the Strategic
Planning Institute in America also seeks to establish the key areas for best practice
with regard to business and profit performance. The idea is that once these best
practices are established, together with the key areas which underpin them they can be
used by the business to evaluate a companys own performance and ultimately to
improve its performance in the market place.
The balanced scorecard
This approach to the evaluation of performance is specifically intended to move away
from purely quantitative measures, and particularly the financial measures of company
performance. Again, important though these financial measures are, as the name of
this approach to evaluation and control implies, they are considered unbalanced
inasmuch as they do not reflect the full range of indicators of business performance. In
order to address this imbalance, it is suggested that the organisation identify key
performance indicators appropriate to the company and markets in question.
Unlike benchmarking, these performance indicators are not directly taken as being
those used by successful competing organisations. Important measures of
performance are likely to encompass aspects such as customer retention levels,
service levels, perceived satisfaction and so on. Objective measures of company
performance against these key criteria are then used, often based on a scorecard
approach.
The learning organisation
This is not so much a technique of evaluation and control but rather an approach with
regard to the control and evaluation process. The notion of a learning organisation
centres on the idea that as a result of evaluation, a company should gradually learn to
perform better. In other words, the learning organisation would require fewer imposed
control procedures if it takes the time and trouble to learn from its past mistakes.
Essentially, the idea is that, eventually, in the learning organisation imposed control
procedures will not be necessary. This does not mean to say that the company will no
longer need to measure performance, or indeed that what constitutes effective
performance might not change over time, but in the learning organisation the control
process becomes one of self-control with managers taking responsibility for their own
actions and learning to improve over time. This idea of a learning organisation leads
us to consider the notion of empowerment in the control and evaluation process.
Empowerment
Again, this is not really a technique of evaluation control, but rather an organisational
approach to the control process. It is now increasingly recognised that employees
being given discretion facilitate effective evaluation and control and authority to take
actions as required to improve performance.
A good example would be dealing with customer complaints. Empowering staff to use
their discretion and authority, within certain guidelines, can enable customer complaints
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to be dealt with much more speedily and effectively. So, for example, instead of having
a process whereby such complaints are passed through a complaints system
employees are allowed to deal with the complaint immediately where they feel this will
be a better approach.
Obviously, empowerment has to do with organisational powers and procedures but
also with the culture that exists in an organisation. In the context of the international
business, empowerment as a means of improving performance would suggest a more
decentralised approach to decision-making, allowing, for example, employees of
subsidiary companies greater discretion and control over important aspects of
performance.
The application of new technology
Information technology is changing the process of evaluation and control by opening up
new possibilities for information acquisition and analysis. Some of the more important
developments in this area are as follows:
(i) The computer has facilitated the growth of sophisticated data collection and
handling systems that facilitate more effective evaluation and control. Using
these systems, the international business can increasingly speed up the control
cycle. Information is available in real time, which enables the business to
respond almost immediately to any adverse trends.
(ii) In many companies, computer technology and databases are combined to
provide decision support systems (DSSs), which allow managers to manipulate
and analyse data at will and act accordingly. Again, such data and decision-
making can be done on-line. Associated with DSS is the use of increasingly
sophisticated software programs to assist managers in their planning and control
processes.
(iii) Developments such as Intranets and the Internet have facilitated improved
communication both within the company and between the company and the other
members of the value chain. This has led, once again, to much speedier on-line
decision-making. This is particularly important in international business where
distances are greater and traditional methods of communication are sometimes
inadequate.
D. PLANNING FOR THE FUTURE
In the development of strategic plans in international business, we have to take account of
future change. The strategies that are being implemented now are based on analysis that
took place in the past. It is therefore highly probable that some of the assumptions that were
used in the formulation of the strategy will prove to be incorrect. In addition, new elements
such as new top managers or the opening of new major world markets (as has happened
over recent years in Central and Eastern Europe and in China) can mean that new strategies
need to be formulated.
What if? Questions
You can consider the consequences for international business strategies by playing the
What if? game. For example, if you took the SLEPT plus C environment framework and
asked What if? concerning each of the factors, it would set you thinking about a number of
possible future scenarios. The following is one approach to this, although you will probably
be able to develop some equally plausible scenarios for yourself.
What if socio-cultural change? If the cultural values that have been significantly
different in the past become more Westernised through exposure to, say, US films and
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television and a market forces type society, will this make it more or less difficult for
Western companies to penetrate Asian markets?
What if legal change? If Islam becomes a more dominant religious force in the
world, will this influence the relative importance of Islamic law in adjudicating
international trade?
What if economic change? If China continues its rapid economic growth, will it
become a fourth dominant market in the world market along with the US, Japan and
Europe? If this happens, in which markets will Chinese companies come to dominate?
Which markets in China will be significant opportunities to companies from other
countries?
What if political change? If countries in various parts of Africa, Asia and South
America become more capable, through political change, in the economic management
of their countries, will this create new opportunities for international business
managers?
What if technological change? If the pace of technological change increases, will
smaller companies be able to survive? If technological innovation becomes
concentrated on Japan and the US, what impact will this have on the international
business strategies for companies in Europe and in other parts of the world?
What if currency changes? If the Japanese yen continues to appreciate against the
US dollar, what consequences will this have? Will it make it more and more likely that
foreign direct investment will be from Japan into the US rather than the other way
round? Why should this be so?
Will the European single currency make exporting more convenient to Europe? Will it
be more beneficial to other European companies or to non-European companies?
What Changes will be Necessary?
In a world in which major change seems likely, but will be difficult to predict with consistent
accuracy, international business managers will have to improve their whole strategic
approach to gain sustainable competitive advantage.
Analysis will need to improve to provide a better and a quicker assessment of customer
buyer behaviour. Marketing and business research techniques will need to improve and
international business managers will need to become better at using marketing research.
Market segmentation is likely to evolve across country boundaries. International business
information systems will need to cope with large flows of information from some countries
and very poor flows of information from other countries. Managers will need to become more
international to minimise the problems caused by self-reference criteria.
The development of strategies will need to take account of different types of option. For
example, joint ventures and strategic alliances have been popular means to speed the
process of international expansion and to share the costs of major new product development.
It is not certain how enduring joint ventures and alliances will be. If they break up, what new
structures will be put in their place? If strategic alliances are used, how will this influence the
evolution of worldwide competition?
It is likely that companies will have to take particular account of how to gain and sustain
competitive advantage in situations in which technological advantages will be swiftly
countered. Differentiation through excellent customer service, through creatively appropriate
marketing communications and through innovating effectively will become very important.
As some companies become more and more significant in the world marketplace, the need
to develop and implement competitive strategies that are co-ordinated across country
markets will become more important.
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In the implementation of international business strategies, companies will need to develop a
more international culture. This will mean more experienced, truly international, international
managers. The equidistant manager might be a long way off, but certainly the ethnocentric
manager influence needs to be substantially reduced.
To be successful in the world marketplace, international businesses need to balance the
financial implications of their strategic options and of the implementation of their preferred
option. We have looked at the financial implications as we have moved through the
international business strategy process. In the future, the likelihood is that the increased
scale of international operations will make the appraisal of financial risk and return even
more important than it currently seems to be.
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Study Unit 13
Finance and International Business
Contents Page
Introduction 218
A. Finance and the Development of International Business 218
Factors Affecting the International Expansion Decision 220
Foreign Direct Investment 221
B. Financing International Trade 222
Terms and Methods of Payment 222
Finance for Exporters 223
Finance for Importers 227
Countertrade 228
C. Finance and the Multinational Company 229
The Role of Subsidiaries 229
Obtaining Funds Internationally 229
Performance Measurement in Divisionalised Companies 231
Transfer Pricing 233
D. International Investment Decisions 237
Factors Affecting the Investment Decision 237
International Investment Appraisal 238
Repatriation of Profits 239
Overseas Taxation 240
218 Finance and International Business
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INTRODUCTION
Financial management focuses on three types of decisions: investment decisions, financing
decisions, and money management decisions. In an international business all of these
decisions are complicated by the fact that different countries have different currencies,
different tax regimes, different regulations concerning the flow of capital across their borders,
different norms regarding the financing of business activities, different levels of economic and
political risk, and so on.
As we have seen, the development of international business usually follows a series of
stages, from exporting to full global operations. These stages also equate with the options
for market entry. Each of these involves a different financial commitment and a different set
of financial implications.
The various levels of international involvement will be a reflection of a number of factors:
The objectives of the business for example, to extract the maximum possible profits
from a subsidiary as quickly as possible, or to develop a lasting presence in the country
to the mutual benefit of all parties.
The conditions applying in the particular country for example, there may be
restrictions on the type of investment allowed, or the level and type of funds that can be
repatriated by a parent company.
The level of risk attached to business operations in the country. This is a significant
factor and we shall examine it in some detail in the next unit. However, it is worth
noting here that the risk associated with committing funds to international business
varies with the type of international involvement.
In this unit we shall examine the financial strategies associated with developing international
business in the light of the above factors.
Note that, in certain areas, we shall be covering similar ground to that in the Corporate
Finance module and the material here will repeat some of the concepts and considerations
examined there.
A. FINANCE AND THE DEVELOPMENT OF
INTERNATIONAL BUSINESS
The sequential nature of international expansion tends to follow a set pattern:
Exporting
This is the lowest risk option from the companys point of view as it involves no upfront
capital outlay. The risks relate to payment for the goods themselves, which we shall
looked at in the next section. Exporting also allows a company to test the water, so to
speak, by learning more about the market it is dealing with in terms of language,
culture, business practices and so on.
Licensing
Under this form of involvement a foreign company manufactures the home companys
goods and in return the latter receives royalties or other forms of payment. Again, the
level of capital investment is quite low, but on the downside returns may also be
correspondingly low and there is the added complication of maintaining quality
standards. A further consideration is that the licensing of a companys products can set
up foreign competition that could well close the market to direct exporting.
Finance and International Business 219
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Technical support or management contract
This can be viewed as an extension of licensing and is an attempt to impose some sort
of control on the foreign producer by having a contract to supply technical or
managerial know-how, spare parts, etc. Further fees can usually be earned as a result.
Technical or managerial support is also applicable where no licensing agreement exists
and can be a useful route into an overseas market.
Franchising
An entity in the UK owning patents or trademarks may want to exploit them abroad
through a local company. This can be done by granting the local entity a licence under
an agreement. The UK company would, under the agreement, ensure that their quality
standards are maintained.
Franchising operates where the licensee is to trade under the marketing image of the
holder of the patent or trademark, and under the name of the franchiser. Although the
franchisee operates under the name of the franchiser, the former, who takes the capital
risk locally, owns the outlet in the foreign centre. The franchiser usually maintains
some measure of control over the activities of the franchisee by the terms incorporated
in the agreement signed by both parties.
Strategic alliance
In recent years the strategic alliance has been prevalent in the motor industry (e.g.
Rover and Honda) and it is a partnership that is advantageous to both parties. It often
takes the form of swapping technical know-how from one party, in return for an entry
into the other companys market.
International sub-contracting
This is applicable to those instances where a company may have won a contract for a
large capital project part of which is best carried out by a company based in the foreign
country. If there are several sub-contractors in different countries this form of
agreement can become complex to control.
Joint ventures
This may take a number of different forms:
(i) Joint organisations
A partnership is defined in the Partnership Act 1890 as the relationship that
subsists between persons carrying on business in common with a view to profit.
Under English law certain rules apply to partnerships and, in the main, a partner
can bind the company, and all partners (except within limited liability partnerships)
are liable for the debts of the company.
In dealing with joint organisations and ventures the relationships and liabilities
between members will differ from those that apply within partnerships. Members
may agree on a loose or close relationship according to the needs and the
purpose of the joint operation.
(ii) Joint business organisation
There are various forms of joint business organisations but here it is sufficient to
say that the main objective is that various manufacturers agree to share the cost
of maintaining an exclusive representative or company abroad, which is
responsible for marketing the goods and manufactures of the companies
represented in the chosen area.
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(iii) Consortia
In order to be competitive when bidding for a contract abroad, say to build a
major plant or project, two or more companies may decide to form a new
company under the Companies Act. This new company will bid for the contract
and if the bid is accepted will be responsible for the completion of the work.
Some guarantees may be called for from participating companies and such
details and responsibilities should be agreed at the time of formation of the new
company. Sometimes the arrangements are less rigid and the result is a
relationship somewhat similar to that between members of a partnership.
(iv) Joint venture
Companies trading abroad may wish to be involved on a business basis with a
local company in the country to which their goods are directed. The two
companies will enter into an agreement to cooperate. Through this agreement
the goods of, say, a British company may be produced or assembled in the
foreign centre from parts exported from the United Kingdom, possibly through a
joint venture company. The agreement will state the conditions and terms under
which the joint venture will operate, the input required of both parties, the
arrangements regarding management; and general details covering the particular
operation including the distribution of profits. Experts, who will be aware of the
objectives of the venture and the wishes of the parties to the agreement, must
draft the form of contract. Having agreed on the terms of the cooperation
agreement, consideration must be given to the legal form the joint venture will
take.
The form of the venture should be flexible and possibly a private limited company
will suit both parties. However, the joint venture company or entity may have to
be incorporated in the foreign centre and the foreign government may dictate its
form. The law relating to the foreign country, including any restrictive trade
practices must, of course, be complied with.
Joint ventures have become of particular importance in trade with China and East
European countries. Some of these countries allow profits to be shared, but after
a term of years all subsequent profits must then go to the local company and sole
control then rests in the foreign country.
Economic interest groups (e.g. European Economic Interest Groups) are
organisations that aid parties to joint ventures to cooperate and overcome
differences in culture and legislation.
This is, of course, the final stage and is usually achieved by the acquisition of an
overseas entity. The advantage is that it provides instant access to the chosen market,
but against this is the high capital investment required and the possibility of
expropriation of the assets by the foreign government.
Factors Affecting the International Expansion Decision
It is often the case that the move into international markets is a sequential one, but one which
can be short-circuited depending on circumstances. Some of the factors affecting the
decision are:
The size and scope of the company concerned The larger the entity the more
likely that it will use its expertise and resources to acquire an overseas subsidiary
rather than begin by exporting.
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The level of international experience gained to date With little or no experience it
makes sense to begin by exporting to an overseas country thus incurring the minimum
risk.
Financial, managerial and technical strengths The considerations here are similar
to the first point. The larger a company is the more likely that it will have the necessary
internal expertise to make a direct acquisition successfully.
Industry and market conditions The condition of the overseas market may be such
that it is considered too volatile to enter, in which case a strategic alliance may be the
only option.
Availability of resources and their costs Does the company have sufficient internal
resources or does it need to borrow or issue new equity and what is the cost of such
funds?
Permissiveness of environment This is very much related to the attitude of the
overseas government to investment from foreign companies.
Risk This includes political risk and currency (exchange rate) risk that we consider in
the next unit.
Foreign Direct Investment
There are several reasons why a company may grow via foreign direct investment (FDI) and
become a multinational, and often in making the decision financial considerations are
outweighed by strategic reasons. The common reasons quoted for FDI are listed below, but
you should note that there is often more than one reason why a company may decide to
invest overseas:
The provision of raw materials such as oil and minerals, many MNCs base part of their
operations at the location of their raw materials, for cost or logistic reasons, or in order
to comply with the political and legislative wishes of the host government.
The provision of cheap and productive sources of labour is a reason given for many
MNCs locating in the Far East and Mexico.
Location in the market for the companys goods, for example, several Japanese car
companies have located in Europe in order to supply the EU market.
Location in centres of knowledge, for example, several Japanese and European
companies have purchased companies in the US in order to gain access to
technological knowledge in the field of electronics, and Microsofts plan to establish
facilities in Cambridge is an example of a company investing in Britain for this reason.
To permit diversification opportunities not available in the companys domestic markets.
To allow growth if there are limited opportunities for the company at home; such
growth can take the form of diversification, horizontal or vertical integration.
For companies based in countries with unstable or unpredictable political regimes FDI
may be a way of ensuring safety from interference in, or expropriation of, their
business. Such fears led to FDI in Australia and North America by Hong Kong-based
companies prior to its repatriation by the Peoples Republic of China.
To avoid import controls or to obtain grants and concessions.
The most common forms of investment abroad are:
The takeover of, or merger with, a company already established in the target country.
This option has the same advantages and disadvantages as a domestic takeover,
established markets, production and distribution facilities, but often poor performance,
financial status and management.
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Joint ventures with an overseas partner local to the area where investment is to take
place, either for a fixed period of cooperation on a defined number of projects, or a
continuing long-term joint-equity venture. Joint ventures are common in the Middle
East and Japan where legislation prevents or makes difficult 100% foreign ownership of
companies. It is also becoming increasingly popular in areas with high research and
development costs such as the aerospace and car industries.
Companies may start up overseas subsidiaries or branches from scratch. This route
reflects the same advantages and disadvantages as domestic start-ups with the
additional problems/opportunities that may occur as a result of differences between the
two countries concerned.
B. FINANCING INTERNATIONAL TRADE
Working capital finance requirements for overseas trade are likely to be greater than for
solely domestic trade because of transport time, administrative delays and perhaps longer
credit terms (90 days from shipment or 60 days from receipt).
Before considering financing methods themselves, it will be useful to briefly review the terms
under which international trade transactions are conducted.
Terms and Methods of Payment
The most common form of settlement for the cost of a trading transaction is by means of a
bill of exchange (also called trade bills). This occurs when the seller draws a bill on the
buyer asking them to pay, on a certain future date, the price of the goods supplied, which is
then accepted by the purchaser (by signing and returning it to the seller). The purchaser is
thus formally acknowledging his debt to the seller. The seller can then use the bill of
exchange as security in order to obtain money from the sellers bank.
A bank may also agree to accept a bill from its customer in exchange for an agreement that
the customer will repay the bank. The cost for arranging this finance is the discount (i.e. the
full amount of the bill is not advanced). The more secure the bill (e.g. from a bank as
compared to a trader) the finer or lower the discount.
Note that a bill of exchange is a method of facilitating payment and could therefore be used
in several of the different ways in which payment for transactions may be effected:
Open account The exporter ships the goods and any documents of title direct to the
importer. The importer in accordance with invoice terms makes payment, the exporter
bearing the risk of non-payment.
Documentary collection The exporter ships the goods and sends the documents of
title through the banking system. There is a collection order that instructs the overseas
bank regarding release of documents to the buyer. The exporter can instruct that the
documents are either released against payment or against acceptance.
Open account trading status reports should be taken on the buyer, and insurance can
also be taken out, if required.
Documentary letters of credit A documentary credit is a guarantee by the buyers
bank (the issuing bank) that bills of exchange drawn by the exporter will be honoured,
provided the credit terms have been fulfilled.
If the credit is irrevocable, it can only be modified or cancelled with the agreement of all
parties.
Concompanyed credits are ones that contain the additional guarantee of a bank in the
exporters country to honour them, should the issuing bank default.
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Documentary credits have an additional security over documentary collections. Banks
deal in documents not in goods and, as the seller must comply with the instructions
issued by the buyers bank, the seller will check those instructions before shipping the
goods and, if he can comply with the instructions, he will get his money. Failure to
comply with the instructions as detailed will mean that the sellers bank must refer to
the buyers bank and get permission to effect payment.
Advance payment terms The most advantageous method of payment from an
exporters point of view is to receive cash for his goods before shipment. This method
affords the greatest protection and allows the exporter to avoid tying up his own funds.
Although less common than in the past, cash payment upon presentation of documents
is still widespread.
Cash terms are used where there is political instability in the importing country or
where the buyers credit is doubtful. In addition, where goods are made to order,
prepayment is usually demanded, both to finance production and to reduce business
risks.
Finance for Exporters
Delays in receipt of payment for goods sold overseas can seriously affect a companys cash
flow, eventually reducing profitability. Banks and other organisations have therefore
developed a wide range of finance facilities to assist exporters in financing their international
business. Export credit can be split into two categories:
Supplier credit Where the exporter sells goods to an overseas buyer on credit terms
(for example, 30 days) and then obtains finance from a bank to cover the period of time
between shipping the goods and receiving payment.
Buyer credit Where the bank provides finance directly to the overseas buyer and the
exporter receives payment upon shipment of the goods.
Payments made by banks in respect of various export finance schemes are paid either:
With recourse Where the bank has the right to claim reimbursement for sums
advanced to the exporter, in the event that the buyer does not pay.
Without recourse Where the exporter is not liable to repay finance received from a
bank, if the buyer defaults.
If the exporter is cash-rich, he may be able to finance export sales from his existing bank
balances. However, the outlay can be considerable and, if credit terms are allowed to the
buyer, the cost of raw materials, manufacturing and shipping will not be recouped in the form
of the buyers payment for some time, and additional funding may be required. The following
are the normal method of obtaining such funding:
Bank overdraft Probably the easiest way of financing export sales is by use of an
overdraft facility agreed with the exporters bankers, though exporting companies are
unlikely to use this method to finance all their exports, since other forms of finance
which are specifically designed for export credit are available at lower cost.
Advance against bills This is short-term, with-recourse, finance obtained by an
exporter who draws a bill of exchange, under the terms of the export contract, on the
overseas buyer. The exporter presents the bill of exchange to the bank, which
advances an agreed percentage of the face amount of the bill to the exporter and
undertakes to present it to the buyer for collection. The bank charges a fee for this
service, together with interest at a variable rate for the period of the advance.
Negotiation of bills This means that the bank buys the bill from the customer. The
customer receives the face amount of the bill immediately. The bank sends the bill of
exchange and the related shipping documents to the buyers bankers for collection and
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reimburses itself upon receipt of the proceeds, at the same time recovering its
collection charges and interest for the period involved.
A negotiation facility must be specifically agreed with the exporters bankers, and funds
made under this facility are on a with-recourse basis. Recourse is available to the
banker upon dishonour of the bill, the charges and interest for this being fixed at the
time of negotiation.
Discount of a bill Banks are prepared to discount bills of exchange which can be
either:
(i) Drawn by an exporter on a buyer and accepted by that buyer.
(ii) Drawn by an exporter on a bank, under a letter of credit, and bearing a bank
acceptance.
Bills are discounted with recourse to the customer and the discounting bank pays the
face value of the bill less the discount charge which depends partly on the length of
time the bill has to run to maturity and partly on the rate of discount which is usual for
that type of bill. Finer rates are available for bills bearing a bank acceptance than for
those accepted by an unknown or doubtful buyer.
Acceptance credit facility This is a facility offered by banks for large companies
with a good reputation. The company draws bills of exchange on the banks, generally
for 60, 90 or 180 days, denominated in whichever currency most matches the needs of
the company. The bills can be drawn on, as and when required, throughout the length
of the agreement, which can be up to five years, provided the credit limit is not
exceeded. The bill is then sold in the discount market and the proceeds passed to the
company (less the banks commission). At maturity the company reimburses the bank
the full value of the bill, and the bank pays the holder of the bill.
A major advantage of acceptance credits is that they can be sold at a lower discount
than trade bills. The cost of them is also fixed, allowing for easier budgeting and may
be lower in times of rising interest rates than that of an overdraft. The credit is also
guaranteed for the length of the agreement, which is not the case with an overdraft.
Where goods are involved, the bank generally has control over the documents and the
goods.
An acceptance credit facility is normally only used by larger companies. Be careful not
to confuse it with a documentary acceptance credit.
Documentary acceptance credit When an exporter presents documents under a
concompanyed irrevocable letter of credit to the concompanying bank, he can obtain
immediate finance, provided the documents comply with the terms of the letter of
credit. The concompanying bank will accept a term bill of exchange that can be
discounted by the concompanying bank, or the exporter can regain possession of the
accepted bill and discount it with any bank for cash. The exporter pays discount fees
unless, under the terms of the letter of credit, the applicant/overseas buyer is
responsible for such costs.
Merchant bank finance A merchant bank could provide most of the facilities already
mentioned but, in addition, it can offer an accepting house acceptance facility. The
exporter again hands over the documents as collateral security and draws a second bill
on the accepting house for up to, say, 75% of the collection value and with a tenor
slightly longer than the export bill, to allow receipt of proceeds before the
accommodation bill matures. The merchant bank accepts the accommodation bill and
discounts it in the market. For protection against risks, the merchant bank would
expect not only to have control of the bill and the documents it is handling for collection,
but also additional safeguards such as insurance cover.
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Factoring Factoring is a without recourse form of finance and the factor will only
enter into an agreement with an exporter after satisfactory reports have been obtained
as to the exporters standing, the reliability of the overseas buyer, and trading
conditions in the foreign country.
There can be many advantages for the exporter in employing a factor to deal with his
debt collection:
(i) Credit risk is eliminated under the non-recourse agreement.
(ii) There is no need for credit and political risk insurance.
(iii) There is no need to take out forward exchange cover.
(iv) Immediate financing is available on approved invoices, if required.
(v) There are no losses through bad debt.
(vi) There is a reduced staffing requirement, since accounting, debt collection and the
sales ledger are handled by the factor.
(vii) It gives the exporter the opportunity of trading on open account terms, but with
the security of also using more traditional instruments, such as letters of credit
and bills of exchange.
(viii) There is no need for any other source of status reports and credit information.
(ix) Experienced credit managers are on hand, whose knowledge of language, local
laws and trading customs are invaluable. A factor with established contacts is
able to assess foreign buyers creditworthiness more easily and thoroughly than
the exporter can from his own sources.
However, the disadvantages of factoring must also be considered:
(i) Costs. These vary, depending upon the extent of the service required by the
exporter, administration of the exporters exports sales ledger; credit protection,
financing.
(ii) A factor is selective in choosing clients and debts.
(iii) A factor may set an overall turnover limit for the exporter.
(iv) A factor may set a limit on the amount owing at any one time by any one buyer.
(v) Terms may be limited to 120 days.
Factors lend or provide finance against debts that are already approved on the strength
of the creditworthiness of the overseas buyer. The exporters own bankers may be
prepared to effect an introduction to a factoring subsidiary of the bank. An exporter
considering employing the services of a factor should always consult his bankers, since
factoring can affect the value of a lending bankers security.
Export house finance Export houses can be grouped into:
(i) Export merchants These buy goods in their own right from suppliers and
export them to their own buyers abroad for cash, usually within seven days. A
merchant can therefore eliminate credit risk for the exporter, and transform the
deal into the equivalent of a domestic cash sale.
(ii) Export agent An export agent acts as agent for the exporter, and the contract
relationship between the buyer and seller is maintained. The exporter receives
payment from the export agent upon shipment of the goods, and the overseas
buyer is allowed a period of credit by the agent, which is provided from the
agents own resources.
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(iii) Concompanying house A concompanying house acts as agent for the
overseas buyer, places an order with the exporter, and accepts a usance bill from
the buyer that can be discounted at a fine trade bill rate. The buyer therefore
receives a period of short-term credit, and the exporter need not be concerned
with credit risk, since this is the equivalent of a domestic sale.
(iv) Export finance house This will provide non-recourse finance to the exporter
under the terms of the export contract and agree credit terms to the buyer. Like
the factoring company, it will deal with obtaining a credit assessment of the buyer
and will relieve the exporter of the need for credit/risk insurance but it can
arrange such, if required, or accept an assignment of a policy, as the banks do.
Instalment finance Some finance houses can arrange hire-purchase finance,
covering a wide range of consumer and capital goods, through a network or credit
union of associates in both buyers and sellers countries.
The exporter will gain satisfaction from the arrangement (which is without recourse to
himself), as he receives immediate payment, while the buyer receives deferred terms
under a hire-purchase agreement. It is a relatively costly plan, and it may not work
where there are exchange control restrictions or other monetary regulations.
Leasing An exporter sells the equipment to a leasing company, which then leases it
to an overseas hirer. The exporter receives payment without recourse from the leasing
company, usually after the equipment has been shipped and installed at the hirers
premises.
There are two main types of lease seen in the international context:
(i) Cross-border leases, which are made directly from the leasing institution (often
subsidiaries of major banks) in the exporters country to the overseas buyer.
(ii) Local leasing facilities, which may be available, perhaps, through overseas
branches or international leasing associations.
Both types of arrangement may be eligible for insurance cover. Where contracts are
arranged between the leasing company and the foreign buyer, the lessor will undertake
the insurance. Here the exporter will have no risk, having sold the goods direct to the
leasing company. In those cases where the exporter arranges his own leasing deals
direct with the foreign buyer, he will himself be able to obtain cover.
Forfaiting Forfaiting is a means of providing exporting companies with trade finance
on a without recourse basis, while their overseas buyer acquires a period of credit of up
to seven years.
When forfaiting, an exporter is giving up the right to claim payment for goods delivered
to an overseas buyer. These rights are surrendered to the forfaiter (normally a bank,
finance house or discount house) in return for cash payment at an agreed rate of
discount.
Any type of trade debt can be forfaited and these debts can be in any form but they are
usually either:
(i) A bill of exchange accepted by the buyer.
(ii) A promissory note issued by the buyer.
The forfaiter will calculate the discount rate, taking into account:
(i) The currency used.
(ii) The buyers credit rating.
(iii) The credit-risk factor for the buyers country.
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The discount rate is calculated as a margin above prevailing eurocurrency market rates
for the period of credit and it varies in line with those rates, since this is the main
source of funds which forfaiters tap to provide finance to exporters. Trade paper is
discounted in any fully convertible currency, although US dollars, Swiss francs and
Euros are usual, since these are the main eurocurrency market currencies.
A forfaiter will not finance a trade debt without the guarantee of a known international
bank, although finance will be considered in respect of bills of exchange accepted, or
promissory notes issued, by a first-class buyer, such as a government agency or a
major multinational company.
Advantages of forfaiting for the exporter include:
(i) Forfaiting offers 100% finance on a without recourse basis and at a fixed rate,
thereby enabling the exporter to build finance costs into the contract price.
Finance is off-balance sheet, thus preserving existing bank credit facilities.
(ii) In addition to removing interest risk, forfaiting also eliminates exchange, credit,
political and transfer risks.
(iii) Forfaiting is flexible, there being no distinction between types of goods and
services and no constraints on origin.
(iv) Forfaiting finance can be arranged very quickly, and documentation is brief and
relatively simple.
(v) Forfaiting transactions are rarely published, and this aspect of confidentiality is
often attractive to exporters.
(vi) The ability to offer forfaiting in a tender may be necessary in order to remain
competitive.
Disadvantages of forfaiting for the exporter include:
(i) Despite the greater degree of competition among financial institutions for
forfaiting business, which has brought interest margins down, forfaiting tends to
be relatively expensive.
(ii) Forfaiting is generally limited to the major currencies, and forfaiters will not accept
countries where too great a risk is perceived. Similarly, the forfaiting institutions
will only accept the aval of a limited number of banks considered suitable.
(iii) The exporter normally has a responsibility to ensure that the debt instruments are
validly prepared and guaranteed.
Finance for Importers
The importer must also have adequate finance available to enable him to purchase goods
either for immediate resale or for processing prior to resale. Banks and other financial
institutions have developed various products to make sterling and foreign currency financing
available to importers.
These are similar in nature to the methods available to exporters and include the following.
Bank overdraft In most cases an importer would not be able to finance all his
purchases from an overdraft facility, since this is an expensive source of finance.
Overdraft facilities may be secured or unsecured, depending on the financial standing
of the importer.
Bank loan Bank loans are available to companies in both sterling and foreign
currency. The bank, however, would call for some form of security.
Importers may take advantage of favourable interest rates by borrowing in foreign
currency, especially if they are able to make repayment of the loan from receivables
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denominated in the same currency. Eurocurrency loans are available for large national
or international projects.
Term documentary letter of credit The importer can ask his bank to open a
documentary letter of credit in favour of the seller, under which drafts are drawn,
payable not at sight but at usance, i.e. 30, 60, 90, 120 or 180 days after sight. The
exporter can readily discount such bills and get spot cash because of the standing of
the accepting bank. The importer, however, does not have to provide cash until the
maturity of the bill. As an alternative, where a documentary letter of credit is not
considered appropriate, the importers bank may simply add his pour aval
endorsement to the bill. This guarantees to the drawer that the bill will be paid at
maturity.
Produce loan or merchandise advance A produce loan is made by a bank to an
importer to enable him to pay for goods that he has contracted to buy. The goods are
the security for the loan, which is repaid from the proceeds of sale.
Produce loans are granted for short periods only, long enough for the importer to be
able to resell the goods and repay the loan with the proceeds, usually between seven
days and three months.
Acceptance credits As described above in respect of exporters.
Export credit Export credit agencies have been established in several countries, to
encourage the export of goods and services. The exporter can obtain credit facilities
from these agencies at fixed and preferential interest rates, which enables credit
finance to be made available to importers in other countries.
Rates of interest and lengths of credit terms are agreed by members of the
Organisation for Economic Cooperation and Development (OECD) and these terms,
which are offered by most national credit agencies, are reviewed on a regular basis.
Concompanying houses The importer can receive short-term credit from the
concompanying house, to which he must pay a commission for the service provided.
In addition to direct financial assistance, banks also provide a range of further services. The
principal service is effecting payment:
Where open account or payment in advance terms is used, banks will effect payment
by means of money transfers, telegraphic transfers, the SWIFT system, or by draft.
Opening of documentary letters of credit, including back-to-back and transferable
letters of credit.
Selling foreign currency to the importer to settle his purchases, both on the spot and on
forward currency markets.
In addition, they will also obtain status reports on prospective suppliers, provide advice and
practical assistance in complying with exchange control requirements, import licences,
documentation, etc., secure travel facilities for importers seeking to make contacts overseas
and assist in finding suppliers via the banks correspondent networks, and arranging
introductions.
Countertrade
Countertrade can be defined as a trading transaction whereby export sales are dependent on
the exporter receiving imports, in one form or another, from the buyer. We have already
considered this as part of the examination of pricing in Unit 9.
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C. FINANCE AND THE MULTINATIONAL COMPANY
The Role of Subsidiaries
As a general rule, the subsidiaries of an MNC will be expected to earn a profit for their parent
organisation, and their financial policies and planning will be based on the objectives and
interests of their parent. In theory, each subsidiary should be capable of financing itself,
whilst continuing to make a profit for the parent company, although this may not always be
possible. New operations in a foreign country may mean that the company does not
generate a satisfactory return in the early years. In such circumstances the parent may have
to support the company by the provision of cash or guarantees.
Nonetheless subsidiaries do, in general, stand on their own feet and provide their own capital
from their own generated profits.
Countries that receive foreign investments have to accept that foreign subsidiaries of MNCs
will become net exporters of cash in the longer term. One of the main benefits to the host
country, beyond the creation of jobs, arises from the payment of taxes and customs duties.
Generally, too, the level of industrial investment will be increased, and the balance of
payments of the host country will be improved as the MNC starts to export to other parts of
the world.
Benefits are not always one-way. Decisions to transfer reserves out of the host country may
not be in its best interests, and pressure may be brought to bear by the government of the
home country of the MNC. An example of this is when companies in a host country are
required to limit their import of capital and to send home high proportions of their foreign
earnings.
Obtaining Funds Internationally
When considering options for financing a foreign investment, an international business has
two factors to consider. The first is the issue of how to finance the foreign investment. Most
importantly, if external financing is required, the company has to decide whether to borrow
from sources in the host country, or to borrow from sources elsewhere. The second factor
that has to be considered is how to configure the financial structure of a foreign affiliate.
Borrowing from the global capital market may be restricted by host government regulations or
demands. In such cases, the discount rate used in capital budgeting must be revised
upwards to reflect this.
For example, fragmented payments infrastructure had been holding back a pan-European
banking market in 2007, and the industry needed to work quickly to ensure that a Singe Euro
Payments Area (SEPA) is up and running on time in 2010.
Enhanced corporate finance markets would give European companies greater access to
capital. By one estimate, a fully integrated financial market could lower the cost of capital by
50 basis points. The Markets in Financial Instruments Directive (MiFID), which created an
EU passport for securities, was a major step towards integrated securities markets.
MiFID came into effect on 1 November 2007, replacing the existing Investment Services
Directive (ISD). This extended the coverage of the ISD by introducing new and more
extensive requirements that companies will have to adapt to, in particular for their conduct of
business and internal organisation.
The aim of the ISD was to set out some basic high-level provisions governing the
organisational and conduct of business requirements that should apply to companies. It also
aimed to harmonise certain conditions governing the operation of regulated markets.
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In general MiFID covered most, if not all, companies currently subject to the ISD, including:
Investment banks.
Portfolio managers.
Stockbrokers and broker dealers.
Corporate finance companies.
Many futures and options companies.
Some commodities companies.
For MNCs, because of the scale of operations there is rarely any difficulty in raising funds,
but there may be a local limit to the amount of borrowings which the host country is prepared
to allow.
A company needs to consider the cost, timing and speed of overseas loans, as well as the
size of loan and the currency the borrower wishes to obtain. The security required should
also be borne in mind, as should any potential to reduce exchange rate exposure.
Treasurers should not forget that interest rate parity can show how, when considering
exchange rate movements, the real cost of interest rates in different currencies are similar.
However sometimes, because of market imperfections, there can be opportunities to obtain
cheaper loans in alternative currencies.
A common method of financing an overseas subsidiary is to finance its fixed assets with a
long-term loan in the host countrys currency; this allows the repayment of the loan using the
profits generated in that country. This is known as matching of assets and liabilities, and
is a method used to reduce exchange rate risk.
MNCs often use international sources of funds, for example, eurobonds, eurodollars and
overseas capital markets, to finance both themselves and their subsidiaries. The borrower
must be of high credit standing and must need large sums of money, as these markets are
for the international gathering of capital resources and are not aimed at the smaller
organisation.
When considering a eurocurrency loan, companies need to consider likely fluctuations in
exchange and differential interest rates creating an interest rate trap, where a lower interest
than that achievable on the domestic market becomes more expensive in both domestic and
foreign currency terms due to changes in the exchange rates.
Arbiloans (international interest arbitrage financing) are variations on currency swaps that
may be of use in financing MNCs. A subsidiary based in a low interest rate country borrows
and converts at the spot rate to its parents currency. The parent then agrees to repay the
loan at the term end and at the same time buys a forward contract. This is common when a
parent faces credit restrictions and high interest rates.
In deciding the financial structure of an overseas subsidiary, the parent must consider a
number of features:
The level of gearing the subsidiary should have, and from what source.
How much equity should be placed by the parent in the subsidiary and how much from
outside (and from what sources).
The level of reserves and working capital the subsidiary should aim for.
These choices will be determined by political and legal restrictions in the parents country and
the host country and the expected level of permanence of the investment. For a longer-term
investment, long-term sources of funds such as equity would be used in preference to short-
term funds such as trade credit, which would be used for a short-term investment.
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Moreover the company, in common with all organisations, needs to consider the cost of
capital, including the cost of local finance. Whilst the factors affecting a domestic company
when deciding on its capital structure also need to be considered by an MNC, the decision is
made somewhat harder by the greater choice of capital available from international capital
markets, taxation and other legal restrictions (such as on dividends or the flexible repayment
of loans to parents) in the various countries in which the MNC operates, as well as potential
subsidies from host governments.
A further factor to consider is that subsidiaries may have a guarantee from the parent
company, thus permitting a higher level of debt than would otherwise be the case.
Governments will often wish to encourage MNCs to establish operations in their country,
thereby creating wealth and increasing employment. This is often achieved through grants,
subsidies, favourable loans and guarantees. Whether help is given to a business applying
for such help will be dependent upon whether its proposals qualify.
Performance Measurement in Divisionalised Companies
A special relationship exists between two companies which are associated or commonly
owned, which may carry on trade with each other, and over which some central authority or
head office wishes to exercise control.
Since, as a division within a group, the results of perhaps formerly independent companies
are now submerged, the groups central management has to monitor its divisions
performance at acceptable levels, without recourse to the market as a barometer of
achievement.
The central or corporate management obviously wishes to exert control over its divisions. It
is claimed that centrally-imposed systems of budgets are restrictive, and that, by constraining
the divisions to some pre-set level of performance, monitored (and sometimes set) by the
central management, the profit-motivated, local management creativity of the entrepreneur is
diminished:
Cash flow
In the majority of groups, cash is controlled centrally rather than at divisional level.
Inter-divisional indebtedness is then passed through a system of current or suspense
accounts. The problem is whether divisions should be charged for their level of
indebtedness to central control. If so, is this unfair to the division that does very little
external business but trades mostly with fellow divisions and regularly has to seek
central funding?
Common facilities
Certain facilities are obviously best not duplicated, especially where more than one
division operates from the same premises, for example, telephone systems, buying
activities, personnel function, financial management, etc. The sharing of such facilities
by divisions leads to the problems of sharing the costs, the cash flows, the supervisory
responsibilities and other similar problems which are almost inevitable where no one
employer (division) controls the facilities.
Measuring management success
Clearly, the all-embracing measure of performance is profit-related in meaningful terms
to investment used in creating that profit. But does managerial success bear an exact
correlation with profit? Managers can manage successfully, and the result may still not
be profitable. The fact that they managed as well as they did might have kept the loss
under reasonable control. Alternatively, bad management might still produce profitable
returns, albeit much lower than might have resulted with good management.
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So, we should attempt to measure management performance quite separately from
return (profit) on resources used. This is perhaps best carried out subjectively, assisted
by considering such things as market share, customer relations, employee turnover,
etc.
Return on investment
Measuring return on investment within a division is by no means straightforward. There
is the problem of usage of central facilities such as warehouses, laboratories, and
advertising. If each division is to be allocated some part of the central facility, the
divisional manager no longer controls all the profit/investment content of the ratio
measuring him. Maybe a divisional manager has control of his investment up to a
certain level, beyond which he must seek further authority. Since presumably in times
of scarce resources some requests for an extension of investment will be refused, the
manager, again, does not control his investment.
It is generally accepted that, in conditions where investment is dictated to the division,
control measurement should be based on maximising the absolute profit earned. This
criterion implies that the central management will dictate policy as to the overall growth
of each division. Maximisation of profit can be achieved quickly in the short term, for
example, by slashing expenditure on maintenance, advertising, research and
development, staff facilities and training, etc. but these economies would leave the
division in poor shape for future growth.
Using return on investment or, more accurately, maximisation of return on investment,
is dubious. Percentages are averaging figures. A manager seeking to maximise return
on investment, who already has a high return of, say, 20%, will reject projects which
offer less than 20% because they will reduce his average return. However, a project
offering, say, 18% would still be of great interest and benefit to the company with a cost
of capital of, say, 16%. By maximising the return of the division, it might also optimise
the results of the company as a whole.
Residual profit
Where the division has large, if not exclusive, control over its investment, the device of
residual profit is important. Consider the following:
Company/Division X
(000)
Y
(000)
Profit 300 900
Capital employed 1,500 6,000
Return on capital employed 20% 15%
Here X offers the best relative return on capital employed and appears to be the better
performer. Of course, the levels of investment are disproportionate, as is often the
case i.e. we cannot say that Y is four times as big as X, etc., because in industrial
activity some aspects have to work side by side as necessary components of the
whole, one may be capital-intensive as opposed to labour-intensive but both are vital.
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If the cost of capital was 10%, then:
X
(000)
Y
(000)
Profit 300 900
less Cost of capital 150 600
Residual profit 150 300
Now Y offers the best absolute amount of money after meeting its capital cost.
Note that residual profit cannot be related directly to capital employed, as the relative
volumes of capital have already been taken into account by charging their costs.
Generally, then, when the company/division has a large measure of control over its
investment, the criterion of maximising residual profit is the best measure of
performance.
The underlying criterion is, remember, the need to give central management a control
measure on their divisions that lets each division behave in a manner that is optimal for
the group as a whole and not just for the individual division.
Currency issues
One of the major problems in overseas performance assessment is that the subsidiary
may operate in a different currency and a decision has to be made as to which
currency to use. When setting budgets, for instance, not only will there be assumptions
concerning performance levels in terms of sales, etc. but also assumptions concerning
exchange rates. In addition to this transaction exposure, if performance is looked at in
home currency terms there may also be translation exposure to deal with.
Several methods have been suggested to try to overcome these problems; one
solution involves preparing a most-likely budget in local currency and applying
sensitivity analysis to produce a worst-case scenario. Once exchange rates are
definitely known (i.e. after the end of the period in question) this information can be
used to calculate a set of standards for the year against which actual performance can
be measured. Another method that has been suggested is to measure the net cash
flows generated, convert them into home currency at the prevailing rate of exchange
and discount them at the appropriate cost of capital to give a figure for net present
value (NPV).
Any performance measurement scheme should have the following objectives:
To evaluate the performance of individual managers.
To monitor cash and profits generated to ensure they are adequate.
To aid resource allocation.
To provide a set of standards to motivate overseas subsidiaries.
Transfer Pricing
The underlying philosophy of the process of divisionalisation is that, by allowing divisions to
trade and operate autonomously, divisional management is able to cultivate its profit
motivation in a competitive atmosphere. Of great importance is the situation where
competing divisions supply not only the outside market but also the other divisions. Such
inter-divisional trading can cause many problems.
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Transfer pricing arises where member divisions of the same group carry on trade,
transferring goods and services, with each other. Other financial transfers occur in the
transfer of money from one country/currency to another within the group.
This is potentially a controversial area of multinational companies activities because
transfers may be made at a price which suits the needs of the group as a whole and ignores
the needs of the subsidiary or the requirements of the host country. The issues associated
are:
If divisions are to be judged by the criterion of profit and yet carry on trade with each
other, profit or some representation of it must be built into the transfer price.
If divisional behaviour is not to cause loss to the overall group, divisions may be
directed by central management to provide or sell goods and services to their fellow
group members.
Alternatively, transfer prices may be determined centrally in order to ensure
optimisation of the groups taxation policy. For example, group ABC (a multinational
concern) finds that company A is facing high taxes on profits in a certain country.
Company A can then be forced to transfer its goods and services to company B (also
part of the group) at such a low price that company A makes little profit and company B
makes a very large profit. The group as a whole gains by avoiding the taxes in the host
country of company A.
The problem is that such direction may act against maximising individual divisions
performance, compared with what would have been achieved, say, by trading with outsiders.
The resulting issues are:
Determining transfer prices
Transfer pricing must be matched to its objectives. No divisional action must be
allowed, by way of transfer price system inadequacies, to enhance the position of the
division at the expense of the corporation. Secondly, it is important to promote
divisional managerial motivation in the profit-orientated environment.
There are a number of methods of calculating transfer prices:
(i) Full cost
Where full cost is used there is an obvious danger. The user-divisions taking
units of service or commodity from a supplying division at full cost (of the supply
division) will regard this full cost as a variable cost to themselves. The more they
use or buy, the greater the cost incurred by them. In fact, the cost they regard as
variable will have a fixed as well as a variable content so far as the supply
division is concerned.
Now, the user-division will have its own fixed/variable cost pattern, although
some of what they regard as variable cost is, in fact, partially fixed. The result is
as shown in Figure 13.1, which represents a break-even chart for a user division
with full cost transfer pricing from a supply division.
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Figure 13.1: Break-even chart for a user division
The overall total cost will be the same but the fixed/variable patterns will be
wrongly assumed, due to regarding transfer prices as variables. The result
could be some dangerously erroneous decisions where profit/volume factors
become significant, with the margin of safety smaller than that assumed.
(ii) Marginal cost
This clearly points to the use of a marginal cost basis that will, however, leave the
problem of disposing of the supply divisions fixed costs. This could be achieved
either by charging them to the user-divisions in blocks (perhaps related to usage)
or passing them to the central head office for charging to the consolidated
accounts, the user-divisions receiving, in effect, a two-part tariff charge.
(iii) Full or marginal cost plus profit
Full or marginal costs could have profit additions made to them to allow
profit/investment measures to be unaffected by inter-group trading. The danger
will be that user-divisions, possibly twice or more removed, will have a
cost/selling price/discounts policy rather confused by the strata of internally
added profits.
(iv) Current market price
Current market prices are the ideal solution to transfer pricing because they are
objective and related to factual situations in the outside world. Unfortunately,
however, there will be few conditions where a one-to-one situation will exist
between a divisions product and one in the open market. External products will
have minor design or quality differences, packing charges and discount
structures, which make exact comparability impossible. Certainly, too, where the
supply divisions output is a half-processed unit, i.e. work in progress, or some
intermediate process, such as polishing or packing, a comparable market price
will not exist anyway.
Activity
Imagined fixed cost
True fixed cost
Total cost
0
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(v) Negotiated price
The above situation may lead to the use of negotiated prices, but, then, might not
individual managers spend more time and ingenuity squabbling over the
negotiations than on advancing the overall corporate effort, perhaps leading to
central dictation again?
Which method to adopt will depend on prevailing circumstances in the company,
namely:
The central control or freedom of action imposed upon or allowed to divisions by
the corporate management.
The existence of comparable markets for the products of the divisions at the
intermediate stages of production.
The extent to which divisions are free to buy from, and sell to, the outside market,
rather than being restricted to using fellow divisions as suppliers or outlets.
All methods of transfer pricing are beset with practical difficulties related to
circumstances in the company. Perhaps the most favourable technique is to have
some two-part tariff arrangement, where each divisions fixed costs are charged to
user-divisions regardless of their use of them. The variable costs, possibly with a profit
addition, are charged on the basis of consumption by the users.
This suggestion, of course, tends to assume that usage is a sequential pattern with A
passing to B, and B to C, etc. Often, in practice, a reciprocal position may arise, where
subsidiarys costs are interdependent.
Also, are the fixed costs to be amalgamated with Bs and passed on? In view of the
optimising/allocation nature of the problem, a mathematical programming approach
may produce the best answer.
Reasons for manipulating transfer prices
One of the most common reasons for the manipulation of transfer pricing is known as
tax planning, which involves the careful and systematic avoidance of taxes to make
sure that profits are not taxed twice i.e. by two governments. Another reason is the fear
that, if too large a profit appears against a particular subsidiary, pressure will be applied
by government or customs to reduce prices, or by trade unions seeking large wage
increases.
Another influence on transfer prices is the market conditions in which a subsidiary
operates. The family network of a large worldwide group may make possible a price
war to gain a market advantage.
Governments are always finding ways to cancel out any tax advantages a company
may discover. They can make a careful check on comparative import and export
prices, and will soon discover if transfer pricing is being allowed to distort the position.
For example, in the UK the Controlled Foreign Company legislation was introduced to
prevent transfer prices being manipulated and tax havens used for undue tax
avoidance.
Large transfers of funds
One of the most controversial aspects of the MNC is its ability to move enormous sums
of money between subsidiaries in different countries.
The reasons for large transfers of funds around the world include:
(i) Funds for new investment.
(ii) Payments of profit and interest.
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(iii) Making and repayment of loans between member companies.
(iv) Payments for goods, services and expenses.
The main fear of international companies is that money will be lost due to factors
beyond their control, such as restrictions on the return of profits from a subsidiary to a
parent company, and the effects of changes in the value of currencies. This is why one
of the trends in international business is to pay the parent company as large a profit
return as possible, even if loans have to be made in order to keep the subsidiary in
liquid funds.
If international trade were entirely a matter of arms length transactions i.e. between
separate and unconnected companies in different countries, the movement of funds
would be easier for governments to follow and control.
(When a subsidiary in another country is not fully owned problems are likely to arise as
group objectives pull one way and those of the subsidiary the other. For this reason
MNCs much prefer to make their subsidiaries wholly owned.)
D. INTERNATIONAL INVESTMENT DECISIONS
The criteria by which investment opportunities are selected will vary between companies.
MNCs often prefer to invest in their own domestic market, and will only go abroad if they can
secure a higher rate on capital by so doing. However, sometimes the MNC will undertake a
foreign investment that is uneconomic. The main reasons for this are:
To ensure an outlet for some other aspect of its worldwide operations, for example, an
oil company may construct a refinery as an outlet for its own crude oil production.
To safeguard its existing interest, for example, by producing a new but uneconomic car,
in order to keep a brand name alive for the sake of a larger, successful model.
Studies indicate that many MNCs do not have a master plan for international investment but
review each individual project on its merits. It is generally the viability of the project, rather
than the finance available for investment, that is the key to the investment decision.
Factors Affecting the Investment Decision
The decision to locate, or relocate, part of an MNCs operations in a foreign country will
follow detailed research and often complex negotiations. Of the issues that will primarily
concern the management team, the following will be of particular significance:
Will the investment be temporary or permanent? For example, a temporary
investment, such as a mine, will be worked out within a finite period of time. In such
cases a loan will generally be the best method of financing, whereas for permanent
investment equity will usually be the best approach.
Is it best to operate as a branch or should a separate local company be created? The
answer to this question will depend on local considerations, including the tax laws of
the country concerned, as well as strategic policy regarding decentralisation of control
of subsidiaries. It may be advantageous to have a branch overseas if unprofitable,
converting it to a subsidiary when it becomes profitable. Special EU rules (for example
on mergers) can create other problems or advantages when deciding on the structure
of overseas operations.
Where borrowing is envisaged, should funds be borrowed locally, provided through the
parent or raised through the euro markets, and what exchange risk will be involved?
What is the cheapest and safest way of providing capital?
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The political, economic and currency environment, and particularly their stability, of the
country will determine a number of important factors, including:
(i) The stability of the market for raw materials.
(ii) Controls on the movement of product and currencies, and particularly how
difficult the repatriation of funds may be in the future.
(iii) Inflation and local taxes.
(iv) Whether it would be politically wise to have a local participation in the chosen
country.
(v) The support, assistance (and interference) of, and by, the government of the
country.
Other aspects of the business environment such as communication facilities, the ability
to acquire an established company or whether a green field operation can be
developed, the availability and cost of suitably qualified labour and management, and
the industrial relations record of the country, and the level of competition already
established in the region.
Entities trading internationally face particular difficulties based around different currency units
that can cause potential problems in translating one unit of currency into another. They also
have the problem of different laws, taxes, business practices and cultures that may be
incompatible with existing operating methods.
International Investment Appraisal
The assessment of the viability of overseas projects has many features in common with the
assessment of domestic projects. There are, of course, also marked differences so that
domestic budgeting techniques form only the foundation of overseas capital budgeting.
Investment appraisal in an MNC is conducted in a similar manner to the assessment of
domestic projects, using such techniques as net present value (NPV) and internal rate of
return (IRR). However, there may be differences adopted to reflect the differing nature of the
investment:
Cost of capital
The first issue is determining the cost of capital to be applied, for example, by using the
capital asset pricing model or the dividend growth model. However, if the risk/return
pattern of the project is in any way different to that of the company as a whole then due
allowance should be made by calculating a project-specific return.
Because the project is overseas based it is possible that the elements used to finance
it will be a mixture from the two countries concerned. If overseas funds are utilised
then further adjustments may be necessary due to the following:
(i) Retained earnings of the subsidiary or project that may be subject to withholding
taxes or tax deferral (which we shall look at shortly).
(ii) Local currency debt this is the after-tax cost of borrowing locally in the country
concerned:
Discount rate applied
An increase in currency and political risk may lead to the company increasing the
discount rate used to evaluate projects; or the company may use the discount rate
determined by its overall systematic risk level (if it is assumed to be unchanged by the
potential investment) and adjust the cash flows for the expected political and currency
risk. In practice the discount rate is adjusted for political risk, because all cash flows
would be affected by adverse political circumstances, whereas currency risk may have
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some beneficial, and some detrimental, effects on cash flows and as such is accounted
for by adjusting cash flows.
Parent or project cash flows
The project must be shown to be beneficial both in the host country and its currency,
and in terms of funds remitted to its parent, in order to fully justify it, both from the point
of view of the parent company and in comparison with other (potential) projects in the
host country.
However, the cash flows that are generated by the project are not necessarily those
that will be received by the parent. There may, for instance, be exchange control
regulations limiting the transmission of funds, in which case some of the methods
outlined earlier under the unblocking of funds may be used. It is important that the
distinction between the two is understood, as decisions made on the strength of project
cash flows can be very misleading.
The factors affecting cash flows, which must be allowed for in investment appraisal,
include the following:
(i) Exchange rates, the added complication that cash flows have to be converted
from the host currency to the domestic one.
(ii) Different tax rates in home and host country, which we shall look in more detail at
taxation shortly, but you should be aware that overseas taxation can play a major
part in determining whether or not a project is viable.
(iii) Royalties and fees payable out of the income, which cause differences between
cash flows to the project and to the parent company.
(iv) Restrictions imposed on the flow of funds from subsidiary to parent, which may
alter the complexion of the project from the parents point of view.
(v) The different rates of inflation between the host country and that of the parent.
Repatriation of Profits
The aim of investment in overseas subsidiaries is to increase group profits for the MNC and
central to this is the ability to transfer value through the group.
Those companies with inter-divisional trade need to determine the level at which to set
transfer prices for goods and services provided by one group member for another. The basis
on which the transfer price is set will affect the profit share of the group, and should be
determined in order to maximise group profits by developing the motivation of subsidiaries
and circumventing any repatriation controls imposed by the host government.
Transfer prices of goods and services provided by group members for each other are one
way of obtaining cash returns from an overseas subsidiary. Others include:
Royalties charged to the subsidiary for making goods, or providing services, for which
the parent holds the patent.
Management charges levied in respect of services provided by head office.
The subsidiary may borrow from its parent, and thus pay interest charges to it.
Dividends that can be paid to the parent on the equity provided by it.
The choice of method of obtaining cash returns, and level received from each (often by
manipulating the various factors, such as the rate of interest for parental loans), will be
determined by the requirements of the parent and the subsidiary, any exchange controls
present and the perceived risk of the investment.
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This manipulation can make the interpretation and evaluation of the accounts of MNCs and
their subsidiaries extremely difficult. The problem is exaggerated by the differing accounting
policies used in different countries; the differing choices made as to which exchange rates
(actual (and at what date) or predicted) to be used in setting forecasts and translating
accounts into the parent companys currency; and the different economic and political
circumstances a subsidiary may be operating in.
Overseas Taxation
The impact of overseas taxation can play an important part in the investment decision, as
noted above.
Withholding taxes, for instance, will be met quite regularly. These are taxes collected from
foreign corporations or individuals on income earned in that country. A UK resident in
France, for instance, may find that any dividends he receives could be subject to a
withholding tax of 20% that is then paid over to the French revenue authorities. Credit is
usually given in the home country for any taxes paid abroad. Thus, if a UK resident was in
the 40% tax bracket and had suffered the 20% withholding tax above, he would be liable for
20% of UK tax on that particular income. It is often the case, however, that if the withholding
tax rate exceeds the home country tax rate then no credit is given for the excess tax paid
abroad.
Thus, double taxation relief is available in income earned abroad. An important strategic
consideration that must be taken into account when setting up an operation overseas is
whether to operate it as a branch or subsidiary. If the former, then UK tax is paid on income
which is repatriated, and there may be cash flow advantages in manipulating dividends to be
taxed in a different accounting period.
If income from abroad is not repatriated then it will be subject only to foreign tax and not to
withholding tax or UK tax.
If the profits of an overseas operation were transferred to a tax haven they would not be
subject to UK tax but the withholding tax would be deducted. A tax haven is a country where
tax on resident companies, foreign investment and withholding tax paid on dividends paid
overseas are low. For these reasons they are often used by MNCs as a means of deferring
tax prior to the repatriation of funds. For this to be successful, the tax haven requires
adequate financial services, a stable exchange rate and a stable government.
UK companies may also consider transferring residence in order to avoid paying UK
corporation tax (this is subject to various Inland Revenue rules).
241
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Study Unit 14
Risk and the International Business
Contents Page
Introduction 242
A. Risk and International Trade/Finance 243
Political Risk 243
Foreign Exchange or Currency Risk 243
B. Managing Political Risk 244
Dealing with Political Risk 245
Restrictions on the Remittance of Funds 246
C. Internal Methods of Managing Exchange Rate Risk and Exposure 248
Currency invoicing 248
Netting 248
Matching 249
Leads and Lags 249
D. External Methods of Managing Exchange Rate Risk and Exposure 250
Principles of Hedging 250
Forward Contracts 251
Currency swaps 252
Currency Futures 253
Currency Options 255
Money Market Hedge 257
242 Risk and the International Business
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INTRODUCTION
All businesses face a degree of risk. One facet of this risk is business risk that arising from
the very nature of the business itself. We can divide this type of risk into two groups:
That which is inherent in the conduct of business itself and cannot be reduced or
eliminated without ceasing trading, effectively closing down the business or selling it.
(The owner(s) accept this type of risk in making their investment and expect some form
of financial return as compensation.)
That which arises as a consequence of the financial transactions taking place in the
normal course of business. Essentially, we are concerned here, in the international
context, with the possibility of incurring a loss of value on certain types of transaction,
those that involve making/receiving payments in a different currency, as a result of
changes in the exchange rate. It is this element of risk exposure that the business can
seek to reduce or eliminate.
In the international arena, there is a further type of risk, political risk. This relates to the
possibility that the conditions under which a business entered a foreign market may change
and adversely affect the financial position of the business. This can arise from the decisions
of governments to change, for example, taxation levels or other aspects of the economic
environment of the country.
Recent economic and political developments have enlarged the scope and deepened the
complexity of risks facing international companies. Global terrorism has sharpened the
anxieties of corporate managers regarding the physical safety of their employees and the
continuity of their business operations. Rising cyberterrorism has accentuated concerns over
IT security, while growing volatility in the world economy has heightened financial and
competitive risks.
The key challenge at hand is not to eliminate, but to manage risk (which is inherent in any
business venture) in a systematic fashion allowing the company to confidently pursue its
business objectives.
The Global Economics Company, experts in international risk management, cite the following
global business risks:
Proprietary Risk The global dispersion of technology heightens the danger of loss of
intellectual property, especially in China and other emerging markets that international
companies are prioritising as growth targets.
Market Risk Global companies confront a variety of market risks, misalignment of
capabilities and target markets, insufficient knowledge of technological disruptions of
those markets; slow responses to emerging market opportunities.
Foreign Exchange Risk Uncertainty over the direction and magnitude of currency
movements places globally active companies at risk of foreign exchange losses.
Country Risk Business risk is particularly high in emerging and developing countries
where regulatory structures are fragile, rule of law is weak, and political/economic
instability is pervasive. But it is precisely these markets that offer the greatest
commercial potential for global companies in coming years.
It is not possible to eliminate these risks completely, but it is possible to reduce them by
adopting appropriate strategies to reduce the amount of exposure to loss that the business is
faced with.
In this unit, we start by examining in some detail the nature of these risks, and then consider
the ways of managing political risk. We then move on to consider techniques to manage
exchange rate exposure in two categories:
Risk and the International Business 243
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Internal, or natural, techniques. Those that are affected entirely by the financial
organisation and structure of the company itself.
External, or transactional, techniques. Those using the range of derivative instruments
which are affected by the use of third party services, such as banks and specialist
exchanges.
Although both types of technique provide effective means of covering the exposure, certain
external techniques offer the possibility of taking advantage of favourable movements in
exchange rates to generate profits.
A. RISK AND INTERNATIONAL TRADE/FINANCE
In addition to normal business and financial risk, companies face extra risks connected with
trading and investing overseas. These risks can be separated into political risk and foreign
exchange risk.
Political Risk
Political risk (also known as country risk) includes the problems of managing subsidiaries
geographically separated and based in areas with different cultures and traditions, and
political or economic measures taken by the host government affecting the activities of the
subsidiary.
Whilst a host country will wish to encourage the growth of industry and commerce within its
borders, and offer incentives to attract overseas investment (such as grants), it may also be
suspicious of outside investment and the possibility of exploitation of itself and its population.
The host government may restrict the foreign companies activities to prevent exploitation or
for other political and financial reasons. Such restrictions may range from import quotas and
tariffs limiting the amount of goods the company can either physically or financially viably
import, to appropriation of the companys assets with or without paying compensation. Other
measures include restrictions on the purchasing of companies, especially in sensitive areas
such as defence and the utilities; such restrictions could be an outright ban, an insistence on
joint ventures or a required minimum level of local shareholders. In order to prevent the
dumping of goods banned elsewhere (e.g. for safety reasons) a host government may
legislate as to minimum levels of quality and safety required for all goods produced or
imported by foreign companies.
Host governments, particularly in developing and underdeveloped countries, may be
concerned about maintaining foreign currency reserves and preventing a devaluation of their
national currency. In order to do this they may impose exchange controls. This is generally
done by restricting the supply of foreign currencies, thus limiting the levels of imports and
preventing the repatriation of profits by MNCs by restricting payments abroad to certain
transactions. This latter method often causes MNCs to have funds tied up unproductively in
overseas countries.
Foreign Exchange or Currency Risk
Exchange rate risk applies in any situation where companies are involved in international
trade. It arises from the potential for exchange rates to move adversely and, thereby, to
affect the value of transactions or assets denominated in a foreign currency.
There are three main types of exchange rate risk to which those dealing overseas (importers,
exporters, those with overseas subsidiaries or parents, and those investing in overseas
markets) may be exposed:
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Transaction exposure
This occurs when trade is denominated in foreign currency terms and there is a time
delay between contracting to make the transaction and its monetary settlement. The
risk is that movements in the exchange rate, during the intervening period, will increase
the amount paid for the goods/services purchased or decrease the value received for
goods/services supplied.
Translation exposure
This arises where balance sheet assets and liabilities are denominated in different
currencies. The risk is that adverse changes in exchange rates will affect their value on
conversion into the base currency.
Any gains or losses in the book values of monetary assets and liabilities during the
process of consolidation are recorded in the profit and loss account. Since only book
values are affected and these do not represent actual cashflows, there is a tendency to
disregard the importance of translation exposure. This is, though, a false assumption
since losses occurring through translation will be reflected in the value of the company,
affecting the share price and hence, shareholders wealth and perceptions among
investors of the companys financial health.
Economic exposure
This refers to changes in the present value of a companys future operating cashflows,
discounted at the appropriate discount rate, as a result of exchange rate movements.
To some extent, this is the same as transaction exposure, and the latter can be seen as
a sub-set of economic exposure (which is its long term counterpart). However,
economic exposure has more wide ranging effects. For example, it applies to the
repatriation of funds from a wholly owned foreign subsidiary where the local currency
falls in value in relation to the domestic currency of the holding company. It can also
affect the international competitiveness of a company, for example, a UK company
purchasing commodities from Germany and reselling them in China would be affected
by either a depreciation (loss of purchasing power) of sterling against the Euro and/or
an appreciation of Yuan.
It can also affect companies who are not involved in international trade at all. Changes
in exchange rates can impact on the relative competitiveness of companies trading in
the domestic market vis--vis overseas companies when imports become cheaper.
Thus, reduced operating cashflows may be a consequence of a strengthening
domestic currency, a situation that has affected UK companies in the late 1990s.
The management of exchange rate risk will involve hedging against adverse movements in
order to contain the extent of any exposure. At the operating level, the focus of attention is
primarily on managing the exposure caused by transaction and economic risk, both
essentially being underpinned by cashflows. The techniques that we shall examine in this
unit, then, relate essentially to these aspects of exposure, with the greater emphasis on
transaction exposure
B. MANAGING POLITICAL RISK
Political risk relates to any action that can be taken by an overseas government that can
affect a companys investment in that country. There are many different ways in which it can
manifest itself, for example:
Changes in tax laws.
Changes in the rules concerning transfer of funds.
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Stipulations concerning the amount of local production or employment.
Changes in exchange controls.
Expropriation of assets i.e. government seizure.
Dealing with Political Risk
Firstly, it is important that any company considering direct overseas investment is aware of
the potential political risks involved and there are two main methods of approaching this
assessment:
The macro approach This is country-specific and can be achieved by using one of
the many political risk-forecasting services that are available. The usual format of
these services is that each country is ranked on a series of different factors to give an
overall rating. These factors take into account items such as political stability (or
instability as the case may be), fractionalisation of the country by language or religious
groups and so on. Depending on its rating a country may be considered a minimal risk
through to a prohibitive risk.
The micro approach This is company-specific and is based on the fact that it is the
type of industry that determines the level of risk rather than the country in which it
operates. Thus, extractive industries are considered to be more at risk than companies
in the service sector.
The methods of dealing with the risk are to:
Identify those areas where the risk is considered unacceptable and refrain from making
the investment.
Insure against the risk, for example, in the UK, through Lloyds of London, which is the
only organisation to provide cover against expropriation of new or existing assets to a
limit of 90% of equity participation.
Negotiate with the overseas government before making the investment as a means of
reaching agreement on the rights and duties of each partner although any agreement
can be negated by a change of government.
Structure the overseas operation to make expropriation by the host government a
waste of time, for example, by making the foreign company dependent on the group for
supplies of spare parts or raw materials.
Operating policies can also be employed to minimise political risk. They can take several
forms including short-term profit maximisation, planned divestment and the encouragement
of local shareholdings.
Where expropriation is threatened or has taken place, the following are some of the courses
of action that could be taken:
Negotiate with the government concerned and attempt to halt or reverse the decision.
Bargaining whereby the MNC offers something in return for the host government
desisting from expropriating the asset, such as agreeing to use more locally-produced
parts in manufacture, hiring more local managers, investing more capital or
surrendering majority control.
Agree to relinquish control in return for compensation i.e. effectively sell the assets and
pull out.
Political lobbying. This could take the form of lobbying the home government to
intervene on behalf of the MNC or alternatively pursuing an action through the
international courts. In addition, it may be worth lobbying to attempt to block certain
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imports from the country concerned, although this has wider trade implications and is
less likely to be successful.
Restrictions on the Remittance of Funds
An MNC is in a position whereby it can transfer funds from one location to another as part of
its regular operating cycle to keep overseas subsidiaries adequately financed and to remit
surplus funds to the home country. This also allows the MNC to take advantage of arbitrage
opportunities that may exist in terms of:
Reducing the overall tax burden by shifting profits from high to low tax areas or from
paying to participating subsidiaries.
Circumventing credit control restrictions in the country of operations by remitting funds
to subsidiaries located there.
Taking advantage of high interest rates to invest surplus funds or low interest rates to
borrow funds.
Unfortunately for the MNC, most countries impose restrictions on the transfer of funds into
and out of their country, usually in order to be able to maintain their currency value within
defined limits.
In order to overcome such restrictions the MNC can adopt one or several of the following
options:
Transfer pricing
We have already examined the importance of transfer pricing to an MNC. Remember
that it is perhaps the most widely used method of transferring funds and one which host
countries assume is used to their detriment and therefore should be tightly controlled.
Transfer pricing is especially relevant to those businesses dealing internationally due to
the increased complexity of the possible sourcing decisions. Much of this complexity
arises from the sheer number of transfers, exchange rate movements and the amount
of information on international sales and costs required. Obviously a good financial
decision support system (DSS) is required for such companies, although the cost may
be prohibitive, one possible solution is to break the organisation down into smaller units
and thereby simplify the amount of information involved.
A further element of complexity for both production location decisions and for transfer
pricing is the need for companies to consider the impact of taxation, the aim will be to
set transfer prices which minimise the level of tax paid whilst ensuring that laws are not
breached. For taxation purposes, MNCs often use cost-plus based transfer pricing
systems, with a separate system being used for performance management. This,
however, may not be allowed in certain countries. UK-resident companies are liable to
corporation tax on profits before foreign taxes of overseas investments (though double
taxation relief is generally available). Thus, where the effective tax rate is lower
overseas than in the UK and there are no exchange rate or cash flow requirements to
repatriate profits, there are benefits in leaving the cash (and profits) overseas.
However, companies must be careful not to fall foul of anti-avoidance legislation.
A large MNC needs to determine its location and transfer pricing systems to ensure
that the best economic outcome from the perspective of the group is achieved. In
doing so, it must consider a large number of factors, for example, relative productivity,
inflation, exchange rate volatility and management, interest rates, transportation costs,
proximity to markets and price elasticity, as well as the costs of reversing such
decisions. The decision may be made by comparing the total contribution to the group
(often referred to as total system profit or decision profit) of the different
alternatives. However, in order to do this a transfer pricing system must have been
developed, thus creating a somewhat circular problem.
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A further method that may be used is arms-length transfer pricing. However, this
reduces HQs involvement and as such it may not be in the groups interest.
Leading and lagging
We consider this in more detail below in respect of managing exchange rate risk.
In the context of unblocking funds, suppose that company A in one country sells goods
to an affiliate in another country of 1m per month, with payment terms one month after
receipt. If the payment terms are then altered to three months an additional 2m will
be lagged. If payment terms are shortened the funds will be transferred more quickly.
Note that each of these will be a one-off movement.
Dividends
This is another important method of moving funds between countries. The level of
dividend set will depend on considerations such as the levels of taxation, the existence
of exchange controls which may restrict the transfer of funds, the expected changes in
exchange rates which may cause a company to accelerate or delay payments, and the
effect on the financial statements of affiliates.
Loans
These can take the form of:
(i) Parallel loans which involve no cross-border movement of funds and usually
allow for the loans to be set off against each other.
(ii) Back-to-back loans which are often used to finance associates in countries
with high interest rates or where different rates of withholding tax apply.
Currency swaps
These are made between two parties who agree to transfer currency at the prevailing
spot rate with an undertaking to reverse the transaction at a future date. No interest is
payable but a fee is usually paid by one party to reflect the forward premium or
discount on the currency transferred.
Again, we examine these in more detail below when considering exchange rate risk.
Fees and royalty agreements
These usually take the form of management fees from the subsidiary to the head office
based on the amount the latter wishes to receive in total, which is then apportioned out
to the subsidiaries based on, for instance, the sales of each. Overseas governments
prefer agreements to be in place in advance and for there to be a steady flow of funds
rather than an erratic one, which could indicate an obvious attempt to manipulate the
flow of funds.
Debt versus equity
Consideration should be given to the best way of financing an overseas subsidiary
depending on the ease of moving different types of funds. In this instance it is the ease
of repatriating interest and repayment of capital compared to dividends or reductions in
equity. Loans are often preferable as reductions in equity may be difficult, or even
impossible, to achieve and loan interest is usually tax deductible. Account will also
have to be taken of local government requirements for financing through the issue of
equity.
Re-invoicing centres
These are often sited in low tax countries and take title to all goods sold across
frontiers either between subsidiaries or to a third party. The goods themselves pass as
usual from seller to buyer with payment being made to the re-invoicing centre. The
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great advantage with this arrangement is the possibility of utilising currency-invoicing
techniques, which we consider next.
Currency of invoice
The objective of this technique is to invoice in a strengthening or weakening currency in
order to transfer funds from one country to another. Thus, if a currency is expected to
weaken, by invoicing in that currency the company will receive less for its goods when
paid for by an affiliate in another country, but of course the affiliate will gain by
effectively paying less for the goods in question. As an example, suppose affiliate A is
transferring goods to affiliate B in a currency that is expected to devalue by 5%. If the
goods are worth 10 million this will effectively mean a transfer of 500,000 to affiliate
B. It is possible to invoice in any currency depending on the circumstances, so if a
country imposes restrictions on capital inflows, it is possible to invoice in a weak
currency in order to transfer funds there.
Again, this is also used as a means of managing exchange rate exposure and will be
considered later in the unit.
Other techniques
It is also possible to utilise blocked funds in other ways to those mentioned above.
One method is to purchase items, such as machinery, with the blocked funds in the
country concerned, but utilise the items worldwide throughout the group. Other
alternatives are to purchase services or carry out R & D in that country, the benefit of
which will again be enjoyed by the group as a whole.
C. INTERNAL METHODS OF MANAGING EXCHANGE
RATE RISK AND EXPOSURE
There are four main internal means of reducing exchange rate exposure. These are based
on methods of processing transactions and payments, and of offsetting assets and liabilities
in different currencies.
Currency invoicing
The first approach is simply to invoice foreign customers in the currency of the seller.
Invoicing for goods supplied, and paying for goods received, in a companys domestic
currency removes the exchange rate risk for that company, but only one party to an
exchange between foreign companies can have this facility, and the other bears the risk of
exchange rate fluctuations. However, the advantages of removing exchange rate risk need
to be weighed against those of invoicing in the foreign currency. These include marketing
advantages such as the ease for the customer of dealing in his own currency and the
possibility of purchasing at a discount if the foreign currency is depreciating relative to the
domestic currency. In fact, often the only way to win a contract overseas is to deal in the
currency of that market.
One way to prevent one or both parties being subject to exchange rate risk is for the
companies involved to set a level of exchange rate to use for a transaction regardless of
what the actual exchange rate is on the day the money is transferred.
Netting
This is an internal settlement system used by multinational companies with overseas
subsidiaries. It involves offsetting (netting out) the outstanding foreign exchange positions of
subsidiaries against each other through a central point, the group treasury.
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Suppose there are two overseas subsidiaries in different countries. Subsidiary A expects to
receive a payment in one months time for the sale of goods to the value of $2m, while
subsidiary B has to make a payment of $3m in one months time to a supplier. The central
treasury can offset the two exposures and set up an external hedge for the net risk of $1m.
This negates the need for two separate hedges to be carried out, the first to cover the $3m
against a rise in exchange rates against the dollar and second to cover the $2m against a fall
in exchange rates against the dollar. The single hedge is more efficient and cost-effective.
Matching
This is the process of matching receipts in a particular currency with payments in the same
currency. This prevents the need to buy or sell the foreign currency and thus reduces
exchange rate risk to the surplus or deficit the company has of the foreign currency. It is a
cheap method of reducing or eliminating exchange rate risk provided that the receipts
precede the payments, and the time difference between the two is not too long.
For example, where a company is selling to the US and has outstanding receipts
denominated in $, it could purchase raw materials in the same currency. The one transaction
will offset the other and minimise the exchange exposure that requires external hedging. It
therefore does not matter whether the $ strengthens or weakens against the domestic
currency.
Alternatively, a company could match, say, dollar currency receipts from the export of goods
to the US with a dollar loan. The receipts will be used to pay off the loan. This again secures
the matching of an asset with a liability.
This process can be made easier either by having a bank account in the foreign country or a
foreign currency account in a companys own country, and putting in all receipts and taking
from it all payments in the overseas currency. The exchange rate risk on the surplus or
deficit can be avoided by utilising one of the other methods of risk management.
Matching may also be used to reduce translation exposure, offsetting an investment in assets
in one currency with a corresponding liability in the same currency. For example, the
acquisition of an asset denominated in Yen could be achieved by borrowing funds in Yen. As
the exchange rate against the Yen varies, the effect it has on the translated value of the asset
and liability will increase and decrease in concert. The amount of the reduction in exposure
will depend on the extent to which the expected economic life of the asset corresponds with
when the loan matures.
Leads and Lags
This final method of hedging internally involves varying payment dates to take advantage of
the exchange rate, for example, paying either before or after the due date, depending on
exchange rate movements. The effectiveness of this is dependent on how well exchange
rate movements can be anticipated. A company will only pay in advance if it expects the
domestic currency to weaken, but if it misreads the movement and the exchange rate
strengthens, advance payment may prove expensive.
Leads are advance payments for imports to avoid the risk of having to pay more local
currency if the suppliers currency increases in value.
Lags involve slowing down the exchange of foreign receipts by exporters who
anticipate a rise in the value of the foreign currency received. When this occurs, they
will then benefit by an exchange rate in their favour.
The table below shows the scope for leading and lagging by financial managers of importers
or exporters:
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UK Exporter UK Importer
Expectation of
foreign currency
Receiving foreign currency Paying foreign currency
Devaluation Leads Lags
Revaluation Lags Leads
Foreign Importer Foreign Exporter
Expectation of
sterling
Paying in sterling Receiving sterling
Revaluation Leads Lags
Devaluation Lags Leads
A UK exporter would accelerate (lead) his receipts in the event of an anticipated
devaluation, but he would delay (lag) his foreign receipts if a revaluation was expected,
and so forth. In leading, he will need to borrow or otherwise raise the cash which will involve
a cost of capital, whilst lagging will attract interest as there will be surplus for investment.
D. EXTERNAL METHODS OF MANAGING EXCHANGE
RATE RISK AND EXPOSURE
It is not possible to eliminate exchange rate risk completely, but it is possible to reduce it by
way of hedging. Hedging the risk involves taking action now to reduce the possibility of a
future loss, usually at the cost of foregoing any possibility of a gain. A simple example in
relation to commodity trading should explain this.
A company knows that it will need certain goods in six months time. It is exposed to the risk
that the price of these goods may rise in the meantime. Entering into a forward contract
may reduce this risk to purchase the goods in six months time at a price fixed now.
However, if the price falls below the current price in the meantime, the company will have lost
the opportunity to make a gain.
Thus, the basis of hedging involves offsetting two transactions against each other:
A cash transaction, the receipt or payment of money arising from normal business
transactions (such as international trade or the management of funds).
Taking a position on (buying or selling) a derivative instrument linked to the type of
cash transaction.
There are a number of such financial derivatives relating to currency, forwards and futures
contracts, swaps and options. Options are somewhat different in that they offer the
possibility of making gains as well as hedging risk.
Principles of Hedging
As we noted above, hedging a risk involves taking action now to reduce the possibility of a
future loss, usually at the cost of foregoing any possibility of a gain. It is a process whereby
the exposure to potential loss caused by adverse movements in prices; interest rates and
exchange rates may be limited.
A hedge against exposure to risk is invariably constructed by using a financial derivative.
Again, as we noted above, there are a range of these instruments. They derive their value
from the price of underlying assets such as foreign currencies, commodities and fixed income
securities, etc. We can demonstrate the basic concept with an example using one such
instrument, a futures contract, in relation to exchange rate exposure.
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A UK company is going to receive a $100,000 in one months time as a result of some
consultancy work carried out in the USA. It is exposed to the risk that a (unfavourable)
movement in the /$ exchange rate before the payment is made will reduce its value.
However, it may hedge this risk by using a futures contract. The futures contract will
comprise a transaction to sell $100,000 in one months time (the time of its receipt) at a /$
exchange rate fixed today. The potential loss of value on the payment is, then, limited to the
difference between the current exchange rate and the agreed rate for the futures contract.
This reduces the companys exposure to any other adverse movements in the exchange
rate, but also means that it cannot take advantage of a favourable movement in the rate.
Futures are one of the derivatives that allow a financial risk to be reduced, but do not
(usually) allow any gain to come from favourable movements in the prices or rates underlying
the instrument. Other such derivatives include forward contracts and swaps. However,
these can be distinguished from option contracts which also allow a risk to be reduced, but
do allow gains to be made from favourable movements.
Forward Contracts
Forward foreign exchange contracts are a binding agreement between two parties to
exchange an agreed amount of currency on a future date at an agreed fixed exchange rate.
The exchange rate is fixed at the date the contract is entered into.
Forward contracts are tailor made to suit the needs of the parties and delivery dates can
range from a few days to upwards of several years, depending on the needs of the business.
They are binding and must be executed by both parties.
In most cases, forward contracts have a fixed settlement date. This is appropriate where the
cash transaction being hedged will take place on the same day that the forward contract is
settled. However, there is no guarantee that the two days will tally, for example, a customer
may be late paying, and in which case the fixed settlement date is less than optimal. An
alternative, to provide flexibility, is an option date forward contract. This offers a choice of
dates on which the user can exercise the contract, although there is a higher premium
payable on the contract for such an additional benefit.
The purpose of a forward exchange rate contract is to purchase currency at a future date at a
price fixed today. As such, it provides a complete hedge against adverse exchange rate
movements in the intervening period.
Consider the following example. (You do not need to worry about the detail of how the hedge
works, but showing the method illustrates the principles.)
A UK company needs to pay SG$1m to an Singapore company in three months time. The
current spot and forward exchange rates for sterling are as follows:
SG$/
Spot 2.730 2.735
3 months forward 4 3 cents pm
What would be the cost in sterling to the UK company if it enters into a forward contract to
purchase the SG$1m needed?
Note the way in which the rates are quoted. The spot rate (the current price) spread shows
the sell and buy prices, the banks will sell SG$s for sterling at the rate of SG$2.730/, and
buy SG$s in return for sterling at the rate of SG$2.735/. The forward rate is quoted in terms
of the premium (pm) in cents that the Singapore dollar is to sterling in the future. If the
currency is at a premium, it is strengthening and the SG$ will buy more pounds forward than
it will spot or, conversely, the pound will buy less SG$ forward than it will spot. (If the quoted
forward rate had been quoted at a discount, say, 3 cents dis this would indicate a
weakening of the currency.)
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To calculate the cost of the forward contract, we need to convert the forward rate premium
into an exchange rate. Because it is a premium, we need to subtract the amount from the
spot to give the following sell/buy forward rates:
(2.730 0.04) (2.735 0.03) = 2.690 2.705 SG$/
The cost of buying SG$1m forward, therefore, is:
690 2
000 000 1
.
, , $ SG
= 371,747
Currency swaps
In general, a swap relates to an exchange of cashflows between two parties. Thus currency
swaps relate to an exchange of cashflows in different currencies between two parties. They
are agreements to exchange both a principal sum and the interest payments on it in different
currencies for a stated period. Each party transfers the principal and then pays interest to
the other on the principal received.
Swaps are arranged, through banks, to suit the needs of the parties involved.
The two key issues in setting up a currency swap is:
The exchange rate to be used.
Whether the exchange of principal is to take place at both commencement and
maturity, or only on maturity.
The following example illustrates the general principles. (Again, you should not be too
concerned with the detail, but just follow the principles.)
A German company is seeking to invest 20m in the UK and has been quoted an interest
rate of 8% on sterling in London, whereas the equivalent loan in Euros is quoted at 7% fixed
interest in Frankfurt. At the same time, a UK company wants to invest an equivalent amount
in its German subsidiary and has been quoted an interest rate of 7.5% to raise a loan
denominated in Euros on the Frankfurt Exchange. It could, however, raise the 20m in
sterling in London at 5% fixed interest.
In the absence of a swap, each company would have to accept the quoted terms for its loan
denominated in the foreign currency. This would result in both companies paying a higher
rate than would apply if the loan was raised in their domestic currency. A swap agreement
would involve each company taking out the loan in its own domestic currency and then
exchanging the principals. Each company would pay the interest on the principal received,
i.e. the other companys loan, and at the end of the loan period, the principals would be
swapped back.
The exchange rate to be applied is clearly crucial. If we assume that this is agreed as 1.3 =
1, the swap would be conducted as follows.
The UK company borrows 20m in England at an interest rate of 5% pa. It then swaps
the principal of 20m for 26m (at the agreed exchange rate) with the German
company. The German company pays the interest payments on the 20m loan (at 5%
interest) to the UK company, which then pays the bank. At the end of the loan period,
the principal of 26m is swapped back for the 20m with the German company.
The German company borrows 26m in Frankfurt at an interest rate of 7% pa. It then
swaps this principal with the UK company which pays the interest payments on the loan
(at 7% interest) to the German company, which then pays its bank. At the end of the
loan period, the principal of 20m is swapped back for the 26m with the UK company.
The process is illustrated in Figure 14.1.
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Figure 14.1: Currency swap
Currency Futures
A currency futures contract is an agreement to purchase or sell a standard quantity of foreign
currency at a pre-determined date.
Futures contracts are exchange traded derivatives. That means that they are bought and
sold on organised exchanges such as the London International Financial Futures Exchange
(LIFFE). As such, there are certain rules affecting the way in which they are transacted, and
some specific terminology associated with them.
Futures contracts on a particular exchange are all of a standard size. For example, on
the IMM Chicago Exchange, the standard size sterling contracts are for 62,500 and
those for yen are for YEN12.5m. Thus, in order to hedge an exposure of million, it
would be necessary to take out eight contracts, each of which would be for 62,500.
Exchange traded contracts, whether futures or options, all have pre-determined
maturity dates on which delivery of the underlying asset occurs. For example, the
contracts quoted on the Chicago Exchange relate to delivery dates at the end of March,
June, September and December.
The vast majority of futures contracts are not delivered, but are closed out. This is a
process whereby the commitment entered into to buy the currency underlying the
contract is cancelled out by taking an opposite position in the market i.e. entering into a
contract to sell the same quantity. Any gain or loss from closing out can be set against
movements in the exchange rate.
Hedging with futures works as follows. A UK company exporting to the USA and invoicing in
US dollars, would need to hedge against a rise in the exchange rate (sterling strengthening
relative to the dollar) in the period before payment is received. If we assume that payment is
due in two months time, the exporter will need to sell dollars then in exchange for sterling.
The strategy would be, therefore, to take out a three-month sterling futures contract and
close it out in two months time i.e. buy sterling futures now, hold them for two months and
then sell them to cancel out the obligation to deliver the underlying currency. Any profit on
London bank Frankfurt bank
UK Company German Company
20m
20m
26m
26m
5%
interest
5% interest
7%
interest
7% interest
UK company now has
26m available for
investment at 7%
interest
German company now
has 20m available for
investment at 5%
interest
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the contract (the difference between the buying and selling prices) will offset any loss on the
dollars received from an exchange rate rise over the period.
We can illustrate the process in more detail by reference to the actions of a speculator who is
anticipating a rise in the value of the $ against the pound. He will, therefore, take a position
to sell sterling futures in anticipation that the future cost (in dollars) of buying the pounds
necessary to meet the contract obligation will be less than the proceeds of the sale under the
contract.
If the current spot rate is $2/ and December sterling futures are trading at $1.95/, what will
be the gain or loss on five sterling futures contracts if the spot rate in December is $1.9/?
(The standard size of sterling futures is 62,500.)
Sale of five December contracts (each of which is for 62,500) at the agreed rate of
$1.95/ results in proceeds of:
5 62,500 $1.95 = $609,375
Purchase of the equivalent amount in sterling in December at the spot rate of $1.9/
results in an outlay of:
5 62,500 $1.9 = $593,750
The gain on the transaction is $15,625 or, converting this into pounds at the spot rate,
8,223.68.
The advantage for the speculator of using the futures contract compared to the alternative of
buying sterling at the current spot rate is that he only needs to put down a small deposit
(called a margin account) as opposed to an up front investment of the full amount for the
five contracts of $625,000 (312,500 x $2).
Hedging using futures and forwards contracts
We can also consider the difference between a hedge using forward contracts and a hedge
using futures contracts.
In December, a UK exporter invoices its US customer for $482,500 payable on 1 February.
The exporter needs to hedge against a change in exchange rates whereby sterling becomes
stronger relative to the dollar and he receives less pounds than now upon exchange of the
dollars received in February. To hedge this exchange rate exposure, the company could take
out either a forward contract or a futures contract. Which would be more appropriate given
the following rates?
In December:
Spot rate $1.9275 1.9295/
February forward rate $1.9250 1.9275/
March sterling futures contracts $1.9300/
(Contract size is 62,500)
Those applying on 1 February:
Spot rate $1.9370 1.9390/
March sterling futures contracts $1.9355
Using a forward contract would require the exporter to commit to the sale of the dollar
receivables (i.e. $482,500) at the February forward price of $1.9275/, resulting in proceeds
of:
9275 1
500 482
.
, $
= 250,324
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The futures contract hedge would require the exporter to take a long position in sterling
futures, i.e. a commitment to buy sterling at the rate of $1.9300/, with the intention of closing
out the contract on 1 February, prior to the receipt of the dollars. If sterling does strengthen
against the dollar, this position will result in a gain. However if the exchange rate falls, then
the exporter will lose on the futures contract, but gain in the cash market.
The number of sterling futures contracts necessary to cover the exposure is:
9300 1
500 482
.
, $
500 62
1
,
= 4 contracts
The gain/loss on the futures transaction is calculated as follows:
Buy four March contracts in December at $1.9300/:
4 x 62,500 $1.9300 = $482,500
Sell four March futures contracts in February at $1.9355
4 x 62,500 $1.9355 = $483,875
Gain through closing out:
$483,875 $482,500 = $1,375
Converting this into sterling at the February spot rate gives a gain of:
9390 1
375 1
.
, $
= 709
The total proceeds from the futures hedge is calculated by adding this gain to the proceeds
of the exchange of the dollars received on 1 February at the then current spot rate of
1.9390$/:
9390 1
500 482
.
, $
= 248,839 + 709 = 249,548
This is marginally worse than the hedge using the forward contract.
Currency Options
A currency option gives the holder the right, but not the obligation, to buy or sell a specified
amount of currency at an agreed exchange rate (the exercise price) at a specific future
date.
Using the options market to hedge exchange rate exposure sets a limit on the loss that can
be made in the case of adverse movements in exchange rates, but also allows the holder to
take advantage of favourable movements.
There are a number of different types of option contract available on the various options
exchanges around the world (the main ones being the LIFFE, New York, Philadelphia,
Montreal and Chicago exchanges). As with futures contracts, these organised exchanges
offer standard format options in which the main elements of the contract are pre-determined:
Size, each currency option contract being in denominations of exactly half of those for
futures contracts (thus, the standard contract sizes for sterling options are 31,500).
Exercise price, as determined by the market.
Option period, with an expiry date usually of three months (or in multiples of three
months).
It is also possible to establish option contracts outside of the organised exchanges. Such
options are known as over the counter (OTC) options, and the individual elements (size,
exercise price, expiry date) maybe negotiated and agreed between the buyer and seller.
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Options tend to be more expensive than other derivatives since they offer the possibility of
making gains should the movement in the underlying asset be favourable (in contrast to
futures and forward contracts).
General principles of options
There are two types of option contract:
(i) Call option This is an option to buy currency.
The buyer of a call option (said to be holding a long call) is anticipating that
exchange rates will rise. He will only exercise the option (i.e. buy the currency) if
the spot rate of the currency is above that specified as the exercise price.
The risk exposure is limited to the amount of the premium in the case of the
exchange rate falling below the exercise price, whereas the potential gain is the
difference between the spot rate and the (lower) exercise price.
The seller of a call option is said to be holding a short call. This position is the
exact opposite of the buyers position. He is obliged to sell the currency at the
exercise price, but will only have to do so where the option is exercised by the
buyer i.e. if the spot rate is above the exercise price.
The potential profit is limited to the price of the option, but there is exposure to
the risk of having to sell the currency at a loss.
(ii) Put option This is an option to sell currency.
These will be purchased where it is anticipated that the exchange rate may fall.
The buyer of a put option (a long put) will only exercise the option (i.e. sell the
currency) if the spot rate falls below the exercise price. This establishes a ceiling
on any loss incurred if the option is not exercised, but allows profits to be taken if
the spot rate falls and the option is exercised.
The risk exposure is limited to the amount of the premium in the case of the
exchange rate rising above the exercise price, whereas the potential gain is the
difference between the exercise price and the (lower) spot rate.
The seller of a put option is said to be holding a short put. This position is,
again, the exact opposite of the buyers position. He is obliged to buy the
currency at the exercise price, but will only have to do so where the option is
exercised i.e. if the spot rate is below the exercise price.
Again, the potential profit is limited to the price of the option, but there is
exposure to the risk of having to buy the currency at a loss.
Hedging with currency options
The following example illustrates their use. Again, you need not be too concerned with
the details, but just get to grips with the general principles.
At the beginning of July, a UK company purchased goods to the value of $250,000 from
its US supplier on three months credit, payable at the end of September.
Because the company needs to pay for the goods in dollars, it needs a strategy that
enables it to sell pounds and buy dollars. The two choices, then, are a long put or a
short call in sterling options. The short call, though, can only provide protection against
exchange rate losses up to the cost of the premium, so the favoured strategy would be
a long put.
We shall assume the following exchange rates:
July $1.92/
September $1.85/
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The relevant sterling options offered on the Philadelphia exchange (with standard
contract sizes of 31,250) are at the following prices:
Strike price September puts
1.9 2.32
1.91 2.65
1.92 3.22
In this case, the company decides to buy a September put option with a strike price of
$1.9/. It could have opted for a different strike price, but this would have incurred
higher premiums (albeit for a higher degree of protection).
The strategy works in the following way:
The company needs to raise $250,000 which, at the exercise price of $1.9/,
equates to 131,579. To cover this amount, it will need to purchase five standard
contracts. The premium paid will be:
$3,625 5 31,250 x
100
32 2
= |
.
|
\
| .
In sterling, at the current exchange rate, that is:
1,888
92 1
625 3
=
.
,
Because the spot exchange rate has declined during the period (the dollar having
strengthened), it is advantageous to exercise the put option i.e. less pounds will
need to be exchanged at the exercise price than at the spot price to buy the
required amount of dollars.
Total proceeds from exercising all five option contracts:
5 31,250 $1.9 = $296,875 (more than matching the liability)
The net sterling cost of the transaction will be:
131,579 1,888 = 129,691
If the option was not exercised, then the liability in dollars would need to be realised by
selling sterling on the spot market. The cost involved here would be:
135,135
85 1
000 250
=
.
, $
Thus, using a long put results in a saving of:
135,135 129,691 = 5,444
Money Market Hedge
The money market can be used to hedge against exchange rate fluctuations by borrowing an
amount in foreign currency equal to the value of, say, invoiced exported goods, exchanging it
for the domestic currency at the spot rate, and then using the receipts from the customer to
repay the loan.
Effectively, this method uses the matching principle we saw earlier in respect of internal
hedging, but applies it to the creation of an asset/liability in the money market, to match the
liability/asset that needs to be hedged.
Thus, a UK exporter due a sum of dollars in three months time may eliminate the exchange
rate exposure by borrowing the sum of dollars at the outset, creating a matching liability. It
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can then exchange the dollars for sterling at the current spot rate, fixing the exchange rate on
the transaction. The sterling can then be invested for the three months. If the money
markets and the foreign exchange markets are in equilibrium, we can expect that interest
rate parity holds and the interest earned on the sterling investment will offset any change in
the exchange rate. The dollars received can be used to pay off the loan, plus interest
accrued, in three months time. This should, then, provide the same result as a forward
currency hedge.
259
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Study Unit 15
The International Business Case Study Guidance
Contents Page
Introduction 260
A. Initial Reading 261
What Does a Case Study Tell You? 261
Getting to Grips with the Scenario 261
Making Notes 262
B. Detailed Analysis 263
Structuring the Analysis 264
Evaluation Considerations 264
Designing Solutions 266
C. The Examination 267
Preparing for the Examination 267
Tackling the Questions 268
Formal Requirements 268
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INTRODUCTION
The method of assessment for the International Business Case Study module is by means of
a case study. This final unit in the Study Manual provides guidance on the approach to case
studies in general and how you may prepare for the examination itself.
The ABE will send you the actual case study upon which you will be examined approximately
four weeks before the actual examination date. This is to enable you to study the case and
ensure that you are thoroughly familiar with it before going into the examination room where
you will be given a number of questions to answer about it. The examination itself is an
"open book" examination that is, you can take any materials you like with you into the
examination to help you answer the questions. You can, therefore, make detailed notes
about the case study beforehand, and identify other sources of information which you think
may help you, and use them during the examination. (Note that any notes and other
materials should not be handed in as part of your answers you will only be marked on what
you write during the examination itself.)
It is important, then, that you make the best of the time between receiving the case study and
the examination date to prepare for the examination. The approach we recommend, and that
which is set out in this study unit, is as follows:
Initial reading identifying the general background and main themes, issues and
problems described in the case.
Detailed analysis - working through the case in more detail to identify underlying
issues and problems, and potential solutions, and also to pick out information which
you can use to support your analysis.
Getting ready for the examination organising your notes and preparing for the written
examination itself.
Note that, as you work through this unit, examples are given to illustrate the process of
preparation and analysis, rather than the content. When you start working on your
examination case study for real, you will need to consider the whole broad range of
international business concepts as covered in the study manual and the recommended
further reading, and select from those according to the content and context of the actual case
study.
Cases specifically directed to International Business can involve you in problem situations in
manufacturing, financial, distributive or service organisations in many parts of the world.
Within these varied spheres of operations, problems arise in similar ways for example, in
organisation, planning, personnel attitudes and relationships, procedures, systems,
techniques, laws and socio-economic pressures. You must be prepared to undertake your
analysis in any of these fields, from knowledge and experience acquired in your work and
studies. It may be that the case relates to an industry which is unfamiliar to you, but with the
pre-examination period to prepare, you should be able to do some research on how such a
business would operate in real life.
One final piece of general advice is that you should find it useful to look at some of the
previous case studies (and their specimen answers) as shown on the ABE website. You
could even try working through one of these, using the approach given in this unit, as
practice for both preparing for and tackling your own examination.
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A. INITIAL READING
When you receive the case study, set some time aside for a first reading. This should be a
"read through" only do not consciously try to make any judgments at this stage. They will
come later. The object is to read it as you would read an article in a newspaper to get a
general impression of, perhaps, a football match or a court case which has taken place. The
case provides a scenario in which the current situation is presented, probably set against a
historical background and setting out certain information about the personnel and other main
factors involved. Read it informally, without pausing, and delay your formal study so as to
allow a period during which you can digest what you have read. In this way, you give time for
ideas to develop. Do not be tempted to concentrate on a point which appears to you to have
immediate interest it is unlikely to be something which can be considered in isolation and
so it is better to obtain an overall impression of events at the first reading and study the detail
later when you look for issues, evaluate them and consider what to do.
What Does a Case Study Tell You?
Case studies are used extensively in professional management training to give an insight
into "real life" situations. The study of problems and solutions through the detailed
consideration of such situations has long been a training feature of law and medicine and is
now used to train managers and administrators in industry and government by enabling
them to obtain experience from case analysis.
In essence, you are the "case analyst" and are required to bring to the study a broad
knowledge of business principles and techniques, understanding of human behaviour in the
work environment, and ability to assess the pressures and influences which affect an
organisation. This means asking the questions:
What has happened in the past?
What is the current situation?
What should be done now and for the future?
A case, though, is not just a limited description of a situation, an example crystallised and
static, but is dynamic in the sense that it is the result of past events and changes in
organisation, its finances or personnel, and is subject to future influences from within and
from outside the organisation which may affect decisions.
Getting to Grips with the Scenario
Whilst each case is different in form and detail, there is a fundamental basic structure which
enables you, the analyst, to assess the main activities involved. In a study of a global trading
organisation, for example, the main features presented may be:
Current situation within the company and the business environment
Organisation, objectives and strategies
History of change and development
Functional performances related to company strategies.
Try to visualise the company described in the case what is going on, what would it be like
to work there, what are the main features, etc. Even if you have no experience of the
particular industry, you will no doubt have some experience of similar situations and the sort
of problems which can occur.
Your initial reading, then, should aim to pick out the general picture of developing events
against a background of corporate development over a period of time. However, be careful
of jumping to conclusions at this stage. For example, you may initially think that the
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problems centre on human resources and their attitudes and relationships. This may be so,
but you may find other reasons within the organisation as a whole which will lead you to take
a wider view and understanding of what may be going wrong, what ought to have been done
and what you consider should be done.
You should be looking for information about the organisation in the form of performance data
(financial or otherwise), management structures, processes and procedures, personnel, etc.
which will indicate the strengths and weaknesses of the enterprise. You also need to assess
the environment within which the business is operating to see what factors are impacting on
it both on its internal organisation and procedures, and its strategies and policies in relation
to the market.
Note that these features will be presented in different degrees of detail according to the
particular situation and this will give you a clue as to where the key themes and issues lie.
You will need to understand and evaluate these main features, assessing the degree of
emphasis given to the constituent parts, in order to identify problems and what opportunities
there are for action to be taken to remedy them.
As you start to understand the situation, consider the extent to which the areas in which
these key themes and issues lie contribute towards the provision of an efficient service and
to organisational profitability. From the evidence given, ask yourself how far these two
objectives are fulfilled and the reasons for any shortcomings which you find.
Understanding the situation within an organisation is the first step towards identifying the
problem (or problems) and asking why it has occurred, to what extent, how long it has
existed and what are the results now and for the future.
Problems may be organisational, process or procedural, financial or a question of personal
relationships, but what we see initially are often the symptoms only.
Just as a doctor's first study of an illness is of the symptoms, so, in studying an organisation,
you may see only the symptoms arising from underlying problems within the organisation.
For example, problems of late delivery, apparently requiring an organisational upheaval in
distribution, may in fact be caused by inefficient inventory control allowing insufficient lead
times to allow for efficient production. Uncompetitive high prices may be due less to efficient
production processes than to a lack of a standardisation, perhaps caused by a reluctance on
the part of design to consider the savings potential of standardisation or to the use of
acceptable commercial tolerances available in the supply market at lower prices.
Problems present symptoms and their solution normally dispels the surface symptoms. But
be wary there are cases where symptoms may still appear when the problem has been
solved. For example, a bad image created by late payment of bills may linger in the shape of
a poor credit reputation. This does not necessarily apply to all cases, but is an example of
why the identification of a problem must depend on the need to diagnose underlying
problems rather than simply their symptoms.
Making Notes
At this stage, having obtained a general idea of the situation, you will find it useful to start
making notes of ideas which come to mind. These need not necessarily be in any particular
order initially, but they will form the basis for a more formal arrangement later.
The following headings, for example, may be useful in describing the company's situation.
(a) Current situation
What sort of organisation are you dealing with?
Is it large or small?
What does it do?
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Where does it operate?
Who are the key players?
How long have they been there?
What are their aims?
(b) Company organisation
How is the company controlled?
Who makes decisions?
(c) Company strategy/policies
What are the key current strategies
Are there any future plans
(d) Company finances
What is the general situation with the company's finance?
Is it profitable?
(d) Company sites
Where is the company situated?
Is there more than one site?
Does this cause logistical problems?
(e) Company staff
How many are there?
Over how many sites?
What sort of age groupings/nationalities?
(f) Company problems
What are the symptoms especially in relation to efficient service provision and
profitability
What particular problems have you identified so far?
B. DETAILED ANALYSIS
The case study in which you will be examined will describe a situation dealing with a range of
international business issues at strategic level. You may be asked, in the examination, to
analyse what has happened to cause the current situation and any problems which are
apparent, to consider what will be the result if the current situation is allowed to continue
without adjustment and/or, by predicting alternative paths in future operations, offer strategic
or operational solutions. Often you will be asked for alternative solutions based on
predictions of what may happen as a result of following different courses of action, with
recommendations for which course of action should be adopted..
In order to prepare for this, you will have to go much further in your analysis of the case than
just the initial reading. Here, we suggest some of the considerations to be borne in mind in
doing so.
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Structuring the Analysis
In essence, the analysis should seek to determine:
What is happening and why;
What should be happening;
How the situation may be remedied.
The stages in making this determination are as follows.
(a) Evaluation of the data and information provided
Here you should be isolating the relevant information and assessing and organising it
so that the you get a detailed and clear picture of the situation.
(b) Identification of the key issues
From your evaluation, you should be in a position to clarify the key issues in the
situation. Remember that these may not necessarily be specific problems, but may
also include potential problems or difficulties, threats or opportunities, etc.
(c) Analysis of the issues
This should detail the evidence associated with the key issues i.e. the causes which
will need to be addressed in seeking solutions. These may be organisational
(structure, management, governance, etc.), process and procedural (including
systems), strategic or policy related, resource driven (including finance and personnel)
or operational. Whilst there will be a concentration on weaknesses, do not ignore
strengths it is often these which can be built upon in proposing solutions.
(d) Identification of possible solutions
Now you need to get your creative hat on and think what can be done about the
problems, etc. which you have identified. It is unlikely that there will be just one
solution, so you need to consider what alternative approaches may be possible and
what the outcomes of these may be. You should try to predict the results of pursuing
different courses of action, taking into consideration potential different circumstances in
which they may be played out (contingencies).
You should also be thinking about which are the best solutions in different
circumstances, and how you would justify recommending one course of action over
another. However, do not get too fixated on particular solutions as the circumstances
in which you may need to make a decision will be dictated by the questions in the
examination, rather than just the information in the case. What is important is that you
have considered a range of possibilities and can then bring them into play in the
examination when you see exactly what is asked.
Evaluation Considerations
You need to build up a detailed body of knowledge about the situation, and this will need to
go further than just the information and data presented to you as the case study. You will
have to work out what that information and data is telling you about the situation. Key
considerations in this evaluation include the following.
Concentrate on the facts
Ask yourself whether the information provided is entirely factual. You may be
presented with opinion in the form of commentaries on the situation or anecdotal
evidence supplied by persons involved in the company. How significant is this?
Apart from the validity of information, there is also the relevance of the material to the
main features of the case and its problems. You must ask yourself whether the
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information is relevant to the analysis or is necessary only to provide a total description
of the situation and events, i.e. mere "padding".
In addition, you need to retain objectivity in your assessment of situations and events.
Everything you use to build your analysis must be supported by evidence even
assumptions about what you might consider to be the case must be backed by
evidence which suggests that your interpretation is true. Note that, when you come to
proposing particular courses of action, these too must be supported by evidence and
not simply your own personal opinion or what you consider right.
Don't expect everything you need to be presented to you
You are likely to have to look beyond the evidence presented to identify some of the
issues and problems. What you are given may well just be the symptoms and you will
need to use the information to look for the underlying issues or problems. It requires
the capacity to interpret data and combine qualitative with quantitative assessments, to
see a problem clearly and objectively.
So, for example, a problem of poor teamwork may not necessarily be evident from the
formal organisation charts (although they may be relevant to underlying problems and
offer ways of finding a solution). There may be significant information missing from that
presented here, for example, job descriptions which may be relevant to the
situation and also need to be noted.
(Note that, if you have to answer a question in the examination on which you think that
sufficient factual information has not been provided in the case, your answer may be
subject to assumptions which you have had to make to proceed with the analysis.
Explain this in your answer and justify your assumptions as far as you can by related
evidence.)
Note that the case may not be full of unsolved problems. You may need to look for
potential difficulties and ways of avoiding future problems.
Use knowledge and techniques from different disciplines
Whilst the case study is very much set in the context of international business, do not
limit yourself to just using the knowledge and skills built up in this module. Business
success depends on the effective interdependence of all the different aspects which
make up the total enterprise, and you should similarly apply your broad understanding
of the business world to the case study. That means bringing in concepts and
techniques from economics, law, quantitative methods, financial management, etc.
The information given in the case may be sufficient in some respects, but there may
often be parts of it which, as they stand, are inadequate to make a judgment. This is
particularly so in the provision of quantitative and financial data. You need to assess
any performance figures given to you in the case and consider whether you need to
obtain more sensitive indicators, both operating and financial. For example, sets of
figures and general summaries may not clearly identify trends or the extent of change.
The use of key ratios to indicate operational or financial performances should be
computed where possible from the information given. (Note that the use of such
techniques in support of judgments will indicate to the examiner the extent of your
analysis.)
This is also true when you come to considering possible solutions to problems. For
example, consider whether there is scope for building performance models to
demonstrate the results to be expected from alternative solutions, by using available
statistics. Could you forecast, by extrapolation and suitable weighting, the effect of
variables and different contingencies on results?
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Consider inter-relationships between elements of the case
Organisations consist of series of inter-related activities, and often it is success at the
interface between such activities or systems which determine effectiveness in overall
performance. So, consider how the different elements of the case fit together to
produce the overall picture and do not just look at them in isolation from each other.
For example, in manufacturing, materials management overlaps with physical
distribution management at the production stage, and in distribution, purchasing and
sales personnel form a combined merchandising exercise. Problems in any of these
areas may be the result of issues elsewhere, and you need to look for any evidence
that may support such a view.
Think about the availability and application of resources
A company operates by setting objectives, and to fulfil the objectives there must be
planning. For plans to be successful, they require adequate resources, and those
resources need to appropriately applied. Optimum utilisation of resources and the
avoidance of problems rests with skilled management.
You need to consider all aspects of this use of resources are they adequate to meet
the objectives, can additional resources be obtained, how successful is their current
management, etc.
Consider strengths and opportunities as well as weaknesses and problems
When assessing the current situation, do not just look for problems, but consider the
strengths of the business and the opportunities that are available. For example, the
financial position may be strong (although possibly under-utilised), the market position
held by the company may be dominant (despite problems elsewhere) or the
competition may be weak or have its own problems. From strengths arise
opportunities to exploit those strengths and develop the company's position.
Don't lose sight of the environment
Companies operate in competitive markets which are subject to change and can be
affected by a wide range of variables. These present threats and opportunities. In
assessing the current situation, you need to think carefully about the environment
within which the company is operating and how this impacts now, and may impact in
the future, on both the company's policies and its operations. Remember the SLEPT
analysis social, legal, economic, political and technological factors as a means of
analysing the environment.
Designing Solutions
When you have completed your analysis of the current situation and identified what you see
as the key issues whether they are current or potential future problems, or possible
opportunities which may be exploited you need to think about what needs to be done to
achieve the best results for the company. The key questions are, how can the present
situation be changed and what will be the result of those changes?
Some of the considerations to bear in mind in answering these questions include the
following.
Consider possible alternatives
A determination to find one way of resolving a problem situation with the certainty it
would be the right one ignores the fact that, in a dynamic industrial organisation, many
variables have to be taken into account which may lead to the possibility of more than
one solution. There is rarely one simple solution to a problem, and the complexities of
organisations mean that you may find a number of ways in which the issues may be
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dealt with. These may also be applied in different combinations to address multiple
parts of the problems.
Work with the information you have
You only have the information provided, and anything that you can justifiably infer or
deduce from that information, to go on. Any future courses of action proposed, then,
must fit that information.
Predict the outcomes of courses of action
It is important to work through the impact of changes so that you can justify taking a
particular course of action, or recommend one course of action as opposed to another.
This may be by using quantitative methods to predict changes in, say, cash flows or
production capabilities, or qualitative assessments of, say, the impact on working
patterns and staffing.
Use contingency planning
Whilst you must fit solutions to the present situation as described in the case study, it is
also important that you consider how the situation may develop (using the information
provided as your starting point, but also bringing in your own understanding of the
circumstances surrounding the case). Any solutions will need to stand up in the future
situation, so you need to test outcomes against a range of potential future scenarios.
This is the basis of contingency planning what will happen if
C. THE EXAMINATION
Preparing for the Examination
Since you receive the case study several weeks ahead of the examination date, you will
have plenty of time to analyse the case and build up your understanding. It is important to
ensure that the results of your analysis are at your fingertips when you go into the
examination room. As this is an "open book" examination, you are allowed to take any
material which may help into the examination room. This can be your own notes, books or
any other printed or copied material you have acquired.
You should ensure that such materials are well organised so that you can access the
information you need about any aspect of the case quickly and easily. You might, for
example, use a system with a number of headings such as company situation,
environment, threats, opportunities, specific problems/solutions, financial and quantitative
analyses and detail both the facts (and your interpretations of them) and your ideas under
each.
Make sure that all your thoughts and ideas about the case are written down do not simply
rely on your memory to recall them in the examination room. Even just a couple of words in
your notes can be enough to jog your memory.
You may find it helpful to try to predict possible questions and note them with the points
which you consider would answer them. Ask yourself what points you see as particularly
suitable for questioning there will usually be a number which seem obvious, and these are
likely to emerge from your analysis and identification of the key issues. However, do not
place so much emphasis on this that you ignore other areas. There are no guarantees that
your prediction of questions will be right and you need to be prepared for whatever is asked
of you.
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Tackling the Questions
What is expected of you in answering the questions? It is required that you bring to the
analysis:
A sound knowledge of the International Business syllabus and all related subjects, and
that you apply their essential theories, principles and techniques to a realistic business
situation.
The ability to identify problems and provide a solution or alternative solutions if
appropriate to the problem, and make a recommendation which can be justified.
The communication skills to produce a logical, clear analysis, and, if necessary,
present a well-written report, i.e. legible and free from grammatical and spelling
mistakes.
You have no doubt been urged many times to read the examination questions carefully for
their meaning and extent, and to answer directly what the question requires. This exhortation
bears repetition.
And finally, here are a few more pointers to getting the right approach to answering the
questions:
Plan to use the time allowed to give adequate time to each question.
Plan the content and structure of each answer.
Plan the presentation clearly written in short paragraphs in logical order, using figures
or diagrams where appropriate.
Marshall your main points give brief explanations, supported by examples of
techniques and data charts where relevant and helpful.
Support your diagnosis of the problems or issues with relevant evidence, using facts
and figures derived from your analysis.
Treat the impulse to make assumptions with care, be objective and seek to link any
assumptions with evidence.
Justify recommendations by reasoned arguments, again supported by facts and figures
(including projections).
Do not assume the examiner can read your mind. Explain your answer.
Make sure your handwriting is legible.
Formal Requirements
The formal requirements in respect of the examination are as follows:
1. You should acquaint yourself thoroughly with the Case Study before the examination.
2. You must take your copy of the Case Study into the examination.
3. Time allowed: 3 hours
4. Answer ALL questions
5. All questions carry different marks. Note the mark allocation and budget your time
accordingly
6. Calculators are allowed
7. This is an open book examination and you may consult any previously prepared written
material or texts during the examination. You must not insert such material into your
answer book. Only answers that are written during the examination on paper supplied
by the examination centre will be marked.
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8. Candidates who break ABE regulations, or commit any malpractice, will be disqualified
from the examinations.
You should also find the following table, which sets out the criteria for grading the case study
(and cites good and bad examples), useful.
Grade Knowledge and
Comprehension
Analysis and
Application
Communication Skills
1
(Distinction)
Quotes appropriate
theoretical knowledge
e.g. theories and
techniques.
Demonstrates
adequate
comprehension of
knowledge, e.g. by use
of illustrative example,
analogy or explanation.
Applies
theories/principles
correctly to the
circumstances quoted.
Analyses the situation
and inter-relates
material from various
parts of the case.
Considers and
evaluates alternative
solutions where these
exist. Evaluation leads
to selection of a
feasible solution (not
necessarily the 'best'
solution).
Logical structuring of
the entire answer.
Analysis and
evaluation are
developed
comprehensively, i.e.
no faults or gaps in the
logic. Answer is well
laid out, well presented
(use of headings,
illustrations, tables, etc)
and well written
(legible, grammatically
correct and effective
style of writing).
2
(Very good
pass)
Quotes appropriate
theoretical knowledge
e.g. theories (correctly
attributed), principles
and techniques.
Demonstrates
adequate
comprehension of
knowledge, e.g. by use
of illustrative examples,
analogy or explanation.
Application of
theories/principles
shows some
weaknesses, e.g.
failure to recognise all
limitations or to use all
evidence available.
Alternative solutions
are not fully evaluated,
even if the 'right'
solution is reached.
Logical structuring of
the entire answer.
Analysis and
evaluation are
developed
comprehensively, i.e.
no faults or gaps in the
logic. Answer is well
laid out, well presented
(use of headings,
illustrations, tables etc)
and well written
(legible, grammatically
correct and effective
style of writing).
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Grade Knowledge and
Comprehension
Analysis and
Application
Communication Skills
4
(Marginal
fail)
Shows a reasonable
grasp of basic
theories/principles but
some elements appear
to be lacking.
Comprehension is not
fully proven, e.g. basic
facts are quoted
(correctly) but not
explained, no
illustrative examples
used.
Circumstances
inadequately analysed
and hence fails to
recognise major
problems which need
to be considered.
Does not demonstrate
the ability to apply
knowledge which
he/she obviously has in
a practical way (these
are common faults,
often demonstrated by
mere repetition of
material from the case
study).
Answer is adequately
presented, given the
limitations of analysis
and application.
Structure is poor,
although knowledge is
reasonably clear.
Grammar is at a
marginal level.
5
(Clear fail)
Answer reveals
fundamental gaps or
misunderstandings in
basic knowledge, and
fails to reveal adequate
comprehension even of
correct theories and
principles.
Poor analysis of
circumstances.
Applications totally
unsatisfactory due to a
lack of knowledge and
comprehension.
Answer very poorly
presented, and difficult
to follow.

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