0053 Soft

International Business Management
Subject Code:
MB 0053
BKID B1724
Revised Edition: Spring 2010
Sikkim Manipal University

Directorate of Distance Education
Department of Management Studies
Board of Studies Chairman HOD Dept. of Management Studies SMU DDE Additional Registrar SMU DDE Dr. T. V. Narasimha Rao Adjunct Faculty and Advisor SMU DDE Prof. K. V. Varambally Director Manipal Institute of Management, Manipal Originally Prepared by: Dr. Tribhuvan J. Professor, Garden City College Bangalore Revised Edition: Spring 2010 Printed: October 2012 This book is a distance education module comprising a collection of learning materials for our students. All rights reserved. No part of this work may be reproduced in any form by any means without permission in writing from Sikkim Manipal University, Gangtok, Sikkim. Printed and Published on behalf of Sikkim Manipal University, Gangtok, Sikkim by Manipal Global Education Services Manipal 576 104. Printed at Manipal Technologies Limited, Manipal. Mr. Pankaj Khanna Director HR, Fidelity Mutual Fund Mr. Shankar Jagannathan Former Group Treasurer Wipro Technologies Limited Mr. Abraham Mathew Chief Financial Officer Infosys BPO Ms. Sadhna Dash Senior HR Consultant Bangalore
Content Revised and Updated by: Dr. Ram Singh is Associate Professor at Indian Institute of Foreign Trade (IIFT) with over 13 years of teaching experience. He specializes; both in training & research; in areas such as Export Import Procedure; Trade Policy & Trade Logistics. He has authored 2 books, 6 structured learning materials and 33 research publications. Dr. Singh is visiting faculty to IFM, Tanzania, UIRI; Uganda, School of Banking & Finance, Rwanda and many other universities in Africa & Europe. He is directly involved in training of Indian Trade Services (ITS) Officers and is visiting faculty, National Academy of Custom Excise & Narcotics for training of Indian Revenue Services (IRS) Officers. Peer Reviewed by: Dr. Rakesh Mohan Joshi is the Professor and Chairperson, International Projects Division at Indian Institute of Foreign trade (IIFT). He is also the Project Director of India-Africa Institute of Foreign Trade (IAIFT), a Pan African institute being set up at Kampala He received his MBA from Rajasthan University, Jaipur and EECPL from Harvard Business School, Boston. He is also a qualified Lead Auditor for ISO certification from British Standard Institute. Prof. Joshi's areas of interest include International Business, International Marketing, Global Business Strategy, International Trade, Agricultural/Processed Foods Exports, International Entrepreneurship and Higher / Management Education. His remarkable contribution in the field of management is evident from his books International Business and International Marketing both published by Oxford University Press. He has also written several excellent case studies and some of his case studies have been awarded by London Business School and published internationally. In House Content Review Team Dr. Sudhakar G. P. HOD Dept. of Management Studies SMU DDE, Bangalore Ms. Arpita Agrawal Assistant Professor Dept. of Management Studies SMU DDE, Bangalore
Contents Unit 1 Introduction to International Business Unit 2 International Trade Theories and their Application Unit 3 International Business Environment Unit 4 Culture and International Business Unit 5 Foreign Investments Types and Motives Unit 6 Regional Integration Unit 7 Global Trade Institutions Unit 8 International Financial Management Unit 9 International Accounting Practices
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46 69
90
114 139 158
177
Unit 10 International Marketing Unit 11 International Strategic Management Unit 12 Ethics in International Business Unit 13 International Human Resource Management Unit 14 Finance and International Trade Unit 15 Global Sourcing and Indian Industries Structure 198
225 245 267 293 316
MB 0053 International Business Management

Course Description
The study of International Business Management includes the activities of international companies and cross border transactions of governments. The purpose of this study is to understand the effort of every individual and organisation in striving to be the global leader. The world economy is globalising at an accelerating pace. Countries that were previously closed to foreign companies have now opened up their markets. Internet has made the world a smaller place. All these factors have contributed to the growth of international business. International business operates under different economic, political, and legal environments. There are various theories that are considered when companies deal with business internationally. When a company deals internationally, it interacts with people from various cultures across the world. Hence, culture is an important aspect in international business and a company must handle the cultural diversity in international business. International business has improved the quality of life of people around the world and has made life simple and easier. Course Objectives: The course International business management of MBA 4th Semester helps students to understand the international business concepts and makes them aware of the risks and returns of doing business globally. After studying this subject, you should be able to: explain the concept of international business. distinguish international business from domestic business. describe the various international trade theories analyse international business environment. understand the intercultural issues in international business list the various regional integrations across the world. examine the international financial management and accounting practices
explain the international marketing concepts analyse the role of human resource management in international organization. understand the importance of ethics in international business discuss the documents in international trade and payment. describe the role of strategy in international business. understand the role of global sourcing and its challenges
This Self-Learning Material (SLM) of the subject is divided into 15 units as follows: Unit 1: Introduction to International Business This unit explains the dynamics of global business in todays business environment. It describes the role of multinational companies in international markets. This unit also covers the differences between international business and global business. Unit 2: International trade theories and their application This unit covers the popular international trade theories. This will help in explaining the origin and need of trade along with the benefits as suggested by various economists. It also discusses the application of these theories by different countries. Unit 3: International Business Environment This unit covers the economic, political, social and other environments in which an international business operates. It explains the need of environment analysis and importance of international business environment study. Unit 4: Culture and International Business Culture is an important factor for practicing international business. Culture affects all the business functions ranging from marketing to finance and production to service. This unit shows a close relation between culture and international business. Unit 5: Foreign Investments This unit describes the meaning, advantages and types of foreign investments. It explains in detail what are foreign direct investments and
foreign portfolio investments and how they are important for international business. Unit 6: Regional integration This unit lists out the various regional integrations across the world. It also discusses the various trading blocs, their importance, structure, and functioning. It explains the purpose, importance, and role of regional integrations in shaping up the world trade and government policies. Unit 7: Global trade institutions The unit covers the various important global trade institutions like WTO, ILO, IMF and World Bank. It discusses various international organizations working towards promoting international business and provide regulatory framework It describes about the role and agreements of World trade organization. It also explains about International labor organization and its main bodies. Unit 8: International Finance Management This unit explains the meaning of international financial management. It gives an overview of the components of international financial management and its scope. This unit also explains the aspects of financial decisions, taxation, and management of working capital. Unit 9: International Accounting Practices This unit describes various factors involved in accounting practices followed by multinational companies. It explains the various regulators and accounting standards followed by different countries and regions across the world. It discusses accounting from an international perspective. This unit also includes international regulatory bodies and the international financial reporting standards. Unit 10: International Marketing This unit gives an overview of international marketing. The topics covered are scanning international marketing, global marketing strategies, policies, valuation of brands, and the different ways of circumventing the challenges of international branding.
Unit 11: International Strategic Management This unit explains the meaning of international strategic management with reference to the strategy to compete. It examines the strategic planning and its types. It also analyses the strategic management process. Unit 12: Ethics international business This unit explains various topics on workplace ethics, its importance and application in a global business environment. It also gives a perspective of business ethics practiced in different countries. It includes the code of ethics, policies and procedures, and the general code of conduct followed by multinational companies. Unit 13: International Human Resource Management This unit examines the structure of multinational companies. It describes the dimensions and strategies for international human resource management. Unit 14: Finance and International Trade This unit explains the benefits, payment systems, and arrangements related to international trade. It discusses the documentation required to make foreign trade transactions. It examines the various export promotion schemes supported by the government and the methods for exporters and importers within India to avail finance. Unit 15: Global Sourcing and its Impact on Indian Industries This unit explains the evolution of globalization in India and its impact on Indian business. It discusses the concept, advantages and disadvantages of global sourcing. It also describes the global sourcing challenges for Indian industries.
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Unit 1
Introduction to International Business
Structure: 1.1 Introduction Objectives 1.2 Introduction to International Business Definition Evolution 1.3 Elements of International Business Domestic vs. international business Advantages of international business Drivers of international business Entry to international business 1.4 Globalisation International vs. global business Benefits of globalisation 1.5 Summary 1.6 Glossary 1.7 Terminal Questions 1.8 Answers 1.9 Case-let
1.1 Introduction
The world economy is globalising at an accelerating pace as countries previously closed to foreign companies have opened up their markets. Geographic distance is shrinking because of the Internet, as the ambitious companies aim for global leadership. All this is possible because of booming international business. International business is mainly concerned with the issues that are related to international companies and governments cross border transactions. International business involves multiple countries to satisfy the objectives of every individual as well as the organisations. International business management is a process of achieving the global objectives of a firm by effectively managing the human, financial, intellectual and physical resources.
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In this unit, you will study about the dynamics of global business in todays business environment and the need for multinational companies to tap international markets for their business. In this unit, you will also examine the difference between international business and global business. Objectives: After studying this unit, you should be able to: describe the evolution of international business. explain the concept of international business. analyse the difference between domestic, international, and global business. explain the dynamics of globalisation.
1.2 Introduction to International Business

International business is a broad term including not only movement of goods and services but various other aspects. Let us learn the definition and evolution of international business in detail. 1.2.1 Definition International business can be defined as any business that crosses the national borders of a country. It includes importing and exporting; international movement of goods, services, employees, technology, licensing, and franchising of intellectual property (trademarks, patents, copyright and so on). International business includes investment in financial and immovable assets in foreign countries. Contract manufacturing or assembly of products for local sale or for export to other countries, establishment of foreign warehousing and distribution systems, and import of goods from one foreign country to a second foreign country for subsequent local sale is part of international business. There are various factors that affect international business. These factors include economic environment, culture, political environment, financial and banking systems, regulatory bodies, human capital, and trade policies and so on, of the target country. Figure 1.1 represents the various factors affecting international business.
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Figure 1.1: Factors affecting international business
In a rapidly changing global economic scenario under World Trade Organization, starting an international business is considered to be more complex than starting a domestic business. There are two specific reasons for it. Firstly, the numbers of parties involved in international trade are more than domestic business. Such parties may include customs officials, Director General of Foreign Trade, Reserve Bank of India, excise officials and duty drawback officials, insurance companies, shipping companies, freight forwarders, and banks except exporter and importer himself. All of them help in administering, regulating, facilitating and financing the export import business. The diagram given below illustrates the agencies involved in entire international trade process.
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Buy
Ship
Pay
Order/Prepare
Transport
Customs
Payment
Importer Exporter Insurance Company Chamber of Commerce Export/Import Agent DGFT Licensing Authority Embassies ECGC/Credit Checking Suppliers/Sub Contractors Other Intermediaries
Freight forwarder Packers & Consolidators Transporter Fumigation & Pest Control Carrier/MTO Shipping line Export Inspection Agency Other Intermediaries
Custom Clearance Custom House Agent ICDs/CFSs Health Authorities/ PHO Terminal Operators Port Management Other Intermediaries
Bank Financial institutions Factor/forfeitors Other Intermediaries
Figure 1.2: Source: Adapted from Trade Facilitation from a Developing Country Perspective; National Board of Trade Sweden; 2003
These will be discussed in detail in the coming units. Secondly, the distances involved in trade transaction, differences in business etiquettes and practices in different countries, varied cultures, languages, preferences and currencies complicate the process and the exporters need to have near accurate, comprehensive and complete information at the right time for a successful international trade entry. It is not an easy job as the information flows as well as export and import related formalities keep on changing on a continuous basis. If such information on countrys cultural, economic and social aspects is successfully administered, traders will have following advantages in successfully conducting the business. a) Speedy delivery of internationally traded goods b) Quicker release of payments in trade transactions
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c) Generating economies of scale by expanding and diversifying business to overseas markets. d) Reduced transactional costs in trade e) Retaining satisfied customers. f) Higher returns on sales, as nations usually do not impose duties and taxes on exportable goods and services.
g) Higher learning curves through feedback for international customers which help trader to customized and improve product or service on regular basis. h) Maximizing overall returns from international business. 1.2.2 Evolution Origins of international trade can be traced thousands of years back to the Babylonians, who used to ply their wares to distant lands. Records of organised international trade have been traced to the ancient Roman Empire, when a common coinage was introduced to encourage trade across the vast empire. The proof of ancient trade routes is found in the regions of Egypt, Arabia, Greece, Asia, and Mesopotamia. The well-known Silk Road and Spice Routes were the epitome of international business. The Silk Road was an overland trade route from the Mediterranean Sea to China, developed during the Han Dynasty between 200 BC and 8 AD. This 6,000 km-long route ran from Mediterranean Sea to the early Chinese capital of Hangman (refer figure 1.3). Goods like perfumes, fine fabrics, silk, and spices were traded from various European ports to China and other places in between.
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Figure 1.3: Ancient Silk Road and Spice Route
Discovery of the America by Christopher Columbus and sea route to the Indian coast by Vasco da Gama opened up the international markets like never before. British East India Company, which was set up in the year 1600 AD, is credited to be the worlds first multinational company. Industrial revolution in the eighteenth century gave way to innovation and technology, which led to mass production facilities, and took the British Empire to global markets. With almost unlimited supply of raw materials, minerals, precious metals, low cost labour, and manpower supply from their colonies, the British Empire became a world power in terms of international trade. Post World War I, the balance shifted to America and Europe. During this period, the world witnessed rapid innovations in science and technology and developments in the field of agriculture. Immediately after the World War II, the governments of western countries felt the need to break the trade barriers across international borders to revive the post war economies of their respective countries. The United Nations Monetary and Financial Conference (Bretton Woodss conference) held in July 1944 at new Hampshire, USA, was attended by
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representatives from 44 nations across the world. It laid down the framework for international business. The outcome of the Bretton Woods conference is stated below: Establishment of International Monetary Fund (IMF) and International Bank for Reconstruction and Development (IBRD). Regulated foreign exchange market system. Currency convertibility. Subsequent to the Bretton Woods conference, after several rounds of negotiations and international agreements, several trade barriers and tariffs were reduced or removed within the guidelines of General Agreement on Trade and Tariffs (GATT). Creation of the WTO on 1 January, 1995, marked the biggest reform of international trade since World War II. Under the Marrakech agreement, WTO was formed to replace GATT. The WTO is the only international body that deals with the rules of trade between nations. Its main objective is to facilitate smooth international trade. Self Assessment Questions 1 1. _____________ can be defined as any business that crosses the national borders of the country of its establishment. 2. Exports and imports do not constitute international business. (True/False) 3. ____________ is considered as the first MNC in the world. 4. Bretton Woods conference led to the formation of _____________. a) World Trade Organisation b) International monetary fund c) United Nations Organisation d) General Agreement on Trade and Tariffs
1.3 Elements of International Business

In the previous section, we discussed the meaning and evolution of international business. Let us now consider the various factors that differentiate international business from domestic business, before learning more about international business.
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1.3.1 Domestic vs. international business The fundamental objective of any business is to generate good profits from its operations. While this remains true in both domestic and international business, we can observe several differences in areas like legal framework, government regulations, financial management, accounting and taxation systems, culture, and market forces. Some of these issues are explained below: Legal and regulatory framework This framework refers to companies having to comply with the law of the land they operate in. Companies involved in international business may have to comply with laws of more than one country. This certainly poses a challenge as each country has its own set of laws. These companies have to ascertain that their scope of business is within the regulatory framework set by the authorities of that country. Financial management In a domestic scenario, all the payments of a business involve the local currency. In an international scenario, for example, a company may pay in Chinese Yuan for sourcing its materials from China, pay wages in Malaysian Ringgits at its production base in Malaysia, and receive payments in Euros from its customer in Germany. Hence, a company has to deal with multiple currencies, exchange rate mechanisms, hedging of currencies, banking systems, fluctuating interest rates and so on. Trade barriers and tariffs In a domestic scenario, a company can move its goods and services almost freely within the country. But in international trade, companies face issues like licensing, anti-dumping laws, quota restrictions, and tariffs for their business operations in a foreign country or region. Accounting and taxation Domestic businesses need to comply with the accounting and taxation standards prevailing in that country. A company with international operations has to comply with the accounting standards and tax laws of the foreign country as well. Culture In a domestic market, a business deals with a homogenous culture whereas .a company with international business has to deal with heterogeneous cultures in multiple countries. The companys management
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has to study different cultures and get accustomed to different languages, culture, sentiments, and traditions of the foreign country in order to conduct business productively. Market forces Demographics of each country have its own perceptions about different products and services. The local, political, economic, and technological environments differ from country to country. While these differences are at a macro level, at the micro level we have to consider several other factors. They may be in terms of customer preferences, product placement, pricing, advertising, distribution channels and so on. An international company has to face the challenges of multiple regional customers, each with unique requirements. 1.3.2 Advantages of international business Let us discuss the need for companies to expand into foreign markets, and the benefits companies get from international business. Some of the advantages are as follows: Low cost production A company can take advantage of low cost production outside its domestic operations by identifying a nation where the labour is cost effective and in abundant supply. For example, countries like China, Philippines, and Mexico offer such low cost production opportunities. Strategic resources A company utilises many valuable resources available in a foreign country either by importing from that country or by setting up a subsidiary, manufacturing, or production plant in that country. These resources can be human or natural resources like minerals. For example, India has an abundance of skilled engineers, and many global companies take advantage of this resource by either setting up a subsidiary in India or through their partners. Similarly, Australia boasts of rich mineral deposits and so it houses the worlds largest mining companies. Large customer base Expanding into markets of foreign countries leads to exposure to more customers, better revenues, increased profits, and lateral growth. This scenario is ideal when the company has already established products in its domestic market. For example, Sweden based IKEA is the worlds largest furniture retailer, and operates in 37 countries after a modest beginning in Sweden.
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Competitive advantage A company with unique competencies and capabilities gain benefits in the international market. For example, Intels (USA) competencies and capabilities in semiconductors and chips have propelled it to global market leadership in microprocessors. Diversify risk Any company can dilute its business risk by spreading its operations to a number of different and diverse countries rather than depending on any one market or region. For example, during the 1997 Asian financial crisis, companies with exposure in European and American countries were able to sustain far better than their counterparts in Asia.
1.3.3 Drivers of international business The tendency of companies to move beyond national borders gained momentum in 1940s and was expedited with the establishment of WTO in 1995. According to the data provided in table 1.1, international trade is growing at a healthy rate, encouraged by several developments across the world. In this section, let us explore some of these factors that drive international business. Global marketplace International business has become easier since the advent of internet and the emergence of e-business. A company must have a good product, the right strategy and an appetite to take risk at the global marketplace in order to do business internationally. Emerging markets Compared to developed countries, developing countries are growing at a healthy pace, thus reducing the barriers of trade. Emerging markets provide an unexplored marketplace with unlimited potential and scope for business. Any company with good or innovative products and services cannot afford to ignore the opportunities provided by these emerging markets. Foreign Direct Investment (FDI) policy of a nation lays down the foundation for competitive and prosperous market conditions. Embracing globalisation has become a vital component of development strategy for developing countries, and is being used as an effective instrument of economic growth. Some countries like China, India, and Philippines also provide tax holidays to foreign companies for setting up their business (in certain sectors) in these countries. Such incentives make these countries an attractive destination for companies looking for low cost production.
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Small domestic market A company, which is mature in its domestic market, is driven to sell in more than one country because the sales volume achieved in its own domestic market is not large enough to fully capture the manufacturing economies of scale. For example, Nokia is an international company based in Finland. Diminishing trade and investment barriers The lowering of barrier to trade and investments (by most countries around the world) also provides an opportunity to companies looking for expanding their business. Expanding into a foreign country provides access to low wage labourers, highly skilled work force, larger market base and so on. Companies have a chance to set up subsidiaries in low-cost countries for manufacturing their products. Easy flow of goods and services results in the company literally designing the product in one country, manufacturing the various components in different countries, assemblings the final product in a third country and marketing the product across the world. Technological innovation The advent of internet and e-commerce, advancement of telecommunication, information technology, and improvement in logistics have changed the dynamics of business operations. The use of mobile telephony, wireless communications, and satellite connectivity has reduced the time needed for decision making at an international level. Constant innovation in technology has enhanced information flow between geographically remote areas, thus bringing the markets of different countries closer and paving the way for international business. Changing demographics Most developed countries face challenges in sourcing workforce as the average age of the population is getting older. In the next 10 years, most of the industrialised nations will have to depend on sourcing its workforce from countries like India, China and other countries, where the population is young, with abundance of skilled labour. India alone produces close to fve lakh engineers and one million English speaking graduates and other diploma holders per year. Figure 1.4 gives you a pictorial representation of various drivers affecting international business.
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Figure 1.4: Drivers of international business
Trading blocs Formation of various regional and international trading blocs like European Union, World Trade Organisation, South Asian Free Trade Agreement, and North American Free Trade Agreement have resulted in increased regional cooperation. These trading blocs promote business within their scope by facilitating free trade zones, which literally eliminates any trade or investment barriers. Regional trading blocs also facilitate easy movement of goods, services, and human resources within the region, thus providing a uniform opportunity to all the countries (in the region) for proper allocation of resources. 1.3.4 Entry to international business For a company that wants to expand internationally, there are several available entry options. They are listed as follows: Export strategy. Licensing. Franchising. Foreign direct investment.
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Export strategy This method remains the most common means of entry into international markets. Export strategy is a very attractive option that is merely an extension of domestic operations. It also minimises the risk component as well as the capital requirement. The host companys involvement in the international market is limited to identifying customers for marketing its products. Licensing A domestic company can license foreign firms to use the companys technology or products and distribute the companys product. By licensing, the domestic company need not bear any costs and risks of entering foreign markets on its own, yet it is able to generate income from royalties. The reverse of this arrangement is the risk of providing valuable technological knowledge to foreign companies, and thereby losing some degree of control over its use. Monitoring licenses and safeguarding companys Intellectual Property Rights can prove to be challenging in an international scenario. Puma adopted licensing strategy post 1999. Franchising Licensing works well for manufacturing companies but franchising is a better option for international expansion efforts of service or retailing companies. Franchising has the same advantages as licensing. The franchisee bears almost all the costs and risks in establishing the foreign operations. The franchisers contribution is limited to providing the concept, technology and training the franchisee in the already established model. Maintaining quality poses the biggest challenge to the franchiser. McDonalds uses franchising model. Foreign Direct Investment (FDI) FDI is the investment made by a company in a foreign country to start its operations. Various options available for an FDI are as follows: Whole owned subsidiary This option is viable if a company is willing to take all the risks of all the operations pertaining to its business in a foreign country. A subsidiary can be formed from scratch (green field investment) to manufacture and market its products and services in a foreign country. A firm can also export its products or services to other countries from its subsidiaries. American Airlines is a wholly owned subsidiary of AMR Corp.
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Joint Ventures (JV) This is a very popular mode of entry into foreign markets, as it minimises business risk and investment. It is owned by one or more firms in proportion to their investment. If a JV is done with an existing competitor, it could be termed as a strategic alliance. Sony Ericsson is an example of joint venture between Sony, a Japanese company and Ericsson, a Swedish company. Merger or acquisition A company can merge into or acquire an existing company with established operations in a foreign country. It saves a lot of time in construction, initial setup, and regulatory approvals and so on. In the bargain, the acquiring company can use all the established brand names, distribution networks and so on of the acquired company. Eg. Proctor and Gamble Strategic investment Any firm can purchase a stake in a foreign company, whereby they are entitled to a share in the profits, if any. The shareholding can be a minority stake and may be without voting rights. Generally, the investing company does not participate in the management of the target company.
Self Assessment Questions 2 5. Domestic business need to comply with the accounting and taxation standards prevailing in that country. (True/False) 6. ___________ is not an advantage of international business. a) Low cost production b) Market forces c) Large customer base d) Diversified risk 7. Franchising and licensing are barriers to international business. (True/False) 8. Technological innovations and diminishing trade barriers are _________ of international business. Activity 1 Discuss examples of Indian companies for each entry strategy for international business. Hint: Refer section 1.3.4 for different entry options.
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1.4 Globalisation
In the previous section, we learnt the various aspects of international business. We will now broaden our perspective and examine globalisation. Globalisation is a process where businesses are dealt in markets around the world, apart from the local and national markets. According to business terminologies, globalisation is defined as the worldwide trend of businesses expanding beyond their domestic boundaries. It is advantageous for the economy of countries because it promotes prosperity in the countries that embrace globalisation. In this section, we will understand globalisation, its benefits and challenges. 1.4.1 International vs. global business Most of us assume that international and global business are the same and that any company that deals with another country for its business is an international or global company. In fact, there is a considerable difference between the two terms. International companies Companies that deal with foreign countries for their business are considered as international companies. They can be exporters or importers who may not have any investments in any other country, apart from their home country. Global companies Companies, which invest in other countries for business and also operate from other countries, are considered as global companies. They have multiple manufacturing plants across the globe, catering to multiple markets. The transformation of a company from domestic to international is by entering just one market or a few selected foreign markets as an exporter or importer. Competing on a truly global scale comes later, after the company has established operations in several countries across continents and is racing against rivals for global market leadership. Thus, there is a meaningful distinction between a company that operates in few selected foreign countries and a company that operates and markets its products across several countries and continents with manufacturing capabilities in several of these countries.
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Companies can also be differentiated by the kind of competitive strategy they adopt while dealing internationally. Multinational strategy and global competitive strategy are the two types of competitive strategy. Multinational strategy Companies adopt this strategy when each countrys market needs to be treated as self contained. It can be for the following reasons: Customers from different countries have different preferences and expectations about a product or a service. Competition in each national market is essentially independent of competition in other national markets, and the set of competitors also differ from country to country. A companys reputation, customer base, and competitive position in one nation have little or no bearing on its ability to successfully compete in another nation. Some of the industry examples for multinational competition include beer, life insurance, and food products. Global competitive strategy Companies adopt this strategy when prices and competitive conditions across the different country markets are strongly linked and have common synergies. In a globally competitive industry, a companys business gets affected by the changing environments in different countries. The same set of competitors may compete against each other in several countries. In a global scenario, a companys overall competitive advantage is gauged by the cumulative efforts of its domestic operations and the international operations worldwide.
A good example to illustrate is Sony Ericsson, which has its headquarters in Sweden, Research and Development setup in USA and India, manufacturing and assembly plants in low-wage countries like China, and sales and marketing worldwide. This is made possible because of the ease in transferring technology and expertise from country to country. Industries that have a global competition are automobiles, consumer electronics (like televisions, mobile phone), watches, and commercial aircraft and so on.
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Table 1.2 portrays the differences in strategies adopted by companies in international and global operations.
Table 1.2: Differences between international and global strategies Strategy Location International Selected target countries and trading areas Global Most global businesses operate in North America, Europe, Asia Pacific, and Latin America Same basic strategy worldwide with minor country customisation where necessary Mostly standardised products sold worldwide, moderate customisation depending on the regulatory framework Plants located on the basis of maximum competitive advantage (in low cost countries close to major markets, geographically scattered to minimise shipping costs, or use of a few world scale plants to maximise economies of scale) Attractive suppliers from across the world Much more worldwide coordination; minor adaptation to host country situations if required Efforts made to use almost the same technologies, competencies, and Page No. 17
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Custom strategies to fit the circumstances of each host country situation Adopted to local culture and particular needs and expectations of local buyers
Product-line
Production
Plants scattered across many host countries, each producing versions suitable for the surrounding environment
Source of supply of raw materials Marketing and distribution
Suppliers in host country preferred Adapted to practices and culture of each host country
Cross country connections
Efforts made to transfer ideas, technologies, competencies and
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capabilities that work successfully in one country to another country whenever such a transfer appears advantageous Company organisation Form subsidiary companies to handle operations in each host country; each subsidiary operates more or less autonomously to fit host country conditions
capabilities in all country markets (to promote use of a mostly standard strategy), new successful competitive capabilities are transferred to different country markets All major strategic decisions closely coordinated at global headquarters; a global organisational structure is used to unify the operations in each country
1.4.2 Benefits of globalisation The merits and demerits of globalisation are highly debatable. While globalisation creates employment opportunities in the host countries, it also exploits labour at a very low cost compared to the home country. Let us consider the benefits and ill-effects of globalisation. Some of the benefits of globalisation are as follows: Promotes foreign trade and liberalisation of economies. Increases the living standards of people in several developing countries through capital investments in developing countries by developed countries. Benefits customers as companies outsource to low wage countries. Outsourcing helps the companies to be competitive by keeping the cost low, with increased productivity. Promotes better education and jobs. Leads to free flow of information and wide acceptance of foreign products, ideas, ethics, best practices, and culture. Provides better quality of products, customer services, and standardised delivery models across countries. Gives better access to finance for corporate and sovereign borrowers. Increases business travel, which in turn leads to a flourishing travel and hospitality industry across the world. Increases sales as the availability of cutting edge technologies and production techniques decrease the cost of production.
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Provides several platforms for international dispute resolutions in business, which facilitates international trade.
Some of the ill-effects of globalisation are as follows: Leads to exploitation of labour in several cases. Causes unemployment in the developed countries due to outsourcing. Leads to the misuse of Intellectual Property Rights (IPR), copyrights and so on due to the easy availability of technology, digital communication, travel and so on. Influences political decisions in foreign countries. The MNCs increasingly use their economical powers to influence political decisions. Causes ecological damage as the companies set up polluting production plants in countries with limited or no regulations on pollution. Harms the local businesses of a country due to dumping of cheaper foreign goods. Leads to adverse health issues due to rapid expansion of fast food chains and increased consumption of junk food. Causes destruction of ethnicity and culture of several regions worldwide in favour of more accepted western culture. In spite of its disadvantages, globalisation has improved our lives through various fields like communication, transportation, healthcare, and education. Self Assessment Questions 3 9. Companies, which invest in other countries for business and also operate from other countries, are considered as ___________. 10. International and global business is different. (True/False) 11. Globalisation improves the living standards of people in developing countries. (True/False) 12. ____________ can be defined as the worldwide trend of businesses expanding beyond their domestic boundaries. Activity 2 Aditya Birla group is a global corporation. Justify this statement based on their business strategies. Refer this link for guidance - http:// www. adityabirla. com/media/ press_reports/20070114_dare_to_dream.htm
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1.5 Summary
Now, let us summarise what we have discussed in this unit about introduction to international business: International business involves cross border movement of goods and services. It includes exporting, importing, franchising, licensing etc. International business dates back to the Babylonians who plied their goods across distant lands. International business differs from domestic business in some important features like the financial management of the business, the legal and regulatory framework, and the market forces that dictate the demand of products. Some of the entry modes for international business include exports, licensing, franchising and FDI. International business and globalisation are two different things. Globalisation involves companies that invest and operate in other countries. It promotes economic growth and prosperity in the countries that embrace globalisation. Some of the benefits of globalisation include liberalisation of economies and the free flow of information.
1.6 Glossary
Acquisition: The process by which a company buys most, if not all, of the target company's controlling shareholding in order to assume control of the target firm. Demographics: The composition of a countrys population in terms of age, sex, marital status, family size, education, geographic location, and occupation. IPR: Intellectual Property Rights are the legal rights over an intangible asset. For example, designs, ideas, music composition and so on. Subsidiary: A company whose controlling interest is held by a bigger (parent) company. Trading bloc: An agreement between some countries or regions to promote trade and eliminate trade barriers within the member states.
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1.7 Terminal Questions

1. 2. 3. 4. 5. Explain the evolution of international business. State the factors distinguishing domestic trade from international trade. Analyse various drivers of international business. Discuss the strategies to enter international business. Explain the benefits of globalisation.
1.8 Answers
Self Assessment Questions 1 1. International business 2. False 3. British East India Company 4. b) International monetary fund Self Assessment Questions 2 5. True 6. b) Market forces 7. False 8. Drivers Self Assessment Questions 3 9. Global companies 10. True 11. True 12. Globalisation Terminal Questions 1. International business can be traced back to 200 BC. Discovery of new sea routes in the sixteenth century propelled international business into dimensions with the formation of multinational companies. Post World War II, it took a new dimension and led to globalisation that has been witnessed today. For more details, refer sub-section 1.1.1. 2. Distinguishing factors between domestic and international businesses are legal and regulatory framework, financial systems, trade barriers and tariffs, accounting and taxation, culture and markets. For more details, refer sub-section 1.3.1.
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3. Some of the drivers of international business are attractive emerging markets, diminishing trade barriers, innovations in technology, changing demographics, and encouraging trade blocs. For more details, refer section 1.3.3. 4. Strategies for entering international business are exporting, licensing, franchising, joint venture, wholly owned subsidiary, and strategic investment and so on. For more details, refer section 1.3.4. 5. Outsourcing to low wage economies, increased living standards in developing countries, competitive pricing of products and services, easy access to finance and global educational opportunities are some benefits of globalisation. For more details, refer section 1.4.2.
1.9 Case-let
BATA An International Company Bata Shoe Company, founded in 1894 in the former Czechoslovakia (presently headquartered in Lausanne, Switzerland), is one of the world's leading footwear retailers and manufacturers, with operations across five continents managed by three regional meaningful business units (MBUs). The MBU approach provides quality resources and support in key areas to the companies operating in similar markets such as product development, sourcing, or marketing support. Each MBU is entrepreneurial in nature, and can quickly adapt to changes in the market place and seize potential growth opportunities. Batas three MBUs are Bata Europe, Lausanne, Switzerland; Bata Emerging Markets, Singapore; and Bata Branded Business, Best, Holland. Bata's strength lies in its worldwide presence. While local companies are self-governing, each one benefits from its link to the international organisation for back-office systems, product innovations, and sourcing. Research and development Bata operates six Shoe Innovation Centres (SICs). Research is conducted in applying new technologies, materials, and designs for shoe comfort features. Each SIC has a product focus to supply complete packages of services for the manufacturing and marketing of innovative shoes.
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Shoe making expertise Apart from being one of the world's leading footwear retailers, Bata is also an expert in making shoes, with over 110 years of experience in manufacturing. Currently, they operate 33 production facilities across 22 countries. While most modern day manufacturers outsource to Asia, Bata manufactures predominantly in their own manufacturing facilities across the world, guaranteeing quality and expertise. Approximately half their factory outputs are destined for sale through Bata-owned retail stores, and the balance is manufactured to the specifications of wholesale customers or under contract to other footwear brands. Bata innovations in footwear production techniques are being used by other competitors in the industry even today. In 2010, Bata served 1 million customers a day; employed more than 50,000 people; operated more than 5,000 retail stores; and managed retail presence in more than 70 countries. Discussion Questions 1. Bata is a global company. Justify. (Hint: operates in 70 countries) 2. Identify the strategy that Bata uses for entry into new markets. (Hint: Own showrooms) 3. What are the factors that help Bata retain its global leadership position? (Hint: Innovation)
Source: www.bata.com, Retrieved on 28 June 2012
References: Batra, G. S. (2006). Liberalisation, Globalisation and International Business. Deep and Deep Publications. Bhalla, V. K. & Shiva, Ramu S. (2008). International Business Environment and Management. Anmol Publications. Chauhan, P.L., Kakkad, Ratish, Patel, Rupal H. (2006). International Business. Shanthi Prakashan.
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Cherunilam, Francis (2010). International Business Environment. Himalaya Publishing House. K. Aswathappa (2010). International Business. Tata McGraw-Hill Publications Co. Ltd. McDonald, Frank and Burton, Fred (2002). International Business. International Thomson Computer Press. Nelson, Carl A. (1999). International Business - A Managers Guide to Strategy in the Age of Globalism. PWS South Western Duxbury Cole Onwo. Porter, Michael (1990). The Competitive Advantage of Nations. The Free Press. Thomson Jr., Arthur; Strickland III, A. J.; Gamble, John E. & Jain, Arun K. (2006). Crafting and Executing Strategy: The Quest for Competitive Advantage. Tata McGraw Hill Publications Co. Ltd.
E-References: http://www.wto.org, retrieved on 17th September, 2010 http://cas.bellarmine.edu/tietjen/Ecol&Evol/connections.htm, retrieved on 18th September, 2010 http://www.bata.com/about-us.php, retrieved on 18th September, 2010 http://www.wto.org/english/news_e/pres11_e/pr628_e.htm, retrieved on 20th April 2012
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Unit 2
International Trade Theories & their Application
Structure: 2.1 Introduction 2.2 Why do nations trade 2.3 Theories of international trade Mercantilism Absolute advantage theory Comparative advantage theory Heckscher-Ohlin trade theory Product lifecycle theory Porters diamond model 2.4 Summary 2.5 Glossary 2.6 Terminal questions 2.7 Answers 2.8 Case-let
2.1 Introduction
From ancient civilizations, world history is essentially a story of wars and trade. Major wars were primarily fought mainly for economic reasons rather than conflict of political, cultural or social ideas. For example, Britons set up their colonies world over for trade, U.S. invaded Iraq and Libya mainly for economic reasons. Africa was colonised for trade and commerce and so was the story of Latin America. Historians, world over, generally agree that most wars are fought for trade-related reasons. Theories of international trade and their application help us understand the motives and reasons behind such wars explaining trade pattern and the benefits that flow from trade. An understanding of international trade theory helps us as investors or consumers/buyers or sellers/companies and governments to determine how to act for their own benefit within the global trading system. In the previous unit, you understood the concept of international business along with various reasons and techniques for entering a foreign market. In this unit, you will study about international trade theories. This helps us explain the trade patterns, trade motives, trade trends and observed trade. It
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helps us explain the characteristics of trade pattern of a trading country, and those characteristics will help in deducing what, why, where and how they actually trade. Various trade theories provide us easy understanding and explanations about reasons, characteristics and motives behind trade. Secondly, trade theory also helps us understand the effects of trade on the domestic economy/sectors of economy and helps diagnose cause-effect relationship which in turn helps the country policy makers to evaluate different kinds of policy. As a result, government can plan for policy interventions to boost trade and international commerce and brining prosperity to country, thus generating welfare in society. Objectives: After studying this unit, you should be able to: understand reasons why nations trade with each other. explain why Mercantilist theory failed? describe Absolute Cost Advantage Theory and its features. understand Comparative Cost Theory. understand how factor endowments affect foreign trade of country. analyse the implications of these theories on international trade.
2.2 Why Do Nations Trade?

Fundamental question that International Trade Theories help us understand is why do countries trade? Why a strong economy like the US does not produce all goods and services at home rather than importing them from countries such as China and India? Why do countries specialise in trade, for example, a strong economy like Japan imports wheat, corn, chemical products, aircraft, manufactured goods, and informational services from other countries. International trade theories attempt to solve the above questions with the help of the diagram given below:
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Figure 2.1
The answer to the above questions would be that countries world over are endowed with different natural, human, and capital resources. Each country varies from the other in combining these resources (land, labour and capital). In a globalised set-up, every country cannot be as efficient as the best in producing the goods and services that their residents demand. As a result, they have to trade off their decisions to produce any good or service based on opportunity cost. Opportunity cost model helps us understand the choice of producing one good or another. The production decision of the country depends on whether it is more efficient to produce the goods and services with lower opportunity cost with increased and specialised production, or to trade those goods, with goods of higher opportunity cost.
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If a country can produce more of any goods or services with the same resources used by any other country, it is said to have an absolute cost advantage in the production of those goods or services. For example, India has absolute cost advantage in cutting and polishing of diamond. Around 68% of the diamonds from all over the world are cut and polished in India. India is the largest producer of diamond jewellery in the world. On the other hand, India would import items which can be imported at a lower cost than it would take to manufacture these items locally, for example Swiss watches where Switzerland has absolute advantage. Thus countries trade their production decision based on absolute cost advantages. Trade in globalised set-up has been used as an instrument for enhancing a countrys economic growth and is usually beneficial to both the exporting and importing countries. Nations even if they have an absolute cost advantage in the production of goods that are to be traded vis a vis its counterpart, would like to specialise in higher opportunity cost products. The production size and scale may be limited by other constraints. For example India and Thailand have signed a Free Trade Agreement. Thailand is cost efficient in both auto component and pharmaceuticals. India would like to import auto component and would export pharmaceuticals to Thailand. This will be beneficial to India as it will benefit from economies of scale with higher production of pharmaceuticals. Opportunity cost and efficiency in production varies from country to country as countries have different endowments of productive resources like land, labour and capital. For example, US, a capital rich country will specialise in production of aeroplanes and India, rich in labour pool will specialise in rendering of information technology services. Trade is also affected as different countries are endowed with different natural resources and climate zones, longer growing seasons for a produce, abundance of natural resources such as oil, mica, coal, iron ore, and highly educated and skilled workers, and larger quantities of sophisticated machinery. For example Saudi Arabia will export oil, India will export mica, iron ore and information technology, Brazil will export coffee and Thailand will export rice.
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Activity 1 Why is India-EU FTA considered as a win-win situation for both India and EU. Discuss if the trade of India and EU are complementary? Hint: Refer the website http://commerce.nic.in/trade/international_ta.asp and read the draft of India-EU FTA Self Assessment Questions 1 1. Trade theories help forecasts and diagnose country trade pattern & trends. (True or False) 2. Opportunity cost and efficiency in production does not vary from country to country. (True or False) 3. Trade occur as result of: a. Choice differential. b. Habit differential. c. Taste differential. d. Resource differential.
2.3 Theories of International Trade

International trade, as discussed in the first chapter, involves cross-border exchange of goods, services and ideas. International trade may be affected by factors like tariff barriers, non-tariff barriers like restrictions, embargoes, nationalisation, sanitary-phyto-sanitary barriers, technical barriers to trade. International trade may also become a costly affair due to factors such as time costs, transactional cost, logistical cost, documentation costs and costs related with legal systems. A comparison between the nations that import and export will show that, the factors of production assume a crucial significance. The mobility of factors of production is less in case of international trade, but their contribution to total revenue of trade is much higher when compared with its share in revenue in domestic markets. The international trade theories attempt to analyze the pattern of international trade and help government and policy makers to understand the ways to maximise the gains from trade. These reasons make international trade theory a preferred field of research not only for
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economists but also for anybody interested in doing business successfully both domestically and internationally as domestic markets are also open for foreign competition in liberalised and globalised era. The following trade theories explain the basics behind international trade: 2.3.1 Mercantilism Mercantilism theory of international trade has its origin in England in the middle of 16th century. Mercantilism theory is based on the principle assertion that government control of foreign trade is of paramount importance for ensuring the prosperity and military security of the state. The main tenet of this theory was that gold and silver were the mainstays of national wealth and government should endeavour to increase the inflow of gold and silver. This is to be achieved by exporting more and importing less, thus having a surplus balance of trade. Profounder of mercantilism theory argued that national wealth and prosperity will increase with more and more inflow of gold and silver which were the main currency of trade at that point of time. An English mercantilist writer Thomas Mun writes on mercantilism in 1630. State should focus on increasing export and controlling imports, thus to increase our wealth and treasure, by accumulation of gold and silver. We must sell more to strangers yearly than what we consume of theirs in value yearly. Between mid-16th century and 18th century, governments world over that had consistent belief in mercantilism, advocated and executed policy interventions to achieve a surplus in the balance of trade. The mercantilists have a belief that it is not important to increase the volume of foreign trade but to maximise exports and minimise imports. Mercantilist advocated policy interventions such as tariffs and quotas on imports and subsidies for exports. Thus, mercantilism becomes zero sum game whereby economic growth/prosperity of a country is dependent on the cost of other economies. Mercantilism theory suffered from many flaws and inconsistencies which were rightly pointed out by the classical economist David Hume in 1752. Hume propounded that if England had a favourable balance of trade with France (i. e, if it exported more than what it imported), the resultant inflow of gold and silver would enhance the flow of money into the domestic system. This in turn will generate inflation as people of England would have more
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purchasing power. Alternatively, people in France would buy less as their purchasing power will decrease with the outflow of gold and silver to England. Thus, prices of commodities will go up in England and will go down in France due to lack in demand and monetary contraction. People of France would be able to buy less English goods, because firstly they have less purchasing power and secondly, English goods are expensive. English trade will be affected till there is equilibrium in trade. Humes arguments were sound. Noted classical economist like Adam Smith and David Ricardo also argued that trade is positive sum game and not a zero sum game as mercantilists argued. Trade benefits everyone due to variety of reasons such as cost competitiveness, comparative advantages, absolute advantages, PLC cycle, factor endowments etc. and mercantilism theory is by all means considered dead or irrelevant in contemporary trade environment. Telmex telecom: Mercantilist way of operations In an era of global economic liberalisation under WTO, an excellent example of mercantilist theory is Telmex a Mexican telecommunication company. It is head quartered in Mexico City and operates in neighbouring countries such as Argentina, Brazil, Colombia and other Central American countries along with Mexico. Telmex offers a variety of services in telecommunication such as telephone services, data services, wireless services, broadband services, internet based services and IPTV services. Telmex owns around 92% of the telephone lines in Mexico City and has virtual monopoly in telecommunications operations in Mexico, Central American countries and parts of South America. Telmex was earlier a state owned enterprise which was privatised in 1990 and was essentially a state grant of a telephone monopoly to a private individual. Telmex, a large telecommunication conglomerate, granted by the crown at very low prices, today enjoys a monopoly in telecommunication services in the region. A market without competition has no motivation to improve its services. It has no intent to invest its large profits on improving the quality of services, increasing productivity, or generating economies of scale. Rather, each year it spends millions of dollars in lobbying with politicians and controlling regulatory bodies for proposing
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favourable laws. Telmex spends millions for lobbying so that MPs do not allow opening the sector for foreign competition. This will eliminate possible competitors and generally oppose progress of telecommunication sector in Mexico. The results are poor telephone services, high prices, and angry consumers. Telmex thus believes in zero sum game of increasing its profits at the cost of customer services.
Source: Adapted from Mercantilism Is Alive and Well in Mexico, By Nancy Conroy at http://mexidata.info/id494.html, downloaded on 20 March 2012
2.3.2 Absolute advantage theory In one of the most notable book Wealth of Nations in 1776, Adam Smith attacked the mercantilism and argued that countries differ in their ability to produce goods and services efficiently due to variety of reasons. At that time, England, by virtue of their superior manufacturing processes, were the worlds most efficient textile manufacturers of the world. This was due to combination of several factors such as favourable climate, good soils, skilled manpower and accumulated experience and expertise in textile production. On the other hand, the French had one of the most efficient wine industries of the world. Thus, England had an absolute advantage in the manufacturing of textiles and France had an absolute advantage in the production of wine. Adam Smith argued that a country has an absolute advantage if it has one of the most efficient and cost effective product in comparison to any other country producing it. Smith argued that countries should specialise in production and manufacturing of goods and services in which they have an absolute advantage. Such cost effective and efficient products can be traded with goods from other countries in which that country has an absolute advantage. According to Smith, England should specialise in the production of textiles and France should specialise in the production of wine. Both countries should exchange such products of absolute advantage with each other, i.e. England should sell textiles to France and France should sell wine to England. The crux of Smiths absolute advantage theory is that a country should not produce goods at home in which it does not have cost advantage; instead it should import from other countries. Absolute advantage theory was based
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on positive sum game where countries benefit from trade unlike mercantilism theory which was based on zero game. Caselet tabled as under illustrates the benefits of absolute advantage theory. 2.3.3 Comparative advantage theory David Ricardo, in his notable book Principles of Political Economy published in 1817 came up with an improvement on Adam Smiths absolute advantage theory. Ricardo argued what might happen if one country has an absolute advantage in the production of all goods. Adam Smiths theory suggests that such a country might not have benefitted from international trade as trade is positive sum game and countries prosper only if they exchange the goods in which they have absolute advantage. Ricardo argued that it was not the case and showed that countries should trade goods with each other where they have comparative cost advantage. For a sustainable economic system, Ricardo argued that a country should specialise in the production of those goods that it can produce most efficiently and import the goods which it produces less efficiently even if it has absolute cost advantage in the production of those goods. Practical case on comparative cost advantage is tabled as under: Comparative cost advantage: A practical case of England and France Ricardo used England and Portugal as examples in his demonstration, the two goods they produced being wine and cloth. This case is explained using table 2.1 and 2.2. Cost comparison Labour cost of production (in hours) 1 unit of wine 1 unit of cloth 70 80 110 90
Portugal England
According to him, Portugal has an advantage in both areas of manufacture. To demonstrate that trade between both countries will lead to gains, the concept of opportunity cost (OC) is introduced. The OC for good X is the amount of other goods that have to be given up in order to produce one additional unit of X.
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Portugal England
Opportunity costs and efficiency Wine cloth 70/80 = 7/8= 0.87 80/70 = 8/7= 1.14 110/90 = 11 /9= 1.22 90/110 = 9/11= 0.81
A country has a comparative advantage in producing goods if the opportunity cost is lower at home than in the other country. The table shows that Portugal has the lower opportunity cost in wine-making while England has the lower opportunity cost in making cloth. Thus Portugal has the comparative advantage in the production of wine whereas England in the production of cloth. 2.3.4 The Heckscher-Ohlin Trade Theory The Heckscher-Ohlin (H-O) theory further improvises on the absolute cost advantage and comparative cost advantage theory. It tries to explain the crucial question of why countries trade goods and services with each other. The theory is based on the hypotheses that countries trade with each other as they differ with respect to the availability of the factors of production i.e. land, labour and capital. For example, US is a capital rich country hence its exports basket will be dominated by capital intensive products like, aeroplanes, submarines, tanks, space system, nuclear plants, super computer, high-end servers etc. Whereas India has labour abundance, so its export basket is dominated by product with labour contents like gems and jewellery, textiles, handicrafts, sports toys, handlooms, apparel, electronics and information technology services. Basic assumptions of H-O theory a. Countries worldwide are endowed with different factors of production, i.e. land, labour and capital may not be in equal proportion in all countries. Some are abundant with land, some capital and some with labour. b. Production of goods either requires relatively more capital or land or labour. c. Factors of production do not move between two countries. d. Theory has assumption that there is no transport cost for trade between two countries. e. The consumers and users in two trading countries may have the same needs.
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H-O theory explains that a country will specialise in the production of goods and services that it is particularly endowed with and are suited for production in that country. Countries that have abundant capital but are scarce in labour force, therefore specialise in production of goods and services that, in particular, require more capital. H-O theory propounds that specialisation in production and trade among countries generates higher economies of scale and scope and ensures higher standard of living for the countries involved. Same can be understood with the example given below: Specialised Export Basket Factor Endowment India Labour Gems & Jewellery Wheat Aeroplanes Cotto n
Canada Land and Capital Egypt U.S. UK Russia Labour Land and Capital Capital Land
Source: Author
2.3.5 Product lifecycle theory This theory was proposed by Raymond Vernon in the mid-1960s. It was based on the observation that in the 20th century, a very large proportion of the worlds new products were developed by American firms and sold there first. He argued that the wealth and size of the market gave American firms a strong incentive to develop new consumer products and in addition, the high cost of labour was an incentive to develop cost-saving innovations. He did not agree with earlier theories and emphasised on information, risk, and economies of scale, rather than on cost. He focused on the lifecycle of
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the product and came up with his theory which identified three distinct stages: New product stage The need for a new product in the domestic market is identified and it is developed, manufactured and marketed in limited numbers. It is not exported in sizeable quantities, since it is primarily for the national market. Maturing product stage Once the product has become popular in the domestic market, foreign demand increases and manufacturing facilities abroad may be set up to meet demand there. After success in the foreign markets and towards the end of the product maturity stage, the manufacturers try and produce it in the developing countries. Standardised product stage In the last stage of the life-cycle theory, the product becomes a commodity, the price becomes optimised and the makers look for countries where it can be made with the least production costs. One of the results of this is the product being imported into the firms home country. Dell manufactures hardware in Asia, which is then transported to the US, its country of origin. Hence a product which started as export commodity of a country may end up becoming an import product. 2.3.6 Porters diamond model In 1990, Michael Porter analysed the reason behind some nations success and others failure in international competition. His thesis outlined four broad attributes that shape the environment in which local firms compete and these attributes promote the creation of competitive advantage. They are explained as follows: Factor endowments Characteristics of production were analysed in detail. There are basic factors like natural resources, climate, and location and so on and advanced factors like communications infrastructure, research facilities. Demand conditions The role of home demand in improving competitive advantage is emphasised since firms are most sensitive about the needs of their closest customers. For example, the Japanese camera industry which caters to a sophisticated and knowledgeable local market. Relating and supporting industries The presence of suppliers or related industries is advantageous since the benefits of investment in
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advanced factors of production spill over to these supporting industries. Successful industries within a country tend to be grouped into clusters of related industries. For example Silicon Valley. Firm strategy, structure and rivalry Domestic rivalry creates pressure to innovate, improve quality, and reduce costs which in turn helps create world-class competitors.
He said that these four attributes constituted the diamond and he argued that firms are most likely to succeed in industries where the diamond is most favourable. He also stated that the diamond is a mutually reinforcing system and the effect of one attribute depends on the state of others. For example, favourable demand conditions will not result in a competitive advantage unless the state of rivalry is enough to elicit a response from the firms. Figure 2.2 gives you an illustration of Porters diamond model.
FIRM ENTRY STRATEGY & RIVALRY
FACTOR CONDITIONS
DEMAND CONDITIONS
RELATED & SUPPORTED INDUSTRIES
GOVERNMENT
CHANCES
Figure 2.2: Porters Diamond Model Sikkim Manipal University Page No. 37
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Self Assessment Questions 2 4. 5. 6. 7. Name any two international trade theories? What are the inherent weaknesses of Mercantilism theory? What are the assumptions of Heckscher-Ohlin Theory? What is the main assumption of Absolute Cost Advantage Theory?
Activity 2 Make a list of 5 businesses that manufacture goods outside the country of origin and import those goods for the domestic market. Include the name of the firm, country of origin, product and its country of manufacture. Refer this link for guidance: http://www.businesslink.gov.uk/bdotg/action/layer?topicId=1077717231
2.4 Summary
Let us now summarise the salient features discussed in this unit about international business environment: International Trade Theories help us understand why countries trade. Trade, in globalised set-up, has been used as an instrument for enhancing countrys economic growth and is usually beneficial to both exporting as well as importing countries. Opportunity cost and efficiency in production varies from country to country as countries have different endowments of productive resources. The mercantilists have a belief that it is not important to increase the volume of foreign trade but they solely insisted on policies to maximise exports and minimise imports. Smith argued that countries should specialise in the production and manufacturing of goods and services in which they have an absolute advantage. Ricardo argued that a country should specialise in the production of those goods that it can produce most efficiently and import the goods from another country which produces it less efficiently even if it has absolute cost advantage in the production of those goods.
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Heckscher-Ohlin theory explains that a country will specialise in the production of goods and services that it is particularly endowed with and those that are suited for production. Michael Porter diamond model outlined four broad attributes that shape the environment in which local firms compete and these attributes promote the creation of competitive advantage.
2.5 Glossary
Opportunity cost: OC model helps us understand the choice of producing one good or another. Zero Game: Mercantilism advocated that export should be maximised and import be minimised thus enhancing prosperity in country at the cost of other country. Positive Sum Game: PSG enunciates that trading countries benefits from trade due to specialisation, opportunity cost and better efficiency. All trade theories advocates positive sum game except Mercantilism. Comparative Cost Advantage: A country has a comparative advantage in producing goods if the opportunity cost is lower at home than in the other country. Standardised Product Stage: The stage in life-cycle theory that enunciates that the price of commodity becomes optimised and the makers look for countries where it can be made with the least production costs. Embargoes: A prohibition by a government on certain or all trade with a foreign nation. Sanitary-phyto-sanitary barriers: A set of basic rules for food safety and animal and plant health standards. This may act as a barrier for international trade.

1. Why do we study trade theories? 2. Why do nations trade with each other? 3. Why did Mercantilist theory failed? 4. Discuss in brief Absolute Cost Advantage Theory and its features?
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5. What is Comparative Cost Theory? Why is it considered as an improvement on Absolute cost Advantage Theory? 6. Elaborate Heckscher-Ohlin Theory. Why do nations trade in factors endowed? 7. Explain in brief the product life cycle theory. 8. Discuss the relevance of Porters Diamond Model in todays business context.
2.7 Answers
Self Assessment Questions 1 1. True 2. False 3. Resource differential Self Assessment Questions 2 4. Mercantilist and Comparative Cost Theory 5. Too much focus on exports only 6. Factor endowment 7. Labour is only factor of production Terminal Questions 1. An understanding of international trade theory helps us as investors or consumers/buyers or sellers/companies and governments to determine how to act for their own benefit within the global trading system. Refer to section 2.1. 2. Countries world over are endowed with different natural, human, and capital resources. Each country varies from each other in combining these resources. Refer to section 2.2. 3. Mercantilism theory suffered from many flaws and inconsistencies. Refer to section 2.3.1. 4. Countries should specialise in the production and manufacturing of goods and services in which they have an absolute advantage. Refer to section 2.3.2. 5. Country should specialise in the production of goods that it can produce most efficiently and import the goods from other country where it is produced less efficiently even if it has absolute cost advantage in the production of those goods. Refer to section 2.3.3.
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6. Theory is based on the hypotheses that countries trade with each other as they differ with respect to the availability of the factors of production i.e. land, labour and capital. Refer to section 2.3.4. 7. It focused on the lifecycle of the product. This theory identified three distinct stages. Refer to section 2.3.5. 8. His thesis outlined four broad attributes that shape the environment in which local firms compete and these attributes promote the creation of competitive advantage. Refer to section 2.3.6.
2.8 Case-let
India is a global leader in diamond cutting and polishing. It is estimated that 6775% of total diamonds cut and polished worldwide are done in India. Gems and jewellery sector is one among the largest employer and number one contributor in terms of exports of India. In the year 2011-12, gems and jewellery exports has gone up by about 5% at Rs 2,000 billion (US$ 36.10 billion) against Rs 1,950 billion (US$ 35.20 billion) in 201011. Gems and jewellery sector accounts for Indias 14% of the total merchandise exports. Import figure of gems and jewellery by India is Rs 721.60 billion (US$ 13.10 billion). India has become the global hub for diamond cutting and polishing. This can be seen by an analysis of trade theories. India has cheap cost of labour, and being endowed with a lot of manpower resources, skilled craftsmanship is easily available in India. Increasing participation of women in gems and jewellery sector, favourable government policies, adoption of Kimberly process etc. are some of the key factors behind Indias success in gems and jewellery sector. These factors are explained below: Low cost of labour: Being endowed with labour factor advantage, the cost of cutting and polishing in India is a fraction of what other countries have. India has dedicated low cost diamond cutting clusters like Surat, Ahmadabad, Jaipur, Kolkata, Bombay etc. Efficiency level of these workers is much higher than that of similar countries in global markets. Diamond jewellery that is produced at a cost of US$ 60 to US$ 90 in India can fetch just double the price like 120$ to 180$ in international markets. This enables India to earn huge profits and generate interest of retailers and workers.
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Availability of skilled craftsmen: Diamond cutting and polishing is an ancient industry in India. India, being endowed with a lot of manpower resources has special pool of skilled, dedicated workers/artisans/craftsmen in this sector. The true strength of the Indias gems and jewellery sector has been its beautiful handcrafted articles that are intricate and comparable to world-class designs. Indian artisans/craftsmen have achieved high level of excellence in this art as it has been passed from generation to generation. Indians have got special expertise in processing of very small diamonds that require immense skill and knowledge. Rising disposable income: As disposable income rises both in developed as well as developing countries, the use of gems and jewellery will increase. The rising disposable income of emerging Indian middle class has been a major demand driver for the sector in recent years. Similarly, there has been an increase in the demand of gems and jewellery from emerging markets internationally. Diamond jewellery is considered as a lifestyle product and as income levels in major markets have risen, the gems and jewellery sector has recorded tremendous growth in the past few years. Even in recession times, the demand for gems and jewellery has been significant and prices of both products are rising internationally. Rise in number of working women: In India, women workers are increasingly joining the workforce in gems and jewellery sector. There has been a spurt in the number of working women in the diamond cluster of India, i.e. Surat, Mumbai, Ahmedabad, Jaipur, Kolkata etc. This trend has worked as a double edged swordfirstly it has empowered women financially, and secondly it has changed the general attitude of women towards purchase of gems and jewellery products. Favourable government policies: Indian government has been very supportive of this industry. It abolished the Gold Control Act, 1992 thus opening up the gold and diamond mining to private foreign investors. The duties on gold and diamonds have been slashed significantly; as a result there has been huge domestic demand for gems and jewellery pushing this industry to high trajectory growth path.
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Nurturing new talent: The government of India has set up Indian Diamond Institute and many regional training centres for nurturing the talent in gems and jewellery sector. Talented personnel have been rendering valuable services to both domestic as well as international requirements in the sector. This has helped design improvement and constant innovation in the sector thereby reducing costs and penetrating global markets. India has the best talent pool in the world as far as diamond cutting and polishing is concerned. The talent is competent at global standards in jewellery design, refining, model making, jewellery manufacturing, CAD/CAM, gemmology and diamond grading. Adoption of Kimberly Process Certification System: India is a member of the Kimberley Process Certification Scheme (KPCS) adopted by General assembly of UN. KPCS promotes conflict-free diamonds and helps in preventing the smuggling of non-standard trade diamonds from conflict zones of Africa. India allows both export and import only if the consignment is accompanied with the Kimberly Process certificate. KPCS increases the credibility of diamonds processed in India in the global market, thus fulfilling social and humanitarian commitments at international level. This has helped India to boost its export to developed countries. Increased awareness and changing preferences: In recent years, there has been significant rise in branded retailing in gems and jewellery sector. Ad campaigns were launched to promote the purchase of diamonds through economically viable options. . An increased promotion by retailers has made consumers aware of diamond jewellery. This has brought about a change in the trend of purchasing diamond by creating a demand from various segments, which include people from all age groups. Development of Special Economic Zones (SEZ): SEZ Act 2005 and subsequent rules has changed the diamond industry in India. Various SEZs are set up to provide special incentives/ benefits/ infrastructural advantages, etc. to this highly export-oriented sector in order to reap the desired expansion and diversification in global markets. Now, SEZ units in various SEZ areas are catering to
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designing, cutting and polishing of jewellery. The development of SEZs for gems and jewellery has facilitated the growth and has enhanced the trade potential for the sector. Discussion Questions: a. Which of the above discussed theory(ies) is relevant to justify Indias leadership as global gems and jewellery hub? b. What are the various reasons that made India global hub for diamond cutting and polishing? c. How far SEZs has contributed to India gems and jewellery success?
Source: Adapted from www.ibef.org and www.dnb.co.in
References: Bhalla V. K. and Shiva Ramu S. (2008). International Business Environment and Management, Anmol Publications. Batra G. S. (2006). Liberalisation, Globalisation and International Business, Deep and Deep Publications. Cherunilam Francis. (2010). International Business Environment, Himalaya Publishing House. McDonald Frank and Burton Fred. (2002) International Business, International Thomson Computer Press. Bennet Roger (2006). International Business, Pearson Education Ltd. Paul Justin (2009). International Business, Prentice Hall of India Pvt. Ltd. Czinkota Michael R, Ronkainen Llkka A, Moffett Michael H. (2002). International Business, PWS South Western Duxbury Cole Onwo. Nelson Carl A. (1999). International Business - A Managers guide to Strategy in the Age of Globalism, PWS South Western Duxbury Cole Onwo. Chauhan PL, Kakkad Ratish, Patel Rupal H. (2006). International Business, Shanthi Prakashan. Aswathappa K. (2010). International Business, Tata McGrawhill Publications Co Ltd.
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E-References: http://www.economywatch.com, retrieved on 20 April 2012 www.ibef.org, retrieved on 25 April 2012
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Unit 3
International Business Environment
Structure: 3.1 Introduction Objectives 3.2 Economic Environment National economic policies Economic structure Balance of payments 3.3 Political Environment Nature of politics Political stability 3.4 Demographic Environment Segment selection Branding and strategy Market trending and comparison among products Assumptions of country culture Understanding demographic changes Socio-cultural Environment 3.5 Legal Environment Legal systems Dispute resolution systems 3.6 Summary 3.7 Glossary 3.8 Terminal Questions 3.9 Answers 3.10 Case-let
3.1 Introduction
In the previous unit, you have studied about the evolution, advantages, globalisation and the future of international business (IB). This unit covers economic, political, and legal environments in which an IB operates and gives an insight into different theories that companies adopt while going international.
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Scanning the global business environment is a must for any firm whether doing business domestically or internationally as the domestic markets are now open to global competition by opening to foreign players. This analysis is part of a companys analysis-system, involving both internal as well as external factors. The analysis system may comprise the following areas in order to explore the business opportunities and challenges in key markets for any firm.
Conducting business within your own country is different than in a global environment, where you will be dealing with international features, prospects and challenges. It is important that managers take an active interest in these economic, political, demographic and legal environments of a country in order to: Analyse market conditions of different countries. Assess risk. Identify growth sectors. Make investment decisions. In order to succeed, a company needs to gather data on national economies, interpret and make cross border comparisons using standard
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criteria. Knowledge of the IB environment allows management to allocate resources so that they reap the benefits and operate with high efficiencies in any country. For instance, garment companies use manufacturing facilities in China and save on costs, which will be higher in the nation of origin. Objectives: After studying this unit you should be able to: analyse economic environment of a country for doing business. interpret the factors affecting political environment of a country. discuss the legal issues involved in the international trade. explain the demographic environment and its increased utility in intentional trade.
3.2 Economic Environment

The economic environment refers to the economic conditions under which a business operates and takes into account all factors that have affected it. It includes prime interest rates, legislation concerning employment of foreigners, return of profits, safety of country, political stability and so on. 3.2.1 National economic policies National economic policies depend on a countrys socio-economic and cultural background. All governments aspire to achieve four major economic objectives: Full employment. A high economic growth rate. A low rate of inflation. Absence of deficit in the countrys balance of payments. The basic problem is that the first two objectives work against the last two. Measures such as low interest rates, tax cuts and increase in public spending creates jobs and stimulates growth but also causes inflation, increase in wage, and higher imports. Due to increased consumer expenditure the countrys balance of trade worsens. 3.2.2 Economic structure International Business managers need to understand and assess international economic forces at work. Key variables that need to be examined include Gross Domestic Product (GDP) per capita, regional
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distribution of GDP, levels of investment, consumer expenditure, labour costs, inflation and unemployment. Variables that are examined when assessing national economic environments include: Economic structure The structure of a nations economy is determined by the size and rate of its population growth, income levels and distribution of income, natural resources, agricultural, manufacturing and services sector. Economic infrastructure is the sum of all the external facilities and services that support the work of firms including communication, transportation, electricity supply, banking and financial services. Industry structure The structure of an industry is determined by factors such as: Entry and exit barriers. Number of competing firms. Market share among firms in that sector. Average size of competing units. Market growth It is measured in terms of local currency and adjusted for inflation. Local currency is used because conversions into other currencies are affected by exchange rate fluctuations. Income levels It is taken as the GDP per capita and GDP is directly proportional to the productivity of the country. Net income is another important variable and is without tax payments from individual gross incomes. Sector wise trends Growth activity in a country might vary significantly among certain industries. For example, India has a vibrant software services industry. Openness of the economy The ratio of a countrys imports and exports to its Gross National Product (GNP) indicates its vulnerability to fluctuations in international trade. A nation with a high foreign trade or GNP depends heavily on the economic well-being of the nations it exports to. Conversely, closed economies have a high degree of control over the economy. International debt An outstanding loan that one country owes to another country or institutions within that country. Foreign debt also includes due payments to international organisations. Foreign exchange reserves should
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not be less than outstanding short-term foreign debts. On the other hand, a high foreign debt servicing requirement maybe a positive indicator, suggesting that a country has borrowed heavily to invest in its future. Degree of urbanisation This is an important factor because there are major differences in incomes and lifestyles between urban and rural areas in most countries such as: Shopping patterns shopping frequency, average purchase value. Nature of goods bought. Expectations in quality and technical sophistication. Education levels. Ease of distribution. 3.2.3 Balance of payments Importance Balance of payments is a record of all economic transactions that occur between residents of a country and foreigners over a specific period of time. The balance is shown monthly, quarterly or annually. The accounts show the structure of the external trade, net position as a lender or borrower and trends in economic relationships with the world. The balance of payments is a good overall indicator of a countrys economic health; the likelihood of the countrys government imposing forex controls, import restrictions and policies such as tax increments and interest rate hikes. Balance of payment account These accounts attempt to identify the reasons behind various categories of international receipts and payments, making it possible to establish the values of payments by domestic residents to foreigners, and vice versa, for purchase of imports, use of services, lending, or direct foreign investment. The account is divided into categories for long and short term financial transactions, which is initiated by the national monetary body, and involves goods and services. Deficits and surpluses Current account deficit records physical imports and exports along with international transactions in invisibles, that is nonphysical items such as residents pensions, interest and royalties from abroad, domestic firms fees for the movement of goods in other countries,
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and so on. The balance of trade within the current account is the balance on physical (visible) imports and exports. The other major grouping is the capital account which shows the balance of transactions in financial assets, including direct investments in foreign financial instruments, movements in short-term assets, inter-governmental loans and changes in the countrys gold and forex reserves. Reserves will decline if there is, for example, a current account deficit which in turn affects the currency rate. To prevent the local currency from depreciating too much, some foreign currency reserves will be sold, but since it is limited, this is only a temporary measure. Self Assessment Questions 1 1. The two objectives of National economic policies are ______ and ______. 2. FDI policy is dictated by the government of the host country. (True/False) 3. Balance of payment is an indicator of a countrys _______.
3.3 Political Environment

In the previous section, the economic environment of international business was discussed. Now, let us focus on the political environment. Political factors influence the economic and legal environment in which the business operates to a larger extent, especially in contract law and rules on advertising and consumer protection. It also affects the business practices, restrictions on market entry, tariffs charged and ability to repatriate profits. Other factors include: Regulatory frameworks. Governmental control over multinational activity. Importance of pressure groups. Trade embargoes. Likelihood of having insurance against losses due to political risk. Strikes and labour unrest due to political turbulence. Political and economic environments are often inter-related. The political environment affects the economic environment. For example, a government
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which is perceived as anti-business by the business community may lead to capital outflows resulting in the fall of the currency, lower savings and investment and hence higher interest rates and lower economic growth. 3.3.1 Nature of politics The nature of a government is based on the type of the government, and the policy that the country follows. The politics of a country is concerned with: The direction and administration of states. The control of aggregate social relationships. Government is involved in the formulation and implementation of laws for a nation. The government also has control over its territory and is the only legal representative. It can enter into or cancel any agreements with other countries. The entire land surface on earth is controlled by nations, except the Antarctic and Arctic regions. Thus international businesses have to deal with nations and are subjected to their authority. Sovereignty Sovereignty refers to the absolute power of the state. The two problems that immediately arise in concern with sovereignty are: The ability to make independent decisions since countries rely on each other for goods, markets, economic assistance and defence. The question of where national sovereignty lies is not clear as it may exist in the head of state, the parliament, the prime minister, the cabinet or in the people.
National interest National interest, as defined by the government, will depend on the cultures, background, perceptions and experiences of the decision makers involved, which might change over time and according to circumstances. A nations ability to define its interests depends on its power, control over raw materials; scientific and technological knowledge; size, structure health and education of its population; political stability and society. 3.3.2 Political stability Political instability may arise from revolution and insurgency, involvement in foreign wars, changes in government, bad international relations, falling national income, high inflation and rising foreign debt, resulting in the physical destruction of a firms assets, higher taxes, import controls and barriers on money leaving the country.
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Political risk It may emerge from social unrest due to unevenly distributed income, competing political ideologies or ethnic groups within a nation, rise or fall of individual leaders or from international relations. In the modern world, a countrys economic prospects depend heavily on foreign investment and goodwill of the business community. There are two types of political risks, namely macro and micro risks as explained below: Macro risk affects all foreign firms operating in the country equally and may include the imposition of exchange controls, special taxes, localcontent rules and so on. Micro risk applies to a particular company industry or project. For example, import restrictions on specific products, compulsory breaking up of a firm into smaller parts, cancellation of contracts and so on.
Self Assessment Questions 2 4. Political factors define economic and legal environment in a business environment. (True/False) 5. _______ refers to the absolute power of the state to coerce and control its citizens. a) Sovereignty b) National interest c) Political stability d) Political risk 6. The two types of political risks are _______ and _______.
3.4 Demographic Environment

In international business; scanning of demographic environment plays an important role as it helps firm understand the various demographic factors such as gender; age; religious background and ethnicity. Firms; while appraising international markets for new business opportunity or product launch; use demographic environments to identify target markets for specific products or services it wishes to cater. There are both advantages and disadvantages in scanning the demographic environment of the country. One has to understand both sides of the demographic environment while planning strategy for international markets.
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3.4.1 Segment selection Demographic profiling of the country helps us select the right segments for which we should offer its products or services. By properly appraising demographic factors such as age; gender; ethnicity; education background; cultural & religious background; income group, etc., the firm can plan good marketing standpoint of sales. Without proper focus on target groups the firm may end up spending on advertising, sales promotion, etc., on groups that has no interest in the product. 3.4.2 Branding and strategy Scanning of demography provides specific information about different consumer groups. Once the firm has this data, it can develop well-defined marketing strategies to reach to target audience and position products better. Appraising of demographic environment also helps the firm to develop their brands thus generating better sales and ensuring sustainability of the product in market. For example, mobile companies are launching a series of products for the teenage group with appealing advertisement campaign and some of them have been successful to establish their products as brands. 3.4.3 Market trending and comparison among products A firm can find out the general trends about a product in a market by collecting demographic data over extended periods of time and comparing such information at different points and angles. Firm can do generalisations based on such trends after cross comparing its product with similar products in the markets and it can plan a corrective action on time including launching of new products. 3.4.4 Assumption of country culture Marketers face problems during the demographic profiling of customers in different cultures like the assumptions taken about consumers or predictions made about what will happen with a particular consumer group in a particular country. Reading people minds and cultural background is a tough job and it becomes even tougher if it has to be done for different global markets. A case let on assumptions of different cultures about numbers is tabled below and is self explanatory.
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Cultural conundrum: Assumptions for numbers and shapes in different cultures i. In the Japanese culture, the numbers 4 and 9 are avoided in all situations. The reason is that the number 4 is a homonym for death, and the number 9 for suffering. ii. Number 7 is considered bad luck in Kenya, good luck in Czech Republic, and has magical connotations in Benin. iii. The number 13 is perhaps the most hated number across different countries of the world such as Japan, Hong Kong, Korea, Taiwan, Germany, Denmark, Greece, Romania, Latin America, Malaysia, Singapore, Egypt, etc. Many people view this number, as a symbol of bad luck and exporters should avoid this number while numbering the packages. iv. The number 17 is considered to have a negative impact in Italy. v. The number 10 is bad luck in Korea. Hence it should be avoided in packing, labelling and marking of export consignments. vi. Even numbers are preferred in Hong Kong, Korea and Taiwan whereas numbers like 1, 3, 5 and 8 are viewed as numbers with positive effects in Japan. vii. Triangular shapes of packages are not preferred in Korea and Taiwan. Round and square shapes of packages are preferred in Hong Kong and amongst the people in Middle East. Egyptians prefer pyramid shaped packages. Adapted from The Mystery of Numbers New York, USA: Oxford University Press Schimmel, Annemarie (1993) 3.4.5 Understanding demographic changes The demographic environment never remains constant as people migrate from place to place in search of better opportunity. Moreover, there will be changes in birth and death rates in due course along with economic development. Marketers; especially in international business have to constantly update such information in order to have a realistic picture of what is happening at given point in particular a market. This requires a great deal of effort and it is a constant expense to a business.
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3.4.6 Socio-cultural environment The cultural and social norms of people differ worldwide in all key markets as they have been shaped over centuries passing from one generation to another. Language, material culture, customs, aesthetics, religious beliefs, attitudes, values and social organisation has been important for survival and development of societies globally. Due to these socio-cultural factors, the customers/consumers of a particular country/region become conditioned to accept certain things as per conditioned behaviour. The increasingly competitive international business environment necessitate the exporters/ companies doing business overseas to customize their organisational polices keeping in mind the local cultural norms. For example, Coca-Cola has to sweeten its drinks in India as Indians have an affinity towards sweet taste. Indian meat exporters export only HALAL meat to Arab countries with the inscription FIT FOR ISLAMIC USE during packing. If a firm fails to adapt their business approach to the culture and traditions of specific foreign markets or is unwillingness to do, its survival may be under danger. In the context of the socio-cultural environment, there are a number of factors that firm has to consider while foraying into international markets. The same has been explained in detail in chapter 4 entitled Culture & International Business.
3.5 Legal Environment

International businesses confront different sets of laws in various countries of operation. IB must not only abide by the domestic laws of each nation but also by the supranational laws which impose obligations beyond those of national legal systems. For example, the European Union. Major disparities in national law affecting business are: Intellectual property protection. Consumer protection and product liability. Competition among businesses. Payment of bribes and other practices. Formation and termination of contracts. Marketing practices. Carriage of goods.
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Domestic, International and supranational law A countrys domestic law deals with aspects of IB, and foreign citizens and firms are normally regarded as the citizens of the country in question. Special laws are passed to guarantee the safety of foreign investment, but in general the ordinary law of a country is applied when conflicts arise. International law applies to sovereign states and imposes rights and duties on nations in their dealings with each other. It is derived from international conventions which establish rules agreed by contesting states; from international customs accepted as law within all nations to internationally recognised legal principles. An IB that is involved in a legal dispute has to seek redressal from the national courts of the country in which the action is heard and can not obtain relief from any international legal system. The treaty of Rome changed everything by creating a new type of law that provided individual persons and businesses with the right to bring cases on their own accounts to a supranational legal body. Individuals and businesses assumed obligations extending beyond those imposed by the national legal systems of the countries in which they functioned. For example, EU companies are subject to laws on competition established at the pan-European level, while employees can appeal to the European Court of Justice on equal opportunities matters. Other regional treaties of economic and political co-operation follow the European Economic Community (EEC) in creating supranational judicial frameworks. 3.5.1 Legal systems The legal systems of some countries are much better developed than others, particularly the mechanisms for the administration of justice and the enforcement of court rulings. Most nations base their legal systems on one of the following: Common law Common law applies throughout the English-speaking world including most countries of the Commonwealth. These systems rely on precedent, judgements in specific cases and on ad hoc legislation to create and interpret statutes. Code law Countries with Code law systems have all their laws written down in Criminal, Civil and Commercial Codes which are used to
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determine all legal matters. Most continental European countries and their former colonies have Code law systems. Although they are quite different in principle, common law and Code law systems have similarities in practice. A large part of the law in the common law countries is derived from statutes and legally binding regulations, while Code law relies heavily on judicial interpretations of the meanings of the words embodied in legislative codes. Islamic law This is derived directly from the Koran and typically is mixed with the pre-existing common law or civil code provisions of the concerned country. Important practical rules apply to the conduct of business in Islamic countries, including the following: Interest payments on financial dealings are forbidden since it is seen as improper to reward those with excess funds while penalising those who need to borrow. The principle of profit sharing. Islamic banks do not pay interest on deposit but give investors profit shares that are the result of the deployment of the funds deposited.
3.5.2 Dispute resolution systems Disputes that may occur in the course of international transactions must be resolved through negotiation, arbitration or litigation. The issue arises when there is conflict of laws. Since each nation has its set of laws, interpretations and different legal methods are applied to commercial litigation, and conflicts between the legal systems of specific countries. Important differences among the business laws of various countries include: Laws concerning the circumstances, in which an offer may be withdrawn without penalty. It varies between countries. Distinguishing between commercial and non-commercial contracts in some countries. In commercial contracts, lower burden of proof is necessary to establish the existence of the commercial contracts. These disputes are heard in special courts. The intervals beyond which cases become statute barred differ. In Britain, the period for most classes is six years whereas in France it can be up to 30 years. In Germany, it depends on whether the case concerns a commercial contract and if so, whether both parties are traders or not.
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Before suing for breach of contract in certain countries, considerations are not necessary to be proved. Examples of such considerations are the price paid for goods, employee wages, hire fee paid for equipment lease and so on. Under the English law, a contract cannot exist without considerations. National differences occurring due to the legality of exemption clauses and penalty clauses. The necessity to protest unpaid debts prior to suing for payment in certain countries. This means getting a notary to ask the customer for payment or reasons for failure to do so. The latter are put into a formal deed of protest which is then used as evidence of refusal to pay.
Nationalisation of assets Domestic laws guarantee that foreign businesses will not be taken over but there are no international laws regarding this matter. Article 2 of the United Nations Charter of Economic Rights and Duties of States adopted by the UN General Assembly in 1974, asserts that every state has and shall freely exercise full permanent sovereignty including possession, use and disposal over all its wealth, natural resources and economic activity. The UN supports the absolute right of its members to nationalise or exercise partial control over businesses operating within its borders. Where cases are heard It is safe to assume that each party prefers a dispute to be settled in its own country. But this is not possible when businesses from different countries are involved. Contracts often contain jurisdictional clauses which specify that the law of a certain country will apply as agreed by all parties to the contract. This ensures that both sides are aware of their legal rights and obligations. If a contract has no jurisdictional clause, then it is heard in the defendants nation, since one cannot be compelled to attend the court abroad. Either the contract of sale will name a country or the country with the closest connection with the contract must be chosen. Concept of residence Even though an MNC operates in a global environment it cannot become an international legal entity. While its subsidiaries have to be set up through the laws of different nations, its headquarters must be incorporated under the laws of a particular state.
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Questions may arise with regard to the definition of the nationality of an MNC and these need to be answered adequately since the laws of the home country will govern many of its core activities such as responsibilities and liabilities of shareholders, taxation, availability of government grants and subsidies, and degree of employment protection for personnel. Countries apply various legal tests when determining a companys nationality. For example: Place of incorporation. The nationality of owners or majority of shareholders. Where decisions concerning the worldwide business are taken. Arbitration This refers to the process of settlement of disputes by having independent referees, who are agreeable to both sides, adjudicate the matter. Arbitration vs. litigation Litigation has the advantage that the rights and duties of the parties are determined by known and definite laws and that aggrieved parties can obtain redress that is legally enforceable. There is however a number of issues related to litigation including: Long delays. High costs. Possible bad publicity from the case. Fear of discrimination by the courts against foreigners. Businesses may have to be suspended while the case is being heard. Lack of business experience of the judges. Matching words across the languages and accurately translating legal concepts are difficult tasks. The meaning of words change during translation and the intentions of the parties may become unclear. Hence, an important practical problem is of proper translation of documents into a foreign language for consideration by the court. Arbitration is faster and cheaper than litigation and cases are heard in secret so that neither party loses public goodwill through adverse publicity. The arbitrators are themselves business people, advised by legal experts, with practical experience of the commercial world. No problems arise from the conflict of international laws since common sense approaches are applied to
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issues. Cases are heard on neutral ground and not in the national courts of one of the parties. However, arbitration lacks legal precision and still costs time and money. Arbitration bodies The main arbitration bodies are the International Chamber of Commerce, the American Arbitration Association, the London Court of Arbitration and the International Centre for the Settlement of Investment Disputes (ICSID). The ICSID, based in Paris is the most preferred, and offers arbitration facilities to members and non-member companies alike. The International Court of Justice (ICJ), based at The Hague, is a UN body that adjudicates between states and only states that have agreed to accept the courts jurisdiction can participate in cases. Self Assessment Questions 3 7. Three of the most used legal systems are _____, _____ and ______. 8. Scanning of demography provides specific information about different consumer groups(True/ False) 9. Few of the international arbitration bodies are _____, ___, __ and ___. Activity Interpret the business environment of Sri Lanka by analysing the economic, political and legal environments of that country. Hint: Refer section 3.4 and 3.5 Technology environment Technology has been the driving force in speeding the process of globalisation of world markets. Innovations such as internet have changed the face of global business. Connectivity through increased sources of cheap telecommunication has brought people closer to each other. US/Europe and Australia can drive Indias BPO industries from thousand miles away using the latest technology. Now; more and more people are doing business online. Science and medicine are also part of technology factors affecting global business landscape. After the emergence of the complex TRIPs regime, Ranbaxy was acquired by Daiichi of Japan. Japan found this as a lucrative business opportunity. Cloud computing is redefining the IT and ITes Industry. Challenge for any company today is to keep up with innovation and offer new cost competitive products.
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To promote innovation, firms should conduct technological environmental scanning of its key markets and analyze all types of relevant information including technology gaps in key markets. This will help a firm to design a technology strategy for a firm/region for surviving, expanding or entering new markets. In simple words, appraisal of technology environment help firms understands the external or internal happenings including technology turbulence in key markets. Such an exercise helps the firm to develop new products in order to fulfil the needs of such new markets. Process of new product development for global markets through technological interventions can be understood as under:
There are rapid technological changes creating opportunities for new products and services in global markets. Country as well as company spending on R&D is an important variable that determines development of new technologies. Companies from countries such as South Korea, Israel, Taiwan, China, Norway, Australia, Poland along with US and Europe are leading in research and development and are also doing good accordingly in international trade. Marketers, in globalised era, should promote R&D activities, both at company level and university levels through government funds. Following can be opportunities for any firm operating in global markets from technological environment. Although there are varying R&D budgets of both countries and companies, it should be considered under the context of the country in which the research is being done. For example, the cost of doing a research in India is a fraction of what in US. The cost of Chip Design
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research in India is a fraction of the cost in the US. Similarly, ISRO can launch the same capacity of satellite at a fraction of cost of Europe, US and South Korea. Accelerating the pace of technological change in new markets in order to beat competitors and garner higher market share. As physical environment in world market is different globally; the firm has to adapt their products as per local markets requirement. There are unlimited opportunities from innovation. When doing business globally; firm can pool the best of manpower and other resources in order to enhance its focus on constantly improving its products and services through innovation. Different countries have different norms and procedures for regulation of technological changes, clinical trial, R&D procedures, etc. There may be complexities involved at times due to safety concerns/cultural and ethical issues. For example, procedure for clinical drug trail in India is different from that of US and Europe.
3.6 Summary
Let us now summarise the silent features discussed in this unit about international business environment: The different factors affecting the environment of IB like political, economical and legal are discussed. Scanning the global business environment is must for any firm whether doing business domestically or internationally as the domestic markets are now open to global competition by opening to foreign players. This analysis is part of a companys analysis-system, involving both internal as well external factors. The economic environment refers to the conditions under which a business operates and takes into account all factors that have affected it. Economic infrastructure is the sum of all the external facilities and services that support the work of firms including communication, transportation, electricity supply, banking and financial services. In international business; scanning of demographic environment plays an important role as it helps firm understand the various demographic factors such as gender; age; religious background and ethnicity.
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Human beings differ worldwide in all key markets as they have essentially created their own cultural and social norms which may have been shaped over centuries passing from one generation to another. Language, Material Culture, Customs, Aesthetics, Religious Beliefs, Attitudes, Values and Social Organisation has been important for survival and development of societies globally. Due to these sociocultural factors, the customers / consumers of a particular country/ region become conditioned to accept certain things as per conditioned behaviour. Political factors influence the economic and legal environment in which the business operates to a larger extent, especially in contract law and rules on advertising and consumer protection. The legal systems of some countries are much better developed than others, particularly the mechanisms for the administration of justice and the enforcement of court rulings. Most nations base their legal systems on common law, code law or Islamic law.
3.7 Glossary
Political factors: They influence the economic and legal environment in which the business operates to a larger extent, especially in contract law and rules on advertising and consumer protection. Economic environment: It refers to the conditions under which a business operates and takes into account all factors that have affected the business. Arbitration: The process of having a mediator to settle a dispute without going to the court. Islamic law: This is derived directly from the Koran and typically is mixed with the pre-existing common law or civil code provisions of the country concerned. GNP: Gross National Product is the total value of goods and services that the countrys citizens produced irrespective of their location in a year. Litigation: The process of taking a party to court to settle a legal matter. Nationalisation: The process by which a government of a country takes over control of a business that operates within that country. Sovereignty: The power of a state over its citizens and land.
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1. 2. 3. 4. 5. Explain factors that affect the international business environment. Evaluate the importance of political stability for conducting international business. Why do firms pay so much attention for economic factors while entering particular markets? Justify your answer by quoting practical examples. What aspects of demographic environment; companies must scan while doing international business? What are the different options available for settling disputes?
3.9 Answers
Self 1. 2. 3. Assessment Questions 1 Full employment, a high economic growth rate. True. Economic health.
Self Assessment Questions 2 4. True. 5. a) Sovereignty. 6. Macro and micro risk. Self Assessment Questions 3 7. Common law, code law and Islamic law. 8. True. 9. International Chamber of Commerce, the American Arbitration Association, the London Court of Arbitration and the International Centre for the Settlement of Investment Disputes (ICSID). Terminal Questions 1. The factors that affect the international business environment include the economic, political and legal. These factors are important as they help to assess risk, establish sizes and characteristics of various markets, identify growth sectors, make investment decisions and also help in using the company resources effectively, that is explained in section 3.1 of this unit. Refer the same for details. 2. Political and economic environments are often inter-related. The political environment affects the economic environments, while economic
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hardship may trigger political change. Political stability is important for conducting international business because political instability arises from revolution and insurgency, involvement in foreign wars, changes in government, bad international relations, falling national income, high inflation and rising foreign debt that are explained in section 3.3 of this unit. Refer the same for details. 3. International Business managers need to understand and assess international economic forces at work. Key variables that need to be examined include Gross Domestic Product (GDP) per capita, regional distribution of GDP, levels of investment, consumer expenditure, labour costs, inflation and unemployment. All this may affect a firms operation and profits. Refer to section 3.2. 4. In international business, scanning of demographic environment plays an important role as it helps the firm to understand the various demographic factors such as gender, age, religious background and ethnicity. Refer to section 3.4 5. International businesses confront different sets of laws in the various countries they operate in. The different options available for settling disputes are through domestic, international and supranational laws that are explained in section 3.6 of this unit. Refer the same for details.
3.10 Case-Let
Maruti Suzuki India Ltd (MSIL) In 1983, Maruti Udyog Ltd entered into a joint venture with Suzuki Motor Corporation (SMC) of Japan to manufacture cars for the Indian market by utilising technology to make low-cost cars in large numbers. The launch model was the Maruti 800, which brought about a revolution in the Indian automobile industry. Now, renamed as Maruti Suzuki India Ltd (MSIL), it has two manufacturing facilities in Northern India with a capacity of 1.2 million cars annually. MSIL offers 14 brands in over 150 variants ranging from Maruti 800, people movers to SUV Grand Vitara. SMC, which had an established market in Europe, started sourcing cars from MSIL, manufactured in India under the Suzuki brand name, thus taking advantage of the low cost manufacturing in India. In 1987, 500
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cars were exported by the MSIL to Hungary and in 2009-10, sales volume crossed 1 million cars, out of which around 1,47,000 cars were exported to other countries. MSIL exports to the more than 100 countries including Poland, Finland, Iceland, Switzerland, Netherlands, Algeria and Italy. In this process, MSIL became the only Indian company to manufacture and sell 1 million cars in a year and is the largest passenger car manufacturer with over 45% market share in India. MSILs revenue has grown constantly over the years:
Table 3.3: Maruti Sales 2006 to 2009-10 Year 2006-07 2007-08 2008-09 Net sales (Rs. in million) 1,45,922 1,78,603 2,03,583 Year 2009-10 Net sales (Rs. in million) 3,01,198
The government of Japan has honoured MSIL with a METI award for promotion of Japanese brand in India. Maruti Suzuki is one of the six companies, and one of the two companies outside Japan, to have received this award. Discussion Questions 1. Which business theory will you associate with this case? (Hint: Porters diamond model) 2. What kind of approach did SMC adopt to make an entry into Indian market? (Hint: SMC utilised technology to make low-cost cars in large numbers taking advantage of the low cost manufacturing in India).
Source: http://www.marutisuzuki.com retrieved on 20 September 2010
References: Bhalla V. K. and Shiva Ramu S. (2008). International Business Environment and Management, Anmol Publications. Batra G. S. (2006). Liberalisation, Globalisation and International Business, Deep and Deep Publications.
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Cherunilam Francis. (2010). International Business Environment, Himalaya Publishing House. McDonald Frank and Burton Fred. (2002) International Business, International Thomson Computer Press. Bennet Roger (2006). International Business, Pearson Education Ltd. Paul Justin (2009). International Business, Prentice Hall of India Pvt. Ltd. Czinkota Michael R, Ronkainen Llkka A, Moffett Michael H. (2002). International Business, PWS South Western Duxbury Cole Onwo. Nelson Carl A. (1999). International Business - A Managers guide to Strategy in the Age of Globalism, PWS South Western Duxbury Cole Onwo. Chauhan PL, Kakkad Ratish, Patel Rupal H. (2006). International Business, Shanthi Prakashan. Aswathappa K. (2010). International Business, Tata McGrawhill Publications Co Ltd.
E-References: http://www.economywatch.com, retrieved on 15 November 2010 http://www.marutisuzuki.com, retrieved on 20th September 2010
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Unit 4
Culture and International Business
Structure: 4.1 Introduction Objectives 4.2 Meaning of Culture Need to understand cultural differences Hofstedes cultural dimensions 4.3 Country Culture Significance of country culture Comparative study on cultures of Japan, China, Brazil, France, and USA 4.4 Culture in an International Business Organisation Cross cultural management Comparative study on corporate cultures of Japan, China, Brazil, France, and USA 4.5 Summary 4.6 Glossary 4.7 Terminal Questions 4.8 Answers 4.9 Case-let
4.1 Introduction
In the previous unit, you have learnt about various factors like economic, political, demographic, technological, social and legal environments in which an international business operates. The unit gave an insight on the effects of environment on companies while dealing with international business. Many developments took place in late twentieth century. All these developments paved way for the people of different countries coming together. Relations between people from different nations grew. This mainly included the globalisation of business. Culture is an important factor for practising international business. Culture affects all the business functions ranging from accounting to finance and from production to service. This shows a close relation between culture and international business.
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Objectives: After studying this unit, you should be able to: explain culture in an international scenario. analyse national cultures of different countries. describe the importance of managing cultures internationally. evaluate corporate cultures from different countries.
4.2 Meaning of Culture

In this section, you will learn about the meaning of culture and the need to understand various cultural differences. Culture is defined as the sum total of knowledge, arts, beliefs, laws, morals, customs, and other abilities and habits gained by people as part of society. The art and other signs or demonstrations of human customs, civilisation, and the way of life of a specific society or group is all included in culture. Culture determines every aspect that is from birth to death and everything in between it. It is the duty of people to respect other cultures too. Research shows that national cultures generally characterise the dominant groups values and practices in society, and not of the marginalised groups, even though the marginalised groups represent a majority or a minority in the society. Culture is very important to understand international business. Culture is a part of the environment which man has created. 4.2.1 Need to understand cultural differences Cultural differences affect the success or failure of multinational firms in many ways. The company will have to modify the product to meet the demand of the customers in a specific location and use different marketing strategies to advertise their product to the customers. Adaptations must be made to the product where there is demand or the message must be advertised by the company. The following are the factors which a company must consider while dealing with international business: The consumers across the world do not use similar products. This is due to varied preferences and tastes. Before manufacturing any product, the organisation has to be aware of the customer choice or preferences in that geography.
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The organisation must manage and motivate people with different cultural values and attitudes. Hence the management style, practices, and systems must be modified accordingly. The organisation must identify candidates and train them to work in other countries because the cultural and corporate environment differs in each country. The training may include language training, corporate training, and training on technology and so on, which will help the candidate to work in a foreign environment. The organisation must consider the concept of international business and must construct guidelines that help them take business decisions, and perform activities. The following are the two main tasks that a company must perform: Product differentiation and marketing As there are differences in consumer tastes and preferences across nations, product differentiation has become a business strategy all over the world. The kinds of products and services that consumers can afford are determined by the level of per capita income. For example, in underdeveloped countries, the demand for luxury products is limited. Manage employees It is said that employees in Japan were normally not satisfied with their work as compared with employees of North America and European countries; however the production levels stayed high. To motivate employees in North America, a study was conducted on this issue. This study showed that there is a relationship between job satisfaction and production. This study also showed the fact that it is tough for Japanese workers to change jobs. While this trend is changing, the fact that job turnover among Japanese workers is lower than the American workers is true. This is because even if Japanese workers were not satisfied with specific aspects of their work, they know that the management style and practices may not change considerably at another place. Thus, discontent might not impact their level of production.
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Exhibit 1: Understanding foreign cultures: Areas of general precautions 1. Gift giving and cultural distaste 2. Entertainment at home and local customs 3. Table manners and etiquette 4. Punctuality 5. Lunch and dinner time 6. Topics in conversation 7. Business entertainment, customs and strategies 8. Eye contact, hand gestures and etiquette 9. Protocol and etiquette 10. Business cards 11. No smoking 12. Dress code 13. Prohibited materials 14. Interpretation or translation 15. No littering
Adapted from Business Class: Etiquette Essentials for Success at Work by Jacqueline Whitmore, St. Martin's Press (2005), The following are the necessary implications in international business: Do not use self reference criterion (SRC) for judging others. There could be many perspectives to a single observation or phenomenon. Our own values and upbringing should not be a hindrance while listening to the points of view of others. Get a niche segment globally as countries have diverse markets with movement of products, people, capital, and culture. Improve the total market share by designing affordable products and services, and making them accessible. Organise global enterprises around global centres of excellence.
4.2.2 Hofstedes cultural dimensions According to Dr. Geert Hofstede, Culture is more often a source of conflict than of synergy. Cultural differences are a trouble and always a disaster. Professor Hofstede carried out a detailed study of how values in the workplace are influenced by culture. He worked as a psychologist in IBM from 1967 to 1973. At that time he gathered and analysed data from many people in several countries. Professor Hofstede established a model using the results of the study which identifies four dimensions to differentiate
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cultures. Later, a fifth dimension called long-term outlook was added. The following are the five cultural dimensions: Power Distance Index (PDI) This focuses on the level of equality or inequality between individuals in a nations society. A country with high power distance ranking depicts that inequality of power and wealth has been allowed to grow within the society. These societies follow caste system that does not allow upward mobility of its people. A country with low power distance ranking depicts a society which de-emphasises the differences between its peoples power and wealth. In these societies equality and opportunity is stressed for everyone. Countries with high PDI index are Arab countries, Russia, India and China. Those with low score are Australia and Japan. Individualism This dimension focuses on the extent to which the society reinforces individual or collective achievement and interpersonal relationships. A high individualism ranking (western countries, Canada, Hungary) depicts that individuality and individual rights are dominant within the society. Individuals in these societies form a larger number of looser relationships. A low individualism ranking (Asian and African countries like Indonesia and Colombia) characterises societies of a more collective nature with close links between individuals. These cultures support extended families and collectives where everyone takes responsibility for fellow members of their group. Masculinity This focuses on the extent to which the society supports or discourages the traditional masculine-work role model of male achievement, power, and control. A country with high masculinity ranking (like Japan, Venezuela, Hungary) shows the country experiences high level of gender differentiation. In these cultures, men dominate the society and power structure, with women being controlled and dominated by men. A country with low masculinity ranking (like Norway and Sweden) shows a low level of differentiation and discrimination between genders women are treated equal to men in all aspects of the society. Uncertainty Avoidance Index (UAI) This focuses on the degree of tolerance for uncertainty and ambiguity within the society. A country with high uncertainty avoidance ranking shows that the country has low
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tolerance for uncertainty and ambiguity. A rule-oriented society that incorporates rules, regulations, laws, and controls is created to minimise the amount of uncertainty. A country with low uncertainty avoidance ranking shows that the country has fewer concerns about ambiguity and uncertainty and has high tolerance for a variety of opinions. A society which is less rule-oriented, readily agrees to changes, and takes greater risks. Latin American countries, Germany, Belgium, Japan and Eastern Europe score high on this. Countries with low UAI score are Sweden, Denmark and China. Long-Term Orientation (LTO) It describes the range at which a society illustrates a pragmatic future oriented perspective instead of a conventional historic or short term point of view. The Asian countries (China, Japan, Honk Kong) score high on this dimension. These countries have a long term orientation, believe in many truths, accept changes easily, and have thrift for investment. Cultures recording little on this dimension, trust in absolute truth, are conventional and traditional. They have a small term orientation and a concern for stability. Many western cultures score considerably low on this dimension.
In India, PDI is the highest Hofstede dimension for culture with a rank of 77, LTO dimension rank is 61, and masculinity dimension rank is 62. Self Assessment Questions 1 1. _______ is defined as the art and other signs or demonstrations of human customs, civilisation, and the way of life of a specific society or group. 2. The consumer tastes and preferences across countries are similar. (True/False) 3. Match the following: a) PDI 1) tolerance for uncertainty and ambiguity. b) Individualism 2) pragmatic future oriented perspective. c) Masculinity 3) equality or inequality between individuals. d) UAI 4) individual or collective achievement. e) LTO 5) support or does not support male dominance
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Activity 1 Visit a nearby bank and observe the cultural diversities. Apply the cultural dimensions of Hofstede and document your study. Hint: Hofstedes five cultural dimensions.
4.3 Country Culture

In the previous section, we analysed the need to understand cultural dimensions and also studied Hofstedes cultural dimensions. In this section, we will discuss country culture and its significance. 4.3.1 Significance of country culture Every society has a unique culture. A countrys culture should not be imposed on individuals coming from a different cultural background. For example, the Cadbury Kraft acquisition, 2009 was a landmark international deal, in which the US based company Kraft acquired the British chocolate giant, Cadbury. These companies were from two countries which were complete extremes in terms of culture. Let us discuss the major cultural elements that are related to business. Cultural elements that relate business The most important cultural components of a country which relate business transactions are: Language. Religion. Conflicting attitudes. Language Language is something more than just spoken and written words. Gestures, non-verbal communication, facial expressions, and body language all communicate a message. An interpreter is used when two people do not speak a common language. Failure in understanding the cultural context when non-verbal communication is used or failure in reading the person across the table results in sending a wrong signal. Religion The dominant religious beliefs within a culture have a great impact on a persons approach to business than most people expect, even if that person is not a follower of a specific culture.
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Exhibit 2 : Culture and international business: Significance of colour in different countries i. Black is believed to have a negative impact on the customers in markets like Singapore, Malaysia, Libya, Japan, Middle East, Greece, Argentina and some countries in Latin America. Hence, that colour should be avoided in packing/labelling the product for sales in these markets. ii. Yellow is associated with illness in South Korea, and certain shades of yellow are reserved for the royal families to wear in Malaysia. iii. In Italy, purple is believed to have negative impact on the minds of customers/people while Italians prefer colours with soft tones as it channelizes positive energy. iv. Red is a positive colour in Denmark, but represents witchcraft and death in many African countries. v. Green is preferred and welcomed among Muslims and countries populated by Muslims except Malaysia which has over 90% Muslim population but a cultural distaste with green. vi. Japanese prefer a combination of red and white and gold and silver. vii. People in Peru, Surinam, Hong Kong, Korea, Taiwan, Greece and Malaysia have positive opinions about bright colours. viii. The colour saffron is preferred among Hindus and Sikhs as it is associated with their religion. ix. White is not preferred by people in China, Taiwan, South Korea and North Korea but white and blue are preferred in the Czech Republic and Denmark. Adapted from Managing Images in Different Cultures: A Cross-National Study of Color Meanings and Preferences by Hewett, Kelly, Madden, Thomas J., Roth, Martin S. (2000) Conflicting attitudes Cultural values have a massive effect on the way business is carried out. The cultural values that are evident in everyday life are not only shown in business but are exaggerated. If the cultural basics are not understood, there is a possibility that a deal ends even before the negotiations start.
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Some of the additional cultural elements which must be known are the customs and manners, art, education, humour, and social organisation of a society. 4.3.2 Comparative study on cultures of Japan, China, Brazil, France, and USA Companies with prospects of business in other countries should be sensitive to that particular countrys culture and business environment. Every country has its own style of communication, the way they treat women in business and dressing style. Let us now discuss the business culture followed by different nations with respect to communication styles, women in business, and dress code. The table 3.1 shows how the business cultures differ from one nation to another nation.
Table 4.1: Comparison of cultures in different nations Country Japan Communication style It is difficult if Japanese language is not known. The combination of vagueness and lack of understanding of the language results in problems which make decision-making very difficult. Body language is very minimal and hence difficult to read for an untrained observer. The Japanese sit in a formal upright posture and look still. Visibility of reaction or emotion is rare. Translators are required if Chinese language is not known. The body language of people from Chinese is very restricted. Women in business Discrimination towards women in the workplace still exists. Women are assigned to perform lower grade tasks. Women from western countries working in Japan probably face difficulties working with Japanese male co-workers. Business dress code The Japanese mainstream business follows a conventional business dress code of dark suit, shirt and tie. Business dress must be restrained and formal for women. In business, women do not wear trousers. Men wear suits and ties and women wear skirts and blouses. It is sensible to have smart business clothing.
China
Women have equal rights in the workplace. But, traditional Confucian thinking does not agree to gender equality. Businesswomen from foreign countries are treated with great respect and courtesy.
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Brazil
Ability to speak Brazilian is an advantage, even though English is spoken and understood by people in Brazil. The body language plays a vital role in normal communication. Eye contact is also very important while speaking to people. The French have great love and respect for the use of language. The logical exposition of welldefined ideas is admired by the French. The comment given by them clearly states their mind. It is important that anything sent in writing is thoroughly checked.
Businesswomen from foreign countries are treated fairly and with respect.
Men are advised to wear conservative dark suits. Women are less conservative in their dressing when compared with women from other countries. With position, dress codes differ within the company, industrial sector, and region in France. People in higher positions within a larger organisation follow a very formal dress code. In southern region the business dress code is informal.
France
Women are gaining high position in French business life, particularly with strong representation in retail and service industries. The requirement for success is to have a suitable level of education for women.
Self Assessment Questions 2 4. The most important cultural components of a country which relate business transactions are _______, _______, and _______. 5. The combination of Japanese vagueness and lack of understanding results in problems which make decision-making very twisted. (True/False) 6. Coded speech and verbosity is considered a waste of time and in time pressured corporate _______, it is a crime. a) Brazil. b) China. c) USA. d) France.
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4.4 Culture in an International Business Organisation

In the previous section, we studied how culture varies from country to country and its significance. In this section, we will discuss the culture in an international business organisation. 4.4.1 Cross cultural management In international management, where people are from different cultures, you have to develop and apply your knowledge about cultures and not use a standard process for everyone. This is called cross cultural management. In a global market even if you do not have a diverse workgroup you may have to deal with clients abroad or vendors or service providers of different countries. So knowledge about different cultures is a must. The factors to be considered in cross cultural management are: Cross cultural management skills. Handling cultural diversity. Factors controlling group creativity. Ignoring diversity. Cross cultural management skills The ability to demonstrate a series of behaviour is called a skill. It is functionally linked to achieving a performance goal. The most important aspect to qualify as a manager for positions of international responsibility is communication skills. The managers must adapt to other cultures and have the ability to lead its members. The managers cannot expect to force members of other culture to fit into their cultural customs. This is the main assumption of cross cultural skills learning. Any organisation that tries to enforce its behavioural customs on unwilling workers from another culture faces conflict. The manager has to possess the skills linked with the following: Providing inspiration and appraisal systems. Establishing and applying formal structures. Identifying the importance of informal structures. Formulating and applying plans for modification. Identifying and solving disagreements.
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Handling cultural diversity Cultural diversity in a work group offers opportunities and difficulties. Economy is benefited when the work groups are managed successfully. The organisations capability to draw, save, and inspire people from diverse cultures can give the organisation spirited advantages in structures of cost, creativity, problem solving, and adjusting to change. Cultural diversity offers key chances for joint work and co-operative action. Group work is a joint venture where, the production of two or more individuals or groups working in cooperation is larger than the combined production of their individual work. Exhibit 3: Doing Business with UAE: Business Etiquettes & Protocol United Arab Emirates in recent years has emerged as the largest destination for Indian goods. Indias exports to UAE are 25.41 billion dollar in 2009 and 27.41 billion dollar in 2010. Indias exports are growing at a Compound Annual Growth Rate (CAGR) of 26% during 20062010. It constitutes around 12.4% share in Indias total exports. Being an Islamic country, UAE has a different culture for doing business. In order to make a business relationships and communication with UAE, one has to have a local sponsor or wakeel to enter the country. This wakeel plays an important role as sponsor and helps in arranging the appointments with appropriate individuals; otherwise it is tough to get in touch with sheikhs. These sheikhs do not require much personal space during business negotiations and they can stand close to you while discussing/negotiating business. Indians and westerners are used to maintain space and usually feel that their personal space has been invaded. Sheikhs of UAE respect people whom they know and trust. Sheikhs especially in first few meetings will spend a great deal of time on the getting-to-know-you part of relationship building. Indians are advised to be patient in business negotiations with Sheikhs as they at time may stare at your appearances, dress etc. to make a judgement. It is important to fix business meetings including appointments with concerned persons/UAE counterparts several weeks or months in advance. However, while meeting very important sheikhs/government officials a date will not be confirmed until one has reached UAE. Sheikhs prefer meetings in the morning. One should reach on time; however, a sheikh may keep you waiting for hours only to check how serious you are
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about business. It is not uncommon if a sheikh/emirate may cancel a meeting at the last minute. During meeting, they will first enquire about your family and health in general. The sheikhs may feel offended if you enquire about his wife or daughter. It is common for a Sheikh to leave a meeting in between, go for prayer, and come back. This should not stop you from continuing the discussion. The Sheikhs speak less and like to watch/observe. Usually they appoint deputies who negotiate for them. During business negotiations, UAE counterparts make sure not to use any kind of pressure techniques as they believe in process driven talks which may be very slow at times. One is advised not to rush through the negotiations process. UAE society is highly bureaucratic; it is not uncommon if you come across several layers of approvals for a normal business decision. Sheikh regards trust, thus it may take several visits even for simple tasks before a contract or order is given. UAE counterparts are slow but steady and tough negotiators. One has to keep immense patience as business decisions are hierarchical and are made by the highest-ranking person. Being tough negotiators, it is not uncommon if a Sheikh makes the initial offer at a very low price but may subsequently agree to buy at a much higher price. Gaining their trust and confidence is very important to business decisions. Sheikhs are very conscious of their dignity and will not compromise at it. Avoid gifting the following to the UAE counterparts: wine, idols or photos of god/goddess. UAE is governed by Sharia law, and one should be careful enough to dress modestly. One should preferably wear robes and if the next option could be a suit. One can make a good impression by dressing well. Being a male-dominated society, business women are strictly advised to keep their collarbones and knees fully covered. Business women should avoid wearing revealing or tight-fitting clothes. Make sure that business cards are shared with each delegate of the opposite side. The cards should have one side in English with Arabic translation on the other side of the card. Source: Adapted from International Management: Cross-Cultural Dimensions by Richard Mead Blackwell Publishers; 3rd edition & Nancy J. Adler, International Dimensions of Organization Behaviour, 2nd ed. Boston PWS-Kent,1991
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Factors controlling group creativity On complicated problem solving jobs, diverse groups do better than identical groups. Diverse groups require time to solve issues of working together. The work experience helps to overcome gender, racial, organisational and functional discriminations. But the impact cannot be evaluated and there is always a risk in creating a diverse group. A successful group is profitable with respect to quick results and the creation of concern for the future. Negative stereotypes are emphasised if it fails. Factors related with the industry and company culture are also important. Diverse groups do well when the members: Assist to make group decisions. Value the exchange of different points of view. Respect each others skills and share their own. Value the chance for cross-cultural learning. Tolerate uncertainty and try to triumph over the inefficiencies that occur when members of diverse cultures work together. A diverse group is known to be more creative, where the members are tolerant to differences. The top management level provides moral and administrative support, and gives time for the group to overcome the usual process difficulties. They also provide diversity training, and the group members are rewarded for their commitment. Ignore diversity It may be difficult to manage diversity. It is better to ignore, which is also an alternative. The management must: Ignore cultural diversity within the employees. Down-play the importance of cultural diversity. This denial to identify diversity happens when management: Fails to have sufficient awareness and skills to identify diversity. Identifies diversity but does not have the skill to manage the diversity. Recognises that the negative consequences of identifying diversity will cause greater issues than ignoring it. Thinks the likely benefits of identifying and managing diversity do not validate the expected expenses.
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Identifies that the job provides no chances for drawing advantages from diversity.
Strategies to ignore diversity may be possible when culture groups are given various jobs, and sharing required resources are independent in the workplace. Groups and group members are equally incorporated and work together. In such cases, confusion occurs when the diverse value systems held by different staff groups are not identified. 4.4.2 Comparative study on corporate cultures of Japan, China, Brazil, France, and USA The success of any multinational company depends on the techniques and cultures. Corporate culture is an organisational culture, related to the management of businesses with respect to organisational structure, strategy, and control. It states all the elements around which a company describes and relates to its stakeholders. Corporate culture also includes the way it organises its workers, lets them express themselves, and conveys its values. The corporate culture is said to be positive when the official relationships are reasonably considered, members have a stake in company profits, and demands for production are considered sensible. The corporate culture is said to be negative when the opposite conditions apply and relationship with the management is not productive. Table 4.2 displays the different approaches to corporate culture.
Table 4.2: Comparison of Corporate Cultures Basis of approach to corporate culture Relationship must come before business.
Country
Business structure
Management style
Team work
Japan
Hierarchically structured, based on harmony and co-operation, with individuals aware of their position within
Information flows from the bottom of the company to the top. Implementation of decisions has been actively involved in the modelling of policy. Individual
Consensusbuilding process is used to define an agreement before a formal meeting to avoid any conflict. People are expected be Page No. 83
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a group.
personality is not modest and selfseen as the promotion is not requisite for encouraged. effective leadership. Subordinates are not allowed to question the decisions of superiors. Consensusoriented despite being hierarchical in approach. The importance is on group orientation with individual requirements being directed to the greater good of the whole. Team members understand their role and responsibilities within the team. Every team member expects to see a chain of command within the team.
China
Based on Confucian values.
Uses operational structures, chains of command that are hierarchical in a Confucian society.
Brazil
Offers business opportunitie s to future international investors.
Organised hierarchical lines with information flowing in a structured way. All important decisions are made at senior levels. Follows hierarchy and functionality within the system. The CEO determines future direction of the company. This vision is then passed down the line by junior management.
A managers personal style is considered to be of importance. The key importance is relationship. The manager and subordinates work hard to nurture a relationship based on trust and respect for personal dignity. Decisions, once taken at senior levels, are delivered down the chain for implementation at lower management levels.
France
The role of the government and the significance of a definite kind of education are important.
There is no encouragement for team work. People wish to have definable, personal sets of objectives rather than to work in more general team roles.
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USA
Every aspect of commercial life is studied and analysed.
The company is an entity in its own right and survives independently from its workers. Senior management is more rooted in the personality at the top. Americans like to know where exactly they are, what are their responsebilities and to whom they report.
Management style is individualistic in approach; managers are responsible for the decisions made within their regions of responsibility. Important decisions are discussed in open environment and the responsibility for the concerns of the decision lies with the manager.
Groups of individuals are brought together to complete a given task. During that period the group is together, everybody is committed to the common goals, and work with dedication to assure that the goals are accomplished. Teams are assumed to be temporary in nature.
Self Assessment Questions 3 7. The ability to demonstrate a series of behaviour is called _______. 8. Diverse groups do not require time to solve issues of working together. (True/False) 9. In international management, where people are from different cultures, you have to develop and apply your knowledge about cultures and not use a standard process for everyone. This is called _______________. Activity 2 Assume that you are the manager of Company manufacturing cellular phones. You have to design a new model that suits the requirements of users in the country of the secondary branch Country Q. There is local sales-force which knows about local needs, market segments which can buy the product, the amount that the users will pay and advertising channels which can be used to interact with consumers. But the local sales-force does not understand modern research methods and the main branch resources for designing new products. The
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marketers of the headquarters have access to the technology and can account on research and development carried out elsewhere, but they are not local experts and have no contacts. The expert team of your company lays out the specifications for a phone designed to fulfil the requirements of the budding youth market in Country Q. How will you handle this case to expand the business in Country Q? Hint: Cultural diversity.
4.5 Summary
Let us summarise the salient points covered in this unit on culture and international business: Culture is an important factor for practising international business. Culture affects all the business functions ranging from accounting to finance and from production to service. It is important for an individual to have knowledge of the impact of cultural differences when working in the global commercial environment. According to Professor Hofstede, the following are five dimensions used to differentiate culture: Power distance index (PDI). Individualism. Masculinity. Uncertainty avoidance index (UAI). Long term orientation (LTO). The following are the cultural elements which affect business transactions: Language. Religion. Conflicting attitudes. Every country in its business environment has its own style of communication, the way they treat women and their dressing style. In international management, where people are from different cultures, you have to develop and apply your knowledge about cultures and not use a standard process for everyone. This is called cross cultural management.
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Companies can build international competencies by improving levels of cultural awareness and help individuals to become globally profound.
4.6 Glossary
Consensus: An opinion or position reached by a group as a whole Globalisation: Integration of regional economies, cultures, and societies through a worldwide network Homogeneous: Part or elements that are all of the same kind; opposite of heterogeneous Individualistic: Attribute that has a markedly independent course in action or thought Marginalise: To make unimportant in a social standing Stereotypes: Generalisations about a specific group, such as people that share common attributes or characteristics

1. What is the need to understand cultural differences? 2. Explain Hofstedes cultural dimensions. 3. Explain the three important cultural elements. 4. Differentiate the communication styles of Japan, China, Brazil, France, and USA. 5. What is cross cultural management? Explain the cross cultural management factors.
4.8 Answers
Self Assessment Questions 1 1. Culture 2. False 3. (a) 3, (b) 4, (c) 5, (d) 1, (e) 2
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Self Assessment Questions 2 4. Language, religion, conflicting attitudes 5. True 6. c) USA Self Assessment Questions 3 7. Skill 8. False 9. Cross cultural management. Terminal Questions 1. Cultural differences affect the success or failure of multinational firms in many ways. Refer to sub-section 4.2.1 of this unit for details. 2. The five cultural dimensions of Hofstede. Refer to sub-section 4.2.2 of this unit for details. 3. The most important cultural components of a country which relate business transactions are language, religion, and conflicting attitudes. Refer to sub-section 4.3.1 of this unit for details. 4. Refer to sub-section 4.3.2 of this unit for details. 5. Cross cultural management is defined as the development and application of knowledge about cultures in the practice of international management, when people involved have diverse cultural identities. Refer to sub-section 4.4.1 of this unit for details.
4.9 Case-let
India-Japan software outsourcing An Indian based software company, PQR has been doing business with Japan. The company faced many issues. The first and foremost issue faced by the company was the Japanese language. Japanese language is considered to be one of the most difficult languages for people of other countries. The Indian employees found it difficult to adjust to the Japanese culture. It was difficult to sign the deal because the software requirements were explained in the Japanese way. The other problem experienced by the employees was to work in the Japanese style. The company took some steps to solve the problem. First step is that the company attempted to train the software developers to speak Japanese at least at basic level. The second step is that the company tried to make
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the employees adjust to the Japanese culture. The company had to know the requirements of the people and understand their needs to derive more data and design the products accordingly. The requirement needs selection from top management, managers, and users. By focussing on all the aspects, the software developed could ultimately adjust itself to the Japanese method of working and accomplishing success. Discussion Questions 1. What are the issues faced by Company PQR? (Hint: Language) 2. What are the steps taken by Company PQR to overcome the issues? (Hint: Train employees) Source: Cross-cultural management: Text and cases References: Paul, Justin. (2008). International Business. PHI Learning Private Limited. Mitchell, Charles. (2000). A Short Course in International Business Culture. World Trade Press. Mead, Richard. (2005). International Management: Cross-Cultural Dimensions. Blackwell Publishing Ltd. Nakata, Cheryl. (2009), Beyond Hofstede, Culture Frameworks for Global Marketing and Management. Palgrave MacMillan.
E-References: http://www.worldbusinessculture.com/, retrieved on 3rd November, 2010
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Unit 5
Foreign Investments Types and Motives
Structure: 5.1 Introduction 5.2 Foreign Investment Explained 5.3 Advantages of Foreign Direct Investment 5.4 Types of Foreign Investments Foreign Direct Investment Foreign Portfolio Investment 5.5 Motives for Foreign Investment Political motives Economic motives Competitive motives 5.6 Summary 5.7 Glossary 5.8 Terminal Questions 5.9 Answers 5.10 Caselet
5.1 Introduction
Foreign investment has emerged as a potent tool to ensure rapid economic development of the countries as developing countries like India lack the capital domestically. In the previous unit you understood how important it is for an international manager to understand and apply cross cultural management. You also gained an idea about the kind of differences that may exist in different cultures. In this unit, we will discuss the aspect of finance including Foreign direct investment (FDI) and portfolio investments. Foreign investment means the investor invests in foreign countries/ companies instead of putting the money in a local company in expectation of good returns. For the country which is attracting investment, the investor is a foreign investor. Foreign investor can be mainly of two types one who is interested in making long term commitment for investment in the form of Joint Ventures
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with local companies or acquiring/ purchasing the local company or starting the Green Field Projects in order to tap the countrys innate potential in the desired areas of economic activity. This becomes FDI. The second type is the one who may also invest in the secondary markets of the country with expectation of good returns; however, the tenure of such investments is short term and cyclical in nature. Such investments are popularly known as Foreign Portfolio Investment and can be in the form of Depository Receipts or Foreign Currency Loans or Institutional Investments. The foreign investor can influence the management of companies in which he has made an investment. The foreign direct investor may have a varying amount of stake in the invested company. Such stakes by foreign investors in a foreign company can be as low as 10% or may also cross 49% of the shares or stock ownership. India allows different levels of foreign stockholding in different areas of industry/services sectors. For example, the Reserve Bank of India allows foreign equity only up to 26% in insurance sector, 51% in banking sector; 51% in organised retail sector and only 50% in specific mining sector. It totally forbids FDI in mining of iron and manganese. In telecom sector, India allows 74% foreign investment and in port sector, it allows 100% foreign investment. Foreign direct investors always try to seek to have a controlling stake in the entity invested; on the other hand portfolio investment in stocks/companies are likely to produce good returns or likely to have very good growth rate in particular years. Objectives: After reading this unit, you should be able to: understand the meaning of foreign investments and understand advantages of foreign investment for a growing economy like India. understand the importance of foreign investment and discuss the various types of foreign investment. list the advantages of direct foreign investment viz a viz foreign portfolio investment. discuss the meaning and significance of Green Field Investment. explain the meaning of joint venture and mergers and how are they used by companies in expanding their operations to global markets. understand the depository receipts, especially about American Depository Receipts and Global Depository Receipts.
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analyse the role of foreign institutional investment for a country like India. understand the Foreign Currency convertible bonds and their utility in capital financing for a country. analyse the motives behind the foreign investment decision by a foreign investor.
5.2 Foreign investment explained

FDI in todays globalised era plays an extraordinary and growing role in the expansion and diversification of global business particularly for developing countries like India which lacks capital back home for efficient and proper management of physical and manpower resources. Foreign investments help the company in accessing new markets, exploring new marketing channels, exploring cheaper production facilities in low cost destinations, accessing new and advanced technology, planning differentiated high quality products, upgradation of skills and financing for future forays. Foreign investment also benefits the host country or the foreign firm by investing which provides a source of new technologies, capital, processes, products, organisational technologies and management skills. Foreign investment has been used like catalyst by developing countries for strong impetus to economic development. Foreign investment, in its classic definition, is defined as a company from one country making a physical investment into building a factory in another country. In an era of global economic liberalisation, privatisation and globalisation, the definition of foreign investment has been broadened to include the acquisition of a lasting management interest in a company or enterprise outside the investing firms home country. As such, foreign investment in another country or foreign firm may take many forms, such as a direct acquisition/purchase of a foreign firm, completely new construction of a facility in form of green field investments, or investment in a joint venture with foreign firm. Foreign investment may also be in the form of strategic alliance with a foreign firm with attendant input of technology/technical knowhow, licensing of intellectual property, or entering into management contract or turnkey projects.
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Activity 1 Find out the sector specifc caps/ceilings put up by the government of India for various sectors/industries in India for FDI? Hint: open the website https://www.iaccindia.com and read Manual for Policy of Foerign Investment in India
5.3 Advantages of Foreign Direct Investment

With waves of globalisation taking place in global economy with the formation of World Trade Organisation (WTO), developed and developing nations are competing for foreign investment in their respective economies. Foreign investment is said to have played an important factor for spurring the development of a nation. This is particularly more important in the context of a developing country like India which has abundance of other two factors of production i.e. land and labour. However it lacks the capital to tap the innate potential of its physical resources. Following are some of the advantages due to which nations give emphasis to their economic development. a. Easier integration into global economy: A developing country like India is keenly interested to have foreign investment in their economy as it can gain greater access and foothold in other economies of the world. Foreign investor may manufacture the products that may be meant for global markets resulting in greater exports of the country and improving the employment scenario in the country. b. Upgradation in technology and advancement in technical knowhow: Foreign investment facilitates the transfer of advanced level of technology mainly from developed countries to developing countries. Thus, less developed countriess and developing countries can have world-level technology and technical know-how to process their physical and non physical resources. Foreign expertise mainly coming from developed countries can be of immense use in upgrading the existing technical processes in the least developed or developing countries. For example India has got access to nuclear technology by signing the deal with Nuclear Supplier Group; thus having an access to advanced nuclear technology form countries like France, USA, Russia, Britain, Germany and Japan. India has also been benefited with advanced
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technology in areas of ports, ship building, power sector, energy sector and telecommunication in the recent year. c. Increased competition improved productivity: Foreign investment from the foreign players brings in advances in technology, technical knowhow and processes. This helps in increasing competition and resultant productivity in the domestic economy of the developing country. As a catalysing effect, its competitors in the domestic markets also start improving their technology or start tying up with foreign players in search of technology. It acts as a spill over effect in improving the productivity in a particular sector or sub sectors of the industry. Each company tries to stay competitive so as to retain the market share and sales turnover. d. Improvement in human development skills: There comes a significant improvement in human resources skills of the country that attracts foreign investment as its employees get exposure to globally valued skills. Foreign investors come with improved skill set to perform in a particular industry. Thus the host country is benefitted from the training and skills upgradation of the foreign investor. For example in the automobile sector in India, Japan has contributed various aspects on quality improvement of the employee. Some of the other advantages of foreign investment are access to a larger market for foreign investor in the host country. Foreign investor also has other advantages of tapping the potential of a cheap and skilled labour, making effective use of raw material and other physical resources in the host country. Foreign investor also has the benefit of expansion in capacity thus generating economies of scale and optimisation in costs along with gaining diversification in different product categories. Self Assessment Questions 1 1. Foreign investment is the investment by foreign compay/ individual in Indian company/industry/sector. (True/False) 2. Foreign Investment is of two types direct and portfolio investment. (True/False)
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3. Identify the correct answer. Which of the following is not result of foreign investment ________________. a) Improvement in human development skills. b) Increased competition improved productivity. c) Grants/donation to Indian companies. d) Easier integration into global economy.
5.4 Types of foreign investments

Different authors have classified foreign investment in different parameters. However, the most commonly acceptable method of classifying the foreign investment is that of FDI and Foreign Portfolio Investment. FDI is done by making a capital investment into green fields and real estate projects such as opening of new factories, infrastructure projects like road/rail construction etc., setting up new financial companies like banks or insurance firms etc. The types of FDI can be in: a) Completely new projects known as green field investment. b) Sick industrial unit which needs complete restructuring and these are known as brown field investment. If a foreign investor acquires an existing and running Indian unit, it is refered to as acquisition and when foreign investor join hands with local firms to manufacture in an agreed proportion, the same is known as joint venture. Foreign portfolio investment, on the other hand, is an investment by foreign investor in the countrys/regions financial instrument, such as investment in bond market or stock investing. The various types of portfolio investment include the buying of depository receipts in the form of Global Depository Receipts/American Depository Receipts/Indian Depository Receipts etc. Portfolio investment forms the major chunk by making investment in the existing stocks of the local companies in stock exchanges by Foreign Institutional Investors, popularly known as FIIs. Foreign portfolio investment can also be in the form of Foreign Currency Convertible Bonds, popularly known as FCCBs. Foreign direct and portfolio investment is diagrammed and discussed as under:
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5.4.1 Foreign Direct Investment FDI is an important component of a country's national financial accounts. Foreign direct investment is an investment by foreign investors into the assets of the host countrys structures, real estate, roads, ports, rail, plants and machinery, equipment, financial institutions such as opening a new bank/insurance company and sometimes in organisations like investment in Indian Premier League (IPL) by foreign counties. FDI does not include foreign investment into the stock markets of host countries that is separately treated as portfolio investment. FDI for any country of the world is thought to be more useful and beneficial than the investment being made in the equity/stocks of host country companies. Portfolio investment in any form is potentially hot money which can leave the host country at any stage if investor realises that there are sign of trouble in the host country. FDI in contrast is for long term, durable and is generally more useful. It is completely unaffected by the conditions in the host country. So, FDI flows are usually preferred over other forms of external finance because they are non-debt creating, non-volatile and their returns depend on the performance of the projects financed by the investors. Any developing or emerging country like India will always try to attract more investment that is non volatile, non debt creating and returns on which are purely dependent on the performance of the project financed. FDI in India, in
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particular, has been very helpful in the orderly development of international trade, transfer of technical knowhow and knowledge, upgradation of skills and advancements in technology. Different types of FDIs are elaborated as under: a. Greenfield Investments: When the FDI comes into new facilities or expansion of existing facilities, it is known as green field investment. Greenfield investments are most welcome in any country of the world, be it developed or developing as the primary target of green field investments is to create new production capacity and jobs, transfer technology and know-how in the host country. Brown field investments, on the other hand refer to the purchasing of an existing production or business facility that has become sick or its products do not have significant demand in the markets or its sales are on decline due to variety of factors like obsolete technology, higher unit cost, poor distribution etc. Such a firm is acquired by companies or government agencies for the purpose of starting new product or service production activity. This type of investment does not involve construction of plant operation facilities. Green field investments also establish linkages from the place of production to the global marketplace. Green field investments are ideal for generating increased employment in the host country at higher wages, upgrading research facilities and overall process of economic development of the host country. However, some critics say that efficiencies generated in host country through Greenfield investments include the loss of market share for competing domestic firms. Greenfield investments also result in perceived profits and losses to foreign multinationals. Profits generated by multinationals may be repatriated to home country, thus making the host countrys job immensely tough by putting a recurring and continuous load of outflow of hard currency from host countries. b. Mergers and acquisitions: Mergers and acquisition can happen in several ways like transfer of existing assets from local firms to foreign firms whereby local firm sell its assets to foreign firm. Due to waves of globalisation, there is a trend for consolidation of business through measures such as cross-border mergers which helps in establishing a new legal entity by combining the assets and operation of firms from
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different countries. Cross-border acquisition on the other hand refers to a situation when the control of assets and operations is transferred from a local to a foreign company, whereby the local company becomes an affiliate of the foreign company. Mergers and acquisitions are not an attractive option from the point of view of the host country as mergers and acquisitions do not provide major long term benefits to the local economy. In most of the cases, the owners of the local firm are paid in stocks by the acquiring firm, meaning that no FDI in terms of hard money is realised by the host country. In WTO era due to consolidation of global business among trade enthusiastic nations, the mergers and acquisitions have become a significant form of FDI and India also has many such deals in the recent past. For example Hutch-Vodafone deal, Coca Cola-Parle acquisition, HLL-UHL deal etc. Mergers and acquisitions are mostly used by multinationals and transnational companies in making FDI in emerging markets. c. Joint ventures: A joint venture is a sort of business agreement in which two or more parties agree to establish and develop a new entity for a finite time with the objective of making profits, increased sales, and expansion of firms long term goal. The risks, responsibility, management and profits of the contributing parties will be equal to the proportion of capital they have contributed to form this new entity. Joint ventures are popular in the economies that are opening themselves up for foreign investment and wish to provide a level playing field to domestic business vis a vis foreign players. Joint ventures are also popular whereby one party has the specialisation in technology or technical knowhow or management or can contribute capital and other party has supplement to the efforts of first party in this business endeavour. As business operations have become complex and integrated in globalised era, parties may agree to have Joint venture agreement that is limited by guarantee whereby the role of either party is limited to the share of ownership that each party contributes to such venture. Other types of joint venture, which are popular in India, are when two or more parties contribute capital, technology, market expertise, distribution channel or even brand image and both the parties have equally invested in the project in terms of money, time, and efforts. In high risks or
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controlled economies, joint ventures are the best way to make an entry or to diversify into such markets. A joint venture can be the best way to ensure success of smaller projects which are just foraying into new business markets/segments and even for established corporations. For green field projects in areas such as power, port, cement, steel, oil, automobiles etc., when the cost of starting new projects is generally high, a joint venture allows both parties to share the burden of the project, as well as the resulting profits. For high gestation periods projects, joint venture are the best way to start with. There are problems associated with joint venture projects. Foremost is the commitment and willingness of all the parties to work cooperatively, sincerely and enthusiastically for the successful commissioning, execution and completion of project. As decisions are taken by all associated parties, 100% commitment to venture is important. Moreover; parties to joint venture must be complementary to each other thus compensating for weaknesses of other parties. Joint venture will be unsuccessful if both the parties are strong in one area and both are weak in same area. Lack of coordination, communication and misunderstanding can destroy a joint venture relationship. Hence, joint venture parties must create a dedicated mechanism for smooth functioning through coordinated planning, execution, command and control of all functional areas of operations. Synchronised communication strategy should be in place so that both parties, act in tandem for the future of the partnership, suitable returns and sustainability of the joint venture. Joint venture parties must be honest, sincere, loyal and have integrity in the system to make the joint venture operations a success. Activity 2 Find out the data for FDI in various sectors; sources of investment and volume of such investments. Hint: Refer www.unctad.org/en/docs/wir2011overview_en.pdf and read World Investment Report
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5.4.2 Foreign Portfolio Investment Portfolio investment means the investment in secondary market of a country. It refers to any collection of financial assets such as securities and stocks, debentures and bonds and cash. Portfolio investment in any country is highly knowledge based decision and one needs to plan, forecast and judge the potential sectors, segments, companies and industries to invest in order to maximise returns. Portfolios investments in todays liberalised environment can be held by individual investors or can be managed by financial professionals, hedge funds, insurance companies, banks and other financial institutions. Portfolio investment, in any country is made on the basis of followings principles:
a. Global Depository Receipt (GDR): Depository receipts are negotiable certificates and are issued by a countrys bank against a certain number of shares held in its custody. Such stocks are traded in the stock exchange of another country. Depository receipt may be of different types: most popular are Global Depository Receipts (GDR)/European Depository Receipts/American Depository Receipts (ADR) and International Depository Receipts. Depository receipts entitle the shareholders to all associated dividends and capital gains
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that come from such investments. Depository receipts can be bought and sold like any other securities in stock exchanges. Such trading flexibility of depository receipts allows investors in any country to buy shares of any other country without losing the income.
A company planning for global forays and requiring capital may opt to issue a GDR to obtain greater exposure in the global market. GDR issues allow the company to have increased liquidity in key markets where it operates. This helps to boost its prestige in the local market as company stocks are traded internationally. GDRs help the company to have broader shareholder base and provide a platform to expatriates a chance or opportunity to invest in their home countries. Depository receipts are also popular as it helps firms to raise capital globally specially in a scenario where there are tight regulatory norms in the country for allowing foreign investments. For information technology companies in India, most popular depository instrument has been the ADR. ADRs are usually referred to as the financial magic as it delivers the world to the doors of US investors. ADRs were introduced for the first time by the investment house of JP Morgan in 1927. ADRs are always priced in US dollars whereby a US bank or financial institution places a certain amount of stock of a foreign company into its depositary which allows US investors to buy shares in that collection of stocks. b. Foreign Institutional Investors: Foreign institutional investors (FII) are the organisations which pool large sums of money and invest such funds usually in the secondary markets of a country. Investment usually follows into securities, real estate property and other investment assets in a country. FII may also get registered as companies in target security markets so as to invest their profits to
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some degree in these types of assets. In India, there are norms for such companies under Qualified institutional investors norms issued by SEBI. RBI guidelines regarding eligibility criteria to be get registered as FII in India is tabled as under:
Eligibility to get Registered As Foreign Institutional Investor In India Entities and funds a. b. c. d. e. f. g. h. i. Pension funds Mutual funds Insurance companies Investment trusts Banks University funds Endowments Foundations Charitable trusts and societies Broad based fund on behalf of investors a. Asset management companies b. Institutional portfolio managers c. Trustees d. Power of attorney holders
Source: Reserve Bank of India
FII usually make an investment into banks, insurance companies, retirement or pension funds, real estate funds; hedge funds, investment advisors and mutual funds. FIIs have high level of expertise in planning, executing and controlling such funds in the target markets as they act on behalf of other investors who cannot directly participate in emerging and growing markets due to lack of knowledge, expertise and time. For instance a government employee gets Contributory Provident Fund from his employer which is deposited in a fund called CPF fund. A team of financial experts will invest such funds into stocks securities, bonds and insurance so as to broaden the portfolio of investments in many companies. Thus, the risk is spread to many portfolio. If one company fails, it will be only a small part of the whole fund's investment. If returns are higher due to careful planning of the financial team it becomes the gain of CPF fund.
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FII Investment In India All values in INR crore Financial Year 1992-93 2002-03 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 (till Aug31, 2011) Equity 2,527.2 25,235.7 53,403.8 -47,706.2 110,220.6 110,120.8 2,367.6 Debt 162.1 5,604.7 12,775.3 1,895.2 32,437.7 36,317.3 8,186.2 Total 13.4 2,689.3 30,840.4 66,179.1 -45,811.0 142,658.3 146,438.1 10,553.8
Source: Securities & Exchange Board of India
When investment takes place at larger scale in stock market of the emerging and growing country, FII can have a lot of influence in the management of companies as they are entitled to exercise the voting rights in a company. From the table above, it is clear that FIIs in recent years in India have been playing a greater role in fulfilling the short term capital needs of corporate/companies etc. and have contributed to foreign exchange reserves handsomely. Due to European economic crisis, there has been a flight of capital from India, putting pressure on Indias foreign exchange reserves and on increased volatility of rupees. SEBI now has allowed FIIs to invest in mutual funds also. c. Foreign Currency Convertible Bonds (FCCB): FCCBs are a popular mode of investment. FCCBs are convertible bond which are issued by a country in a currency other than its own. By using FCCBs, a country can raise the capital in the form of a foreign currency which may be vital for funding its overseas investments. This ensures short term loans and leveraging its capital requirements. They are called freely convertible as such bonds act like a debt as well as equity instrument. Like any bonds in the market, it makes regular coupon and principal payments to investor and at the same time give an opportunity to convert them into equity or stock of the company. Indian companies have used FCCBs a lot especially in financing their overseas acquisitions in recent years.
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Accordingly to Ministry of Finance, Government of India; Foreign Currency Convertible Bonds means bonds issued in accordance with this scheme and subscribed by a non-resident in foreign currency and convertible into ordinary shares of the issuing company in any manner, either in whole, or in part, on the basis of any equity related warrants attached to debt instruments. Self Assessment Questions 2 4. Portfolio Investment is better for a country in the long run. (True/False) 5. India does not allow Green field investment in India? (True/False) 6. Which of the the following is not the route for portfolio investment in a country? a) Foreign Institutional Investor. b) Joint Venture. c) Depository Receipts. d) Foreign Currency Convertibale Bonds.
5.5 Motives for foreign investments

Motives for foreign investments have always been a debatable subject due to a variety of historical reasons. Communist/social model of economic development has questioned the need of foreign investment for speeding up the economic growth and countrys overall economic development. As India has a historical legacy of colonisation, economic planners at the time of independence in 1947 were not in favour of allowing foreign investment into the country. Such a perception changed when country got into economic crisis in 1991 and it was learnt that a country like India will have to allow foreign capital as it is not endowed with capital domestically. For smoother, systematic and synergised economic development of the country, foreign investment was allowed in almost all areas except the sectors with strategic interests. How far foreign investment has helped India or what has been the foreign investment on any other such countries has been a debateable, complex and unclear subject. The level of foreign investment to be allowed has also been a topic of arguments because the country may lose its economic sovereignty to foreigners. Other school of thought propounds that free flow of capital is beneficial for the country as it promotes an efficient allocation of countrys economic
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resources. It has been found that for shorter periods and within a given country or region, the impact of foreign investment has been mixed. The most immediate impact of foreign investment has been the creation of more jobs and employment opportunities within the immediate locality. In the long run, foreign investment helps in increasing competition, production-intensive nature of economy and higher productivity. Foreign investment acts as a catalyst for generating additional economic activity especially in countries which are deficient in capital resources, however are rich in land and labour like India. All these developments lead to the development of a robust services sector, thus leading to greater economic activity in general and higher per capita income in particular. The host country may have reasons for allowing or not allowing foreign investment into country. Similarly, investor country may also have certain motives when deciding upon a foreign investment decision. Motivations for foreign investment for any country can be broadly classified and understood in three broad categories, discussed as under:
5.5.1 Political motives Countries, usually do not allow foreign investment mainly because of political motives. Countries which have a colonial past are usually apprehensive of foreign investment and are convinced that it is in their best
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interest to not allow import from abroad. For example, India did not liberalise its market to open it to foreign competition. This is due to the governments fear of foreign investment. In recent times, Burma is the best example of a country that has not opened its market for foreigners, fearing sovereign issues and negative impact to indigenous industry. There may be disadvantages in not allowing imports as goods from abroad may be cheaper and this will help in controlling inflation, will be cost competitive and of better quality. Governments, especially in developing and least developed countries are of the opinion that it is in the interest of their country to protect domestic jobs from the perceived threats of losing sovereignty as a result of nationalism or xenophobia. Foreign companies that are denied the right to export to such countries usually plan for foreign investment as it can help in alleviating the fear of job loss, import servicing, pressure on foreign exchange etc. They can penetrate such markets by agreeing to manufacture or at least assemble goods within the target country. They may even agree to establish themselves as the local production hub, thus catering to adjoining markets resulting in exports from such country. India has allowed investment in areas where the foreign investor has come not only to cater to domestic market but also to export to nearby emerging and adjoining markets. This has helped in increasing country exports. For example automobile sector, pharma companies, engineering companies, telecom sector etc. Investing countries use such tactics to overcome restrictions on imports such as quotas, tariffs, and import duties. Local productions in the host country also mitigate the concerns for employment loss and nationalistic pride. 5.5.2 Economic motives: Most notable motives for seeking or planning foreign investment are economic factors. Some companies plan foreign investment in the expectation that they can obtain substantial economies of scale and scope in emerging and developing markets. Conglomerates are usually convinced to invest abroad as they desire to reap benefits in areas such as research and development, marketing, distribution, financing, and production by operating at volumes that can be justified only by a worldwide market. In addition to economies of scale, companies also plan their foreign investments in many countries as they desire to overcome the shortages
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and imperfections of domestic markets for factors of production. Sometimes the local population cannot provide sufficient numbers of technicians and engineers, or particular raw materials may be unavailable or overpriced in local markets. For example, American companies have invested in Indias Information Technology sector as India has a demographic dividend of a large pool of labour force at very competitive cost. Similarly pharmaceutical multinational companies in Japan are looking at India as it produces most cost competitive generic drugs and is also a good market for health care products. 5.5.3 Competitive motives Another important motive for making or seeking foreign investment is the competitive advantages that the company will enjoy in foreseeable future in target markets. Competitive motives for foreign investment are resultant of economic and political motives. A company may make foreign investment in overseas markets for which there are no immediate economic or political gains. However, the company may get benefitted in the long run from such markets due to a variety of reasons. Prime motive for making overseas investment with competitive motive is to secure the future business opportunity against the threat of existing or potential competition. Companies usually invest in emerging markets as they may desire to increase their international market share or production even though this effort may be apparently unprofitable at that moment. In cases where companies have antidumping cases due to export of goods at prices that are below the cost of production, they may be interested to make an investment to penetrate/operate in such potential markets. Another example of competitively motivated direct foreign investment decision are merger and acquisition by foreign company in the host country as it desires to get access to foreign technology/brand image, established distribution channel etc. Tata Sky deal can be quoted as an example of competition seeking investment. Tatas investment in Jaguar is another good example as Tata Automobile wished to increase its presence in higher segments/established markets of Europe at the cost of existing gains.
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Activity 3 What shall be the impact of foreign investment on Indias retail sector? Hint: Refer www.iimk.ac.in/wto/seminar/KakaliMajumdar.doc and read docuemtn on Impact of FDI on Indias retail trade
5.6 Summary
Foreign investment has emerged as a potent tool to ensure rapid economic development of the countries in globalised era as developing countries like India lack the capital domestically. In cases when an investor invests his capital in the foreign countries/companies in expectation of good returns rather than putting his money in a local company, it is known as foreign investment. For the country which is attracting the investment, the investor is known as foreign investor. Foreign investment, in its classic definition, is defined as a company from a country making a physical investment by building a factory in another country. Following are the motives for making an investment in the foreign country. Easier integration into global economy. Upgradation in technology and advancement in technical knowhow is increased. Competition improved productivity. Improvement in Human Development Skills. FDI is done by making a capital investment into green fields and real estate projects such as opening of new factories, infrastructure projects like road/rail construction etc, setting up financial companies like banks or insurance firms etc. Roughly the types of FDI can be investment in completely new project known as green field investment or an investment by a foreign investor in sick industrial unit which needs complete restructuring known as brown field investment. If a foreign investor acquires an existing and running unit, it is refereed as acquisition and when foreign investor shares the hand with local firm to manufacture sometimes in an agreed proportion it is known as joint venture.
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Foreign portfolio investment, on the other hand, is an investment by the foreign investor in the countrys or regions financial instrument, such as investment in bond market or stock investing. The various types of portfolio investment include buying of depository receipts in the form of Global Depository Receipts/American Depository Receipts /Indian Depository Receipts etc. Portfolio investment forms a major chunk by making investment in the existing stocks of local companies in stock exchanges by Foreign Institutional Investors, popularly known as FIIs. Foreign portfolio investment can also be in the form of Foreign Currency Convertible Bonds; popularly known as FCCBs. Motives for making foreign investment can be any of the followings: Political motives. Economic motives. Competitive motives.
5.7 Glossary
Green field investment: An investment in completely new project. Brown field investment: An investment by foreign investor in a sick industrial unit in India needing complete restructuring for revival. Acquisition: A foreign investor acquiring an existing and running Indian unit. Joint venture: A business agreement in which two or more than parties agree to establish and develop a new entity for a finite time with the objective of making profits; increased sales; and expansions of firms long term goal. American Depository Receipt: A stock that trades in the United States but represents a specified number of shares in a foreign corporation. Global Depository Receipt: A bank certificate that is issued in more than one country for shares in a foreign company. The shares are held by a foreign branch of an international bank. The shares trade as domestic shares, but are offered for sale globally through the various bank branches. Foreign Currency Convertible Bond: A type of convertible bond that is issued in a currency different than the issuer's domestic currency. In other words, the money being raised by the issuing company is in the form of a foreign currency.
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1. What do you mean by foreign investments? Discuss by giving relevant examples. 2. Define foreign investment. What are various types of foreign investment? 3. What are the advantages of making an investment in the foreign country? 4. What is green field investment? Why is it considered the best option for a developing country like India? 5. Differentiate between any two of the followings? a. ADR and GDR. b. Green field and brown field investment. c. Foreign direct and portfolio investment. d. Joint venture and merger. 6. Define portfolio investment. Discuss the various types of portfolio investment with relevant examples. 7. What do you mean by direct foreign investments? What are the advantages of direct investment over the portfolio investments? 8. Discuss the increasing role of foreign institutional investor for a country like India. 9. Write short notes on any two of the followings: a. Joint Ventures. b. Mergers and Acquisition. c. Foreign Currency Convertible Bonds. d. Foreign Portfolio Investment. 10. What are some of the motives behind the foreign investment decision of the investor? Explain with relevant examples.
5.9 Answers
Self Assessment Questions 1 1. True 2. True 3. C
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Self Assessment Questions 2 4. False 5. False 6. B Terminal Questions 1. 2. 3. 4. 5. Refer to sec 5.2 of the chapter Refer to sec 5.4 of the chapter Refer to sec 5.3 of the chapter Refer to sec 5.4.1 sub para A entitled as Green Field Investment. a. sec 5.4.2 of the chapter, sub para A b. sec 5.4.1, sub para A c. sec 5.4.1 and 5.4.2 of the chapter d. sec 5.4.1 refer to section B and C Refer to sec 5.4.2 of the chapter Refer to sec 5.4 Refer to sec 5.4.2 of the chapter a. Refer to sec 5.4.1, Section C b. Refer to sec 5.4.1 Section B c. Refer to sec 5.4.2 Section C d. Refer to sec 5.4.2 Refer to para 5.5 of the chapter.
6. 7. 8. 9.
10.
5.10 Caselet
Case: Impact of FDI on Indias automobile sector India, in an open economy era, is fast emerging as a regional hub for automobile sector with the entry of leading players into Indian market. Indian automobile sector in the recent past has been one of the best performing sectors of Indian economy. India attracted quite a number of FDIs in automobile sector as its domestic market is very attractive. It is fast emerging as a hub for exports to regional and global markets especially for Africa, Middle East, South East Asia, SAARC countries and Europe. India allowed 100% FDI under automatic route to automobile sector, which has a turnover of over $11.5 billion in the Indian auto industry and over $ 3 billion in the auto parts industry. 100% FDI is also
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allowed under automatic route for manufacturing automobiles and components. No additional licenses are required for Indian automobile companies except what is mandated under the law for any company for doing business. Import regime including policy has been liberalised allowing the import of auto components without any special licenses and restrictions. As a result, Indias automobile industry has witnessed an 18% growth even in years of economic slowdown. Entry of foreign players along with foreign investment in India has provided Indian automobile industry advantages such as access to advanced technology, cost-effectiveness, and efficient manpower. In addition to this, foreign investment in automobile sector facilitated the growth of a well-developed and competent Auto Ancillary industry along with automobile testing and R&D centres. The automobile sector in India ranks third in manufacturing three wheelers and second in manufacturing two wheelers. Some of the opportunities provided to Indian auto sector due to foreign investment are diagrammed as under:
Discussion Questions: 1. Discuss the benefits of FDI to Indian industry and customers. 2. What is the current scenario of automobile industry in India? 3. Discuss the role of foreign investment in Indias growth.
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References:

International Financial Management; PG Apte; Fourth Edition; Tata McGrawhill Multinational Business Finance; Global Edition; 12th Edition David Eiteman, Arthur Stonehill, Michael Moffett; Sep 2009, Pearson publication Reports: India Brand Equity Fund 2011 Foreign Direct Investment: Analysis of Aggregate Flows; Assaf Razin & Efraim Sadka; Princeton University Press Foreign direct investment in India; Volume 4, Issue 93 of OECD Working papers ; Author Kelly A. Johnson ; Publisher O.E.C.D, 1996 Manual On Foreign Direct Investment In India- Policy and Procedures; MAY-2003 Secretariat for Industrial Assistance; Department of Industrial Policy and Promotion; Ministry of Commerce and Industry; Government of India Foreign Investment in India : 1947-48 to 2007-08; By Niti Bhasin; New Century Publications; 2008
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Unit 6
Regional Integration
Structure: 6.1 Introduction Objectives 6.2 Overview of Regional Integration Need for integration Impact of integration 6.3 Types of Integration Preferential trading agreement Free trade area Custom Union Common market Economic union Political union 6.4 Regional Trading Arrangements The European Union (EU) European Free Trade Association (EFTA) North American Free Trade Agreement (NAFTA) South Common Market (MERCOSUR) ASEAN Free Trade Area (AFTA) Asia-Pacific Economic Cooperation (APEC) Gulf Cooperation Council (GCC) South Asian Free Trade Area (SAFTA) 6.5 India and Trade Agreements Asia-Pacific Trade Agreement (APTA) Bay of Bengal Initiative for Multi-Sectoral Technical and Economic Cooperation (BIMSTEC) Framework Agreement on Comprehensive Economic Cooperation between India and the Association of South East Asian Nations India-MERCOSUR Preferential Trade Agreement (PTA) 6.6 Summary 6.7 Glossary 6.8 Terminal Questions 6.9 Answers 6.10 Case-let
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6.1 Introduction
By now you must be familiar with international business and some of its facets including FDI and FII. In the previous unit, you learned about the different types of foreign investments and their roles. In this unit, we shall discuss about the need and importance of regional integration. Regional integration is the bonding between nations and states through political, cultural and economic cooperation. The cooperation is overseen by rules and regulations decided upon by the states entering into an understanding. This unit covers the need, process and different types of integration among countries. It also discusses various trading blocs in existence, its importance, structure and functioning. This unit also includes Indian participation in the regional trading blocks and trade agreements that Indian Government has with other nations and regions. Objectives: After studying this unit, you should be able to: explain the need for regional integration. analyse the impact of different types of integration amongst countries. describe several regional trade arrangements. evaluate different trade agreements of India.
6.2 Overview of Regional Integration

Regional integration can be defined as the unification of countries into a larger whole. It also reflects a countrys willingness to share or unify into a larger whole. The level of integration of a country with other countries is determined by what it shares and how it shares. Regional integration requires some compromise on the part of participating countries. It should aim to improve the general quality of life for the citizens of those countries. In recent years, we have seen more and more countries moving towards regional integration to strengthen their ties and relationship with other countries. This tendency towards integration was activated by the European Union (EU) market integration. This trend has influenced both developed and developing countries to form customs unions and Free Trade Areas (FTA). The World Trade Organisation (WTO) terms these agreements of
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integration as Regional Trade Agreements (RTA). Table 6.1 gives a list of regional trade integration initiatives taken by India.
India's Trade Agreements at a Glance Existing Ongoing FTAs/PTAs under Study and Consideration 1. Gulf Cooperation Council (GCC) 2. China 3. South Korea 4. Japan 5. Malaysia 6. Pakistan 7. Southern African Customs Union (SACU) 8. Egypt 9. Israel 10. Russia 11. Australia
1. Bangkok Agreement 2. Global System of Trade Preferences (GSTP) 3. SAARC Preferential Trading Agreement (SAPTA) 4. India - Sri Lanka FTA 5. India - Thailand FTA 6. India Singapore Comprehensive Economic Cooperation (CECA) 7. Indo-Nepal Trade Treaty 8. India-Mauritius PTA 9. India-Chile PTA
1. Indo-ASEAN CECA 2. South Asian Free Trade Agreement (SAFTA) 3. BIMSTEC (Bay of Bengal Initiative for Multi-Sectoral Technical & Economic Cooperation) 4. India - MERCOSUR PTA
Table 6.1: India's Trade Agreements Source: www.indianindustry.com
6.2.1 Need for integration Regional integration can be achieved with different approaches. To some extent, each country and region will find its own way. But typically there are some common ideas/reasons for achieving regional integration. Some of these are to: Facilitate trade growth. Achieve conducive climates for investment. Surmount the regulatory and administrative barriers to transit zones. Ensure safe and reliable trade routes. Enhance infrastructure physical and institutional. Encourage economic expansion. Newcomers to industrialisation enjoy some substantial benefits that their ancestors did not. Today, the economic policy makers have a better understanding of the process of industrialisation than their earlier
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counterparts. They have the comprehension of microeconomic inputs and market opportunities. Therefore, policy makers can make use of this knowledge made possible by the rise of the global economy. On the long run, regional integration may transform the regions. The initiative of regional integration should perform at least the following functions: Strengthen regional trade integration. Create a conducive environment to enable private sector development. Develop infrastructure programmes to support economic growth and regional integration. Develop strong public sector institutions and good governance. Reduce social disparities and develop an inclusive civil society. Contribute to the peace and security of the region. Build environmental programmes at the regional level. Strengthen the regions interaction with other regions of the world. 6.2.2 Impact of integration Regional integration results in the creation and diversion of trade. It supports overall growth of the region, coupled with efficient trading practices. Trade creation increases production and income and also leads to new entrants in the market and, therefore, results in tougher competition. The transfer of technology is also faster. Regional integration induces reduction on tariffs and prohibitions. It spreads goodwill among member countries and also helps in reducing the chances of conflict. Self Assessment Questions 1 1. Regional integration can be defined as the unification of countries. (True/False) 2. Promoting ____________________ is a need of regional integration. 3. Identify the correct answer. Regional integration should not ________________. a) Build environmental programmes at the regional level b) Strengthen trade integration in the region c) Contribute to the peace and security of the region d) Break ties with other countries
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6.3 Types of Integration

In the previous section an overview and the need for regional integration was covered. A whole range of regional integrations exist today. Different types of regional integration are discussed in this section. 6.3.1 Preferential trading agreement Preferential trading agreement is a trade pact between countries. It is the weakest type of economic integration and aims to reduce taxes on few products to the countries who sign the pact. The tariffs are not abolished completely but are lower than the tariffs charged to countries not party to the agreement. India is in PTA with countries like Afghanistan, Chile and South Common Market (MERCOSUR). The introduction of PTA has generated an increase in the market size and resulted in the availability and variety of new products. 6.3.2 Free trade area Free Trade Area (FTA) is a type of trade bloc and can be considered as the second stage of economic integration. It comprises of all countries that are willing to or agree to reduce preferences, tariffs and quotas on services and goods traded between them. Countries choose this kind of economic integration if their economical structures are similar. If countries compete among themselves, they are likely to choose customs union. The importers must obtain product information from all suppliers within the supply chain in order to determine the eligibility for a Free Trade Agreement (FTA). After receiving the supplier documentation, the importer must evaluate the eligibility of the product depending on the rules pertaining the products. The importers product is qualified individually by the FTA. The product should have a minimum percentage of local content for it to be qualified. 6.3.3 Custom union Custom Union is an agreement among two or more countries having already entered into a free trade agreement to further align their external tariff to help remove trade barriers. Custom union agreement among negotiating countries may encompass to reduce or eliminate customs duty on mutual trade. Under customs union agreement, countries generally impose a common external -tariff (CTF) on imports from non-member countries. Such
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common external tariff helps the member countries to reap the benefits of trade expansion, trade creation and trade diversification. In the absence of common external tariff, there is a possibility that countries with lower custom duties may become conduits for members which has higher custom duty. Custom union is third stage in level of economic integration and is followed only after free trade agreement among participating countries.
Table 6.1: Levels of economic integration
Levels of Economic Integration Stages/Level of Economic Integration Preferential Tariff & Highly reduced non tariff barrier Free Movement of Goods & Services Common External Tariff Free Movement of Labour & Capital Common Banking & Monetary Policies Common Foreign & Defence Policy
Preferential Trade Agreement Free Trade Agreement Custom Union Common Market Economic Union Political Union
6.3.4 Common market Common market is a group formed by countries within a geographical area to promote duty free trade and free movement of labour and capital among its members. European community is an example of common market. Common markets levy common external tariff on imports from non-member countries. A single market is a type of trade bloc, comprising a free trade area with common policies on product regulation, and freedom of movement of goods, capital, labour and services, which are known as the four factors of production. This agreement aims at making the movement of four factors of production between the member countries easier. The technical, fiscal and physical barriers among the member countries are eliminated considerably as these barriers hinder the freedom of movement of the four factors of
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production. The member countries must come forward to eliminate these barriers, have a political will and formulate common economic policies. A common market is the first step towards a single market. It may be initially limited to a FTA with moderate free movement of capital and services, but it is not capable of removing the other trade barriers. Benefits and costs A single market has many advantages. The freedom of movement of goods, capital, labour and services between the member countries results in the efficient allocation of these production factors and increases productivity. A single market presents a challenging environment for businesses as well as for customers making the existence of monopolies difficult. This affects inefficient companies and hence, results in a loss of market share and the companies may have to close down. However, efficient companies can gain from the increased competitiveness, economies of scale and lower costs. Single market also benefits the consumers in a way that the competitive environment provides them with inexpensive products, more efficient providers of products and increased variety of products. A country changing over to a single market may experience some short term negative effects on the national economy due to increased international competition. National companies that earlier benefited from market protection and subsidies may find it difficult to cope with their efficient peers. If these companies fail to improve their methods, they may have to close down leading to migration and unemployment.
Level of Integration Free Trade Area Main Features of Regional Economic Grouping 1. Free movement of goods & services among countries 2. No tariffs or non tariff barriers 3. Countries are free to decide their trade policies towards non-members 1. Second stage of economic integration 2. Common external tariff for non member countries 3. Ensures orderly & balanced economic development of Examples 1. India Srilanka Free Trade Agreement 2. India Asean Free Trade Agreement 3. North America Free Trade Agreement, etc. 1. Southern African Customs Union (SACU) 2. Andean Pact; 3. Southern Common Market (MERCOSUR) Page No. 120
Customs Union
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member countries 4. Promotes regions as single trading areas for all tariff & non tariff purposes for non member countries with single customs policy Common Market 1. Third stage of economic integration of countries 2. Free movement of labour and capital among participating countries 3. No restrictions on migration of people with economic grouping 1. Fourth stage of economic integration of countries 2. Common currency with aligned banking & monetary policy 3. Single trade policy 4. Harmonisation of tax rates 5. Common fiscal, banking & interest rate policy with common bank 1. Fifth stage of economic integration 2. Treaty of Lisbon provides for such framework for European Countries 3. If implemented, EU will have single defence & Foreign policy
4. EU- Turkey 5. Customs Union of Belarus, Kazakhstan and Russia
1. Caribbean Common Market ( Carricom); 2. Association of South East Asian Nations (ASEAN) 3. Central American Common Market (CACM)
Economic Union
Only example is European Union (EU)
Political Union
No living example however; European Union will become first political union if treaty of Lisbon is ratified by member countries
6.3.5 Economic union Economic union is a type of trade bloc and is instituted through a trade pact. It comprises of a common market with a customs union. The countries that are part of an economic union have common policies on the freedom of movement of four factors of production, common product regulations and a common external trade policy. The purpose of an economic union is to promote closer cultural and political ties while increasing the economic efficiency between the member countries.
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Economic unions are established by means of a formal intergovernmental legal agreement among independent countries with the intention of fostering greater economic integration. The members of an economic union share some elements associated with their national economic jurisdictions. These include the free movements of: Goods and services within the union along with a common taxing method for imports from non-member countries. Capital within the economic union. Persons within the economic union. Some forms of cooperation usually exist while framing fiscal and monetary policies. 6.3.6 Political union A political union is a type of country, which consists of smaller countries/nations. Here, the individual nations share a common government and the union is acknowledged internationally as a single political entity. A political union can also be termed as a legislative union or state union. Self Assessment Questions 2 4. Countries under a political union do not have a common government. (True/False) 5. Countries under a Common External Tariff on imports from non members are known as Common Market. (True/ False) 6. The purpose of an economic union is to promote closer __________ and _____________________ ties. 7. Identify the factor of production. a) Capital. b) Consumers. c) Market. d) Policy maker. Activity 1 Analyse the reasons that lead to the formation of economic unions and common markets. Hint: Economic regionalism, taxation and regional integration.
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6.4 Regional Trading Arrangements

After learning the various types of integration, we will now discuss the regional trading arrangements required for integration. The different regional trading agreements that are in existence today among various countries spread across different continents are discussed in this section. 6.4.1 The European Union (EU) The European Union (EU) is an economic and political union established in 1993. This came into effect because of the Treaty of Maastricht, signed on 7th February 1992 by the European Communities. The EU comprises of 27 member states committed to regional integration. The EU has developed a single market for all the member states and sixteen member states have adopted a common currency called the Euro. The member states sign an agreement called Schengen Agreement, which ensures the free movement of people, goods, capital and services, including the abolition of passport controls. The agreement enacts legislation in justice and home affairs, and maintains common policies on trade, agriculture, fisheries and regional development. EU has also devised a common foreign and security policy for its member states. It has established diplomatic missions around the world and represent the member states at the United Nations, WTO, G8 and G20 summits. EU ambassadors head the EU delegations. Important organisations of the EU include the European Commission, the Council of the European Union, the European Council, the Court of Justice of the European Union, and the European Central Bank. The EU citizens elect the European Parliament every five years. 6.4.2 European Free Trade Association (EFTA) The European Free Trade Association (EFTA) is a free trade organisation established in 1960 between four European counties, Norway, Switzerland, Iceland and Liechtenstein. The EFTA was formed at the Stockholm Convention between seven countries, presently only four countries remain as the members of EFTA. The EFTA was formed as an alternative to EU, allowing countries to join EFTA if they were not willing to join EU. It operates parallel to the EU. The Stockholm Convention was replaced by the Vaduz
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Convention. This Convention provides a framework for a free and liberal trade amongst its member states. 6.4.3 North American Free Trade Agreement (NAFTA) The North American Free Trade Agreement (NAFTA) was signed in 1994 by three governments, Canada, Mexico and the United States. This trade agreement is the largest in the world in terms of combined purchasing power parity Gross Domestic Product (GDP) and second largest by nominal GDP comparison. The NAFTA is divided into two sections, the North American Agreement on Environmental Cooperation (NAAEC) and the North American Agreement on Labour Cooperation (NAALC). The North American Agreement on Environmental Cooperation (NAAEC) was established in 1994. It is an environmental agreement between the United States of America, Mexico and Canada. The agreement comprises of a declaration of objectives and principles regarding conservation and the protection of the environment. The Commission for Environmental Cooperation (CEC) was set up as part of the agreement. North American Agreement on Labour Cooperation (NAALC) was also established in 1994 to achieve the following goals: Improve working conditions and living standards. Promote a set of guiding labour principles. Encourage cooperation to promote innovation. Improve the levels of productivity and quality. NAALC provides various benefits such as exchanges of information, technical assistance and consultations for achieving the above goals. 6.4.4 Southern Common Market (MERCOSUR) MERCOSUR is a trade pact between Argentina, Brazil, Paraguay and Uruguay. It was established in 1991 to promote free trade and a smooth movement in currency, goods and people between these nations. The pact helps reduce tariffs between the nations by 90 percent. MERCOSUR was initiated in 1985 when the Presidents of Argentina and Brazil signed the Argentina-Brazil Integration and Economics Cooperation Program. Since then, other countries like Bolivia, Chile, Columbia, Ecuador and Peru have become members in this pact. In the 2004 presidential summit, it was
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agreed that it should have 18 representatives from each country by 2010. The only non-South American partners are Egypt and Israel. 6.4.5 ASEAN Free Trade Area (AFTA) AFTA is a trade agreement formulated by the Southeast Asian Nations association that supports local manufacturing in all the ASEAN countries. The AFTA agreement was signed in Singapore on 28th January, 1992. Initially when the AFTA agreement was signed, ASEAN comprised of six members: Thailand, Singapore, Philippines, Malaysia, Indonesia and Brunel. Then Vietnam joined the AFTA agreement in 1995, followed by Myanmar and Laos in 1997 and Cambodia in 1999. Now, AFTA consists of ten ASEAN countries. The four latecomers had to sign the AFTA agreement to join ASEAN; however, they were given longer time duration to meet the tariff reduction obligations of AFTA. The AFTAs primary goals seek to: Enhance the competitive edge of ASEAN as a production base in the world market by eliminating the ASEANs non-tariff and tariff barriers. Fascinate more overseas direct investment to ASEAN. Common Effective Preferential Tariff (CEPT) scheme is the prime source for attaining the goals mentioned above. The CEPT scheme established a schedule for its initiation in 1992 with their self-described goal to enhance the competitive advantage of the region as a production base for world market. The Association of Southeast Asian Nations (ASEAN) is an economic and geo-political organisation of ten countries situated at Southeast Asia. The ASEAN organisation was formulated by Thailand, Singapore, Philippines, Malaysia and Indonesia on 8th August, 1967. From then on, the membership has extended to comprise Vietnam, Laos, Cambodia, Burma (Myanmar) and Brunei. The ASEAN organisation aims to accelerate cultural development, social progress, economic growth among their members, protection of stability and peace of the region, and offer opportunities for member countries for discussing differences peacefully. ASEAN spans across 4.46 million kilometres area, three percent of the overall land area of the Earth with a population of approximately 600 million, that is, 8.8 percentage of the worlds population. If ASEAN was the only
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country, it would rank as the ninth largest economy worldwide and third largest in Asia, as per nominal GDP. 6.4.6 Asia-Pacific Economic Cooperation (APEC) The Asia-Pacific Economic Cooperation (APEC) is the best forum for assisting investment, trade, cooperation and economic growth in the AsiaPacific region. APEC is the sole inter-governmental grouping in the world functioning on the basis of equal respect, open dialogue and non-binding commitments for the views of its participants. Unlike WTO and the other multilateral trade bodies, APEC does not have any treaty obligation for their participants. The decisions within APEC are finalised by commitments and consensus undertaken on voluntary basis. The 21 Member Economies of APEC are Australia, Brunei, Canada, Chile, China, Hong Kong, Indonesia, Japan, South Korea, Malaysia, Mexico, New Zealand, Papua New Guinea, Peru, Philippines, Russia, Singapore, Taiwan, Thailand, USA and Vietnam. APEC came into existence in 1989 to further enhance the prosperity and economic growth of the region and to uphold the Asia-Pacific community. From its initiation, APEC has worked to bring down the tariffs and other kinds of trade barriers around Asia-Pacific region. They have also worked towards increasing the exports dramatically and for creating efficient domestic economies. The key to achieve APECs vision is what is referred to as Bogor Goals of free and open trade and investment in the AsiaPacific by 2010 for industrialised economies and 2020 for developing economies. In fact, these goals were embraced by the leaders in their meeting in Indonesia and Bogor in 1994. Let us consider more about Bogor Goals in 1994 Leaders Declaration. The free and open trade investment assists economies to grow, generates jobs and offers greater prospects for international investment and trade. In contrast to this, protectionism maintains higher price tags and fosters inefficiencies in few industries. Free and open business assists in lowering the production costs and in reducing the prices of services and goods which is a direct advantage for everyone.
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APEC also functions to create a safe and efficient environment for the movement of people, services and goods across the borders with the help of technical and financial collaboration and policy alignment. Objectives: In order to meet Bogor Goals, the APEC functions in three prime areas: technical and financial collaboration. trade assistance. investment and business liberalisation. 6.4.7 Gulf Cooperation Council (GCC) On 25th May, 1981, GCCs leaders of United Arab Emirates like State of Kuwait, State of Qatar, Sultanate of Oman, Kingdom of Saudi Arabia and State of Bahrain met in Abu Dhabi. Here, the leaders formulated a framework to join the six states for effective inter-connection, integration and coordination among member states in every field for achieving unity as per article four of GCC Charter. Article four highlightes the strength and depth of cooperation, links and relations among their citizens. In fact, the underpinnings that are clearly provided in the GCC charters preamble confirms the similar systems, common qualities and special relations founded on the creed of Islamic faith, in sharing a common goal and to cooperate among these states to serve the objectives of the Arab nation. GCC on one hand is an institutionalisation, evolution and continuation of the old prevailing realities. On the other hand, it is a practical solution to challenges of economic development and security in those areas. Also, GCC is a fulfilment of aspirations of their citizens towards certain kind of Arab regional unity. Objectives: GCC charter helps to inter-connect, integrate and coordinate between the member states in every field. The GCC also known as Cooperation Council for the Arab States of the Gulf (CCASG) is an economic and political union that involves six Arab states of Persian Gulf with various social and economic objectives. Few of the stated objectives are to: Formulate similar kind of regulations in several fields like administration, legislation, tourism, customs, trade, finance and economy.
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Foster technical and scientific progress in animal, water, agriculture, mining and industry resources. Formulate scientific research centres. Establish joint ventures. Encourage cooperation of private sector. Strengthen relationship among the people. Formulate a mutual currency by 2010.
However, on December 2006, Oman announced that they would not be able to comply with the target date. Then in May 2009, UAE announced their withdrawal from monetary union project. This happened just after they had announced that their monetary union central bank would be situated at Riyadh instead of UAE. They have proposed the currency name to be Khaleeji. Recently, the Council leaders had to face lots of issues for combating the economic downturn. The GCC countries were the first to be hit by the downturn and the prime ones to react to the crisis. Their programs had lots of disparities which deepened the crisis. The recovery plans were present in the private sector which failed to set concise priorities for development and failed to restore confidence in the investor and weak consumer. 6.4.8 South Asian Free Trade Area (SAFTA) South Asian Free Trade Area (SAFTA) agreement was initiated at the 12th SAARC summit on 6th January, 2004 in Pakistan. This agreement envisaged the creation of a free trade zone model in its seven member nations. The seven member nations consist of nearly 1.4 billion people from various countries like: Nepal. Maldives. Bhutan. Bangladesh. Pakistan. India. SAFTA agreement was formulated to levy zero customs duty for trading products by 2012. This agreement was implemented after confirming its compliance by governments of seven member nations. Also, the agreement
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might facilitate healthy trades and investment relationship across the borders to bring about several structural reforms in economy of seven countries. But there are a few obstacles that hinder trade across the South Asian countries, thereby, the trade across the South Asian borders accounts for just five percentage of the overall trade. In fact, the reason could be attributed to the following two prominent factors like: Political causes: During the late 1940s, most nations of South Asia were a part of the British India. During this period, there was considerable trade between many South Asian countries. But in 1947 when Pakistan and India became independent, Pakistan started importing most of their important articles from India. Pakistan also exported many of their commodities to India. Because of the conflicts happening in various spheres, trade activities started declining sharply between Pakistan and India. Protectionism: Almost all the South Asian countries started stressing on their import activities rather than promoting their export activities. Such a tendency lowered the productivity in various sectors of economy. However, things are not the same now. Various economies have started cooperating among themselves, which is evident from the fact that both India and Pakistan lowered their trade tariffs in 2005.
Self Assessment Questions 3 8. The European Free Trade Association (EFTA) was established in the year: a) 1950. b) 1960. c) 1970. d) 1980. 9. ____________ is a trade pact between Argentina, Brazil, Paraguay and Uruguay. 10. The EU comprises of ____________ member states 11. SAFTA agreement was initiated at the 12th SAARC summit held in Bangladesh. (True/False) 12. The Gulf Cooperation Council (GCC) is also known as Cooperation Council for the Arab States of the Gulf (CCASG). (True/False)
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Activity 2 Find out how the Bogar goals set by APEC are being pursued by APEC member countries. Hint:http://www.apec.org/apec/news__media/media_releases/08_pe_sin gaporeiap.html
6.5 India and Trade Agreements

After learning about regional trading arrangements in the previous section, we shall now discuss the trading agreements conducted by India. India considers Regional Trading Arrangements (RTA's) as the building blocks towards the objective of trade liberalisation. Therefore, India participates in a number of RTAs, which include Free Trade Agreements (FTAs), Preferential Trade Agreements (PTAs) and so on. These agreements take place bilaterally or in a regional grouping. We shall now discuss some of the major agreements signed by India. 6.5.1 Asia-Pacific Trade Agreement (APTA) The Asia-Pacific Trade Agreement (APTA), previously known as the Bangkok Agreement, was signed on 31st of July 1975, as an initiative of the United Nations Economic and Social Commission for Asia and the Pacific (ESCAP). The United Nations Economic and Social Commission for Asia and the Pacific (ESCAP) is the regional development arm of the United Nations for the Asia-Pacific region. It focuses on issues that are most effectively addressed through regional cooperation and includes issues oft: All or a group of countries in the region face, for which it is necessary to learn from each other. Benefit from regional or multi-country involvement. Cut across boundaries, or that would benefit from collaborative intercountry approaches. Are sensitive or emerging and require further advocacy and negotiation. The first agreement on trade negotiations among the developing member countries of ESCAP was the APTA/ Bangkok agreement. It is basically a preferential tariff agreement that aims at promoting intra-regional trade
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through exchange of mutually agreed concessions by the members of the ESCAP region. The first signatories to the agreement were Bangladesh, India, Lao Peoples Democratic Republic, the Republic of Korea and Sri Lanka. China's accession to the agreement was accepted at the 16th Session of the Standing Committee of the Bangkok Agreement in April 2000. The objective of this agreement is to encourage economic development gradually through trade expansion among the developing member countries of ESCAP and to further international economic cooperation through the adoption of mutually beneficial trade liberalisation measures. The following general principles govern the agreement: The Agreement shall be based on overall cooperation and mutuality of advantages in such a way, to benefit all participating states equally. The principles of transparency, national treatment and most-favourednation treatment shall apply to the trade relations among the participating states. The special needs of least developed country participating states shall be clearly recognised and concrete preferential measures in their favour shall be agreed upon.
6.5.2 Bay of Bengal Initiative for Multi-Sectoral Technical and Economic Cooperation (BIMSTEC) Bangladesh India Myanmar Sri Lanka and Thailand Technical and Economic Cooperation (BIMSTEC), a sub-regional economic cooperation grouping, was formed in Bangkok in June 1997. Myanmar joined the grouping later in December 1997. Bhutan and Nepal too joined in February 2004. Five members of SAARC (India, Bangladesh, Bhutan, Nepal and Sri Lanka) and two members of ASEAN (Thailand, Myanmar) are members of this agreement. Thus, it is considered as a bridging link' between the two major regional groupings that is, ASEAN and SAARC. The chairmanship of BIMSTEC rotates among the member countries in alphabetical order. The immediate priority of the grouping is to merge its activities to make it attractive for economic cooperation.
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Initially, cooperation was proposed into six sectors. But, during the 11th Senior Official Meeting in New Delhi on August 2006, it was agreed that the areas of cooperation should be expanded to 13 sectors and each sector will be led by members in a voluntary manner. The member countries proposed cooperation in the following sectors: Trade and Investment (Bangladesh). Technology (Sri Lanka). Energy (Myanmar). Transport and Communication (India). Tourism (India). Fisheries (Thailand). Agriculture (Myanmar). Cultural Co-operation (Bhutan). Environment and Disaster Management (India). Public Health (Thailand). People-to-People Contact (Thailand). Poverty Alleviation (Nepal). Counter-Terrorism and Trans-national Crimes (India). BIMSTEC member countries agreed to establish the BIMSTEC Free Trade Area Framework Agreement in order to encourage trade and investment in the countries party to the agreement, and attract outsiders to trade with and invest in BIMSTEC at a higher level. The Framework Agreement on the BIMST-EC FTA was signed on 8th February, 2004 in Phuket, Thailand. 6.5.3 Framework Agreement on Comprehensive Economic Cooperation between India and the Association of South East Asian Nations Look East Policy led India to engage with the Association of South East Asian Nations (ASEAN) and it started in the year 1991. The ASEANs political economic and strategic importance in the larger Asia-Pacific Region and its capability to become a major partner of India in trade and investment made India to join association with ASEAN. While, ASEAN looks to utilise and access Indias technical and professional wealth, India and ASEAN look forward to strengthen the security in the region.
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ASEAN was established on 8th August 1967 in Bangkok by the five original member countries, namely, Indonesia, Malaysia, Philippines, Singapore, and Thailand. Now, it has a membership of 10 countries namely Brunei Darussalam, Cambodia, Indonesia, Lao PDR, Malaysia, Myanmar, Philippines, Singapore, Thailand and Vietnam. India is one of the four 'Summit level Dialogue Partners' of ASEAN. An agreement on Comprehensive Economic Cooperation between ASEAN and India was signed on 8th October 2003 in Bali (Indonesia). The key elements of the agreement are, FTA in services, goods and investment as well as in the areas of economic cooperation. The objectives of this agreement are to: Promote and strengthen trade, economic and investment co-operation between the parties. Progressively liberalise and promote trade in goods and services as well as create a transparent, liberal and facilitative investment regime. Explore new areas and develop appropriate measures for closer economic co-operation between the parties. Facilitate the more effective economic integration of the new ASEAN Member States and bridge the development gap among the parties.
The areas where economic cooperation is required are when appropriate parties: Agree to strengthen their cooperation in the following areas: Trade facilitation. Sectors of cooperation. Trade and investment promotion. Agree to implement capacity building programmes and technical assistance, particularly for the New ASEAN Member States, in order to adjust their economic structure and expand their trade and investment with India. Establish other bodies, which may be necessary to coordinate and implement any economic cooperation activities undertaken pursuant to this Agreement.
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6.5.4 India-MERCOSUR Preferential Trade Agreement (PTA) India and MERCOSUR signed a framework agreement on 17th June 2003. The objective of this agreement is to create an environment for negotiations in the first stage, by granting mutual tariff preferences, and in the second stage, to negotiate a FTA between the two parties in conformity with the rules of the WTO. As a follow up to the framework agreement, a Preferential Trade Agreement (PTA) was signed in New Delhi on January 25, 2004. The aim of this PTA is to expand and strengthen the existing relations between MERCOSUR and India and promote the expansion of trade by granting mutual fixed tariff preferences with the ultimate objective of creating a free trade area between the parties. Other agreements include: India and Singapore Comprehensive Economic Cooperation Agreement (CECA). India-Sri Lanka Free Trade Agreement (ISFTA). India-Chile Preferential Trade Agreement (PTA). India-Afghanistan Preferential Trade Agreement (PTA). India-Bhutan Trade Agreement. India-Nepal Trade Treaty. Framework Agreement for Establishing Free Trade between India and Thailand. Free Trade Agreement (FTA) between India and Gulf Cooperation Council (GCC). India- Japan Trade Agreement. Joint Study Group between India and Korea. Trade Agreement between India and Bangladesh. Comprehensive Economic Cooperation and Partnership Agreement (CECPA) between India and Mauritius. Self Assessment Questions 4 13. India and MERCOSUR signed a Framework Agreement on ________. 14. The association of India and ASEAN started in the year 1991. (True/False)
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6.6 Summary
Let us summarise the points covered in this unit: Regional integration is necessary to improve the relationship between countries and to promote trade. The overall development of the region is the principal behind regional integration. There are different types of regional integration such as free trade area, customs union, common market, economic union, political union, preferential trading agreement and free trade area. These are the basic ideas behind the different regional integration agreements existing in the world. The different regional integration agreements are NAFTA, APEC, EU, EFTA, AFTA, MERCOSUR, GCC and SAFTA. India also considers RTSs to be the basis for trade liberalisation. Therefore, India has entered into various agreements with many countries spanning many continents.
6.7 Glossary
GDP: Gross Domestic Product is the amount of goods and services produced in a country every year. Trade bloc: It is an agreement between countries to reduce tariffs and other trade barriers. Preferential Trade Agreement: Trade agreement whereby negotiating countries offer each other tariff & non tariff preference on all tariff line or on select tariff lines. Custom Union: Regional economic engagement of countries with a single mutually agreed common external tariff. Transit zone: It is a free trade area and goods passing through a transit zone are normally not subject to any customs formalities, duties, or import restrictions of the host country.
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1. What is the need for regional integration? 2. Write short notes on common market, economic union and free trade area. 3. Write short notes on NAFTA and APEC. 4. How has India reacted towards regional integration?
6.9 Answers
Self Assessment Questions 1 1. True 2. Economic diversification 3. d) Break ties with other countries Self Assessment Questions 2 4. False 5. True 6. Cultural and political 7. a) Capital Self Assessment Questions 3 8. b) 1960 9. MERCOSUR 10. 27 11. False 12. True Self Assessment Questions 4 13. 17th June 2003 14. True Terminal Questions 1. Regional integration facilitates the growth of trade, ensures peace and security of the region and binds different countries together. These are explained in section 14.2 of this unit. Refer the same for details. 2. Common market is a group of countries within a particular geographical area, whereas, FTA is a trade bloc that has agreed to reduce tariffs. An economic union comprises of a common market and a custom union. These are explained in sub-section 14.3.2, 14.3.3 and 14.3.4 of this unit. Refer the same for details.
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3. NAFTA is largest in the world in terms of purchasing GDP. APEC is a best form for trade cooperation in the Asia-Pacific region. These are explained in sub-section 14.4.3 and 14.4.6 of this unit. Refer the same for details. 4. India considers RTAs as building blocks towards the objective of trade liberalisation. Therefore, India is participating in a number of RTAs. This is explained in section 14.5 of this unit. Refer the same for details.
6.10 Case-let
Role of Integration in Maintaining Peace The war in the Balkans proved to be the motivation behind the development of European Foreign policy to establish stability and security in the region. The policy proposed to integrate the Western Balkans through political and economic assistance especially provided by a regional approach and by the Stabilisation Association Process and the Stability Pact. In the context of the policy towards the Balkans, Siberia was charged with the responsibility to oversee the transition of democracy and participate in the integration process. The role of Siberia is crucial as it has to take care of its own political and economic progress in the process of integration. Therefore, the policy emphasise that the process of the integration is not mainly related to security and economic interests, but also with a normative ambition that is most importantly building and enforcing the rules needed to guarantee democratic development and political stability. The EUs more rationale interests such as economic development and security are correlated and also embedded in the EUs normative concerns. The strategies employed by the EU towards Serbia particularly had the ambition to create political stability and in turn, increase the security throughout the Balkans, and thereby decrease the risk for further conflict around Europes borders. For instance, the support towards the democratic entities and the promotion of European norms and rules is of high priority. Discussion questions 1. Analyse the role of Siberia in integrating the Balkans. (Hint: Political and economic participation) Source: http://www.essays.se/essay/f468debd57/
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References: Bernadette Androsso-O'Callaghan (2005), Regional integration: Europe and Asia compared. Ashgate Publishing. Rouhollah K. Ramazani, Joseph A. Kechichian (1988), The Gulf Cooperation Council: record and analysis. University Press of Virginia. Hill; International Business-competing in Global Market Place; fourth Edition; Tata McGraw-Hill Sisir Gupta (1981), India and regional integration in Asia. Asia Publishing House.
E-References: http://business.gov.in/trade/trade_agreements.php, retrieved on 10th November, 2010 http://en.wikipedia.org/wiki/Regional_integration, retrieved on 6th November 2010 www.indianindustry.com, retrieved on 22 April 2012
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Unit 7
Global Trade Institutions
Structure: 7.1 Introduction Objectives 7.2 Introduction to Global Trade Institutions Institutions Objectives 7.3 WTO Objectives and functions Structure Principles Agreements Issues 7.4 International Labour Organisation (ILO) History International labour code 7.5 Summary 7.6 Glossary 7.7 Terminal Questions 7.8 Answers 7.9 Caselet
7.1 Introduction
In the previous unit, you understood about regional integrations and its role. You also learned about the various regional integrations across the world along with important agreements which India has with other countries. International business is a process of conducting business between several countries. It creates opportunity as well as challenges. To support the challenges faced by international business, certain support systems are established. In this unit, you will learn about support systems for international business. This unit covers the institutional support systems It discusses various international organisations working towards promoting international business and provide regulatory framework. It also covers the International Labour Organisation and the international labour code.
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Objectives: After studying this, unit you should be able to: describe the various international organisations working to facilitate international trade. evaluate the role of WTO. discuss the major agreements in WTO. interpret the scope of ILO. explain the international labour code.
7.2 Introduction to Global Trade Institutions

International business is the process of conducting business in multiple countries. Multinational corporations (MNCs) and international business companies (IBCs) conduct business between different countries. After World War II, the Western leaders did not want to repeat economic isolationism that played a major part in leading to the war. The leaders decided to establish an international trade organisation that helped to create new international political and economic institutions which encouraged and preserved peaceful international relations. A countrys trade policy choices are connected to various factors of the international system. A number of institutions provide support for an open, multilateral trading system. Trade liberalisation is influenced by institutions like GATT (General Agreement of Tariffs and Trade) and IMF (International Monetary Fund). The influence of these international institutions depends on economic conditions of the debtors or on changing domestic preferences of trade. 7.2.1 Institutions The support system institutions for international business include WTO (World Trade Organisation), World Bank, and International Monetary Fund (IMF). Regional trade institutions have an ambiguous effect on the multilateral system whereas some institutions such as NAFTA (North American Free Trade Agreement) and ASEAN (Association of Southeast Asian Nations) have a positive effect on lowering trade barriers. These institutions have different effects on the countries trade policies. The major support systems for international business are:
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The IMF is an international organisation of 187 countries. It ensures the stability of the international monetary and financial system. The World Trade Organization (WTO) is an international organisation with 153 members which deals with the rules of trade between countries. World Bank is an international financial institution that provides leveraged loans to developing countries for major projects. United Nations Conference on Trade and Development (UNCTAD), the permanent body of the United Nations General Assembly was set up in 1964 to deal with trade and development issues.
7.2.2 Objectives The international institutions provide information about other countries behaviour, forum for dispute resolution and a common framework for sustaining trade flows. A strong international financial system is required to support growing international trade. It helps to reduce the risk of payment imbalances and financial crisis. The international institutions work together to provide a strong system for international trade which is open to all countries. This kind of system is essential for supporting economic growth, reducing poverty and raising the standard of living around the globe. The main objective of IMF is to facilitate the expansion and balanced growth of international trade and provide exchange stability. The WTO helps in the smooth flow of international trade and provides countries with a constructive platform for dealing with disputes over trade issues. The main objective of UNCTAD is to formulate policies regarding trade, finance and technology. It is a specialised agency that performs three main functions: Provides a forum for intergovernmental discussions. Undertakes research, data collection and policy analysis for debates of government representatives and experts. Provides technical assistance to the specific requirements of developing countries.
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Self Assessment Questions 1 1. _____________ is the process of conducting business in multiple countries. 2. IMF stands for: a) International Monetary Fund. b) International Management Foundation. c) Indian Monetary Fund. d) Indian Management Foundation. 3. NAFTA is a major support for international business. (True/False)
7.3 WTO
In this section we will discuss about the World Trade Organisation (WTO). WTO was established on 1st January 1995. In April 1994, the Final Act was signed at a meeting in Marrakesh, Morocco. The Marrakesh Declaration of 15th April 1994 was formed to strengthen the world economy that would lead to better investment, trade, income growth and employment throughout the world. The WTO is the successor to the General Agreement of Tariffs and Trade (GATT). India is one of the founders of WTO. WTO represents the latest attempts to create an organisational focal point for liberal trade management and to consolidate a global organisational structure to govern world affairs. WTO has attempted to create various organisational attentions for regulation of international trade. WTO created a qualitative change in international trade. It is the only international body that deals with the rules of trades between nations. 7.3.1 Objectives and functions The key objective of WTO is to promote and ensure international trade in developing countries. The other major functions include: Helping trade flows by encouraging nations to adopt discriminatory trade policies. Promoting employment, expanding productions and trade and raising standard of living and income and utilising the worlds resources. Ensuring that developing countries secure a better share of growth in world trade. Providing forum for trade negotiations. Resolving trade disputes.
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The important functions of the WTO as stated in the WTO agreement are the following: Developing transitional economies Majority of the WTO members are the developing countries. The developing countries such as India, China, Mexico, Brazil and others have an important role in the organisation. The WTO helps in solving the problems of developing economies. The developing states are provided with trade and tariff data. This depends on the countrys individual export interest and their participation in WTO-bodies. The new members benefit hugely from these services. Providing help for export promotion The WTO provides specialised help for export promotion to its members. The export promotion is done through the International Trade Center established by the GATT in 1964. It is operated by the WTO and the United Nations. The International Trade Center accepts requests the member countries, usually developing countries in assisting to plan and execute programmes for export promotion. The center provides information on export market and marketing techniques. The center also provides assistance in establishing export promotion and marketing services. The WTO proves its commitment in the upliftment of the world economy through this. Cooperating in global economic policy-making The main function of the WTO is to cooperate in global economic policy-making. In the Marrakesh Ministerial Meeting in April 1994, a separate declaration was adopted to achieve this objective. The declaration specifies the responsibility of WTO as, to improve and maintain the cooperation with international organisations such as the World Bank and International Monetary Fund (IMF) that are involved in monetary and financial matters. WTO analyses the impact of liberalisation on the growth and development of national economies which is the important factor in the success of the economy. Monitoring implementation of the agreement The WTO administers sixty different agreements that have the statue of international legal documents. The member-governments sign and confirm all WTO agreements on attainment. Providing forum for negotiations The WTO provides a permanent forum for negotiations among members. The negotiations can be on
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matters already stated in the WTO agreements or matters not addressed in the WTO law. Administrating dispute settlement The important function of WTO is the administration of the WTO dispute settlement system. It helps in settling multilateral trading dispute. A dispute arises when a member country adopts a trade policy and other fellow members consider it as a violation of WTO agreements. The Dispute Settlement Body (DSB) is responsible for the settlement of disputes. The dispute settlement system is prohibited from adding or deleting the rights and obligations provided in the WTO agreements. The WTO dispute settlement system helps to: Preserve the rights and responsibilities of the members. Clarify the current provisions of the agreements.
7.3.2 Structure The structure of the WTO consists of the Ministerial Conference, which is the highest authority. This body consists of the representatives from all WTO members. The members meet once in every two years and decisions on all matters regarding the multilateral trade agreements are taken. Subsidiary bodies and the General Council composing of WTO members undertake the daily activities of the WTO. The members report to the Ministerial Conference. On behalf of the Ministerial Conference the General Council administers as the Dispute Settlement Body to handle the dispute settlement procedures. It also acts as the Trade Policy Review Body that regularly reviews the trade policies of individual WTO members. The General Council delegates responsibility to other major bodies. They are: Council for Trade in Goods It manages the implementation and functioning of all agreements covering trade in goods Trade in Services and Trade of Intellectual Property Rights These two councils are responsible for their respective WTO agreements. They can also establish their own subsidiary bodies, if required. Committee on Trade and Development It handles issues related to the developing countries.
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The Committee on Balance of Payments Consultations between WTO members and countries that take trade-restrictive measures to handle balance-of-payments difficulties. Committee on Budget and Administration Issues concerning financing and budget of WTO are handled by them.
Source: WTO Sectariat; Geneva; Switzerland
7.3.3 Principles The WTO principles of the trading system are: Trading without discrimination One aspect of indiscrimination is that foreigners and natives must be treated equally. This implies that
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imported goods that are in the market must not face discrimination. There is also a Most Favoured Nation (MFN) principle which requires the nations to treat all WTO members equally. If one nation grants a special trade deal to another nation, the deal must be extended to all WTO members. Trade barriers negotiated downwards Trade barriers such as import tariffs, red tape should be lowered and trade growth must be encouraged. Predictable trading The predictability in business helps to know the real costs. The WTO operates with tariff bindings and agreements that restricts raising a specific tariff over a given time. This provides the business with realistic data. The business can also anticipate a stable future if the trade rules are made clear and accessible. Competitive trading The WTO works towards trade liberalisation and understands that trade relationships between nations can be very complex. The WTO agreements support healthy competition in services and intellectual property and discourage subsidies and dumping of products at prices below the cost of their manufacturer. Encourage development and economic reforms The majority of the WTO members are developing economies that are changing to market economies. The developed nations must give market access to goods from the under developed countries and provide technical assistance. Developed countries are allowing duty-free and quota-free imports for all the products from the under developed countries.
7.3.4 Agreements The WTO agreements are a set of rules that are followed by the member governments while formulating policies and practices in the area of international trade. The agreements mainly cover goods, services and intellectual property. The agreements comprise of the rights and obligations of the government that are enforceable in multilateral framework. The agreement supports individual countries commitments to lower customs tariffs and other trade barriers, and to open services markets. The agreements also recommend governments to make their trade policies transparent. According to the agreement, the government must notify the WTO about the measures adopted to make their trade policies transparent.
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The major agreements are: General Agreement on Trade in Services (GATS) GATS is a framework agreement defining the rules under which trade in services must occur. GATS aims at extending the rules covering trade in goods to trade in services. A detailed rule has been included to take into account the differences between goods and services and the way in which trade in services is conducted. Trade in services cover a wide range of activities in the area of telecommunication, information, banking, insurance and education. WTO has recognised over 150 service sub-sectors. The main objective of GATS is to establish a framework for liberalising trade in services. It encourages countries to modify their domestic regulations. This modification results in elimination of restrictions applied to service products entering the country and is applicable to international service suppliers who are carrying out business in various modes. According to the GATS, MFN status and transparency is applicable to all services. Other commitments such as national treatment and market access are only applicable to services that are opened according to the specified negotiated commitments. GATS covers services known as consumption abroad where services such as e-commerce are used by the consumers in a host country and citizens of a country travel overseas to consume products such as tourism or education. Trade-Related Aspects of Intellectual Property Rights (TRIPS) The Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) is one of the WTO agreements that is compiled by all WTO members. According to TRIPS, developed and developing members of WTO must adopt the same minimum levels of intellectual property protection. The TRIPS Agreement includes rules on domestic enforcement procedures. TRIPS Agreement focuses on issues such as innovation and the dissemination of technology, development of biotechnology, health care and the operation of multilateral environment agreements. The TRIPS agreement states that members can take actions to protect the public health and nutrition. It encourages protection of new plant varieties. The members are encouraged to develop national systems
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that promote local breeding, rights of farmers and protect human fundamental human rights which include the right to food and health. It promotes the use and protection of knowledge that is relevant to the conservation and use of biological diversity. This includes knowledge in technology and genetic material. The 1995 WTO TRIPS Agreements covers copyright and related rights, geographic indications, trademarks, and patents of integrated circuits, protection of information and control of anticompetitive practices in contractual licenses. General Agreement on Tariffs and Trade (GATT) GATT is a multilateral agreement among countries providing a framework for conducting international trade. GATT is regarded as an international institution governing international trade relations. It consists of disciplines on governments and matters related to import and export of goods. It was established to promote international trade by reducing tariff and non-tariff restrictions on imports imposed by member nations. Tariff barrier refers to imposing import duty and non-tariff barriers means restricting imports through import licensing and by banning the imports. GATT provides a framework for negotiations on the level of tariff. It promotes multilateral trade among member nations. It provides protection against unfair trade and obstructions to trade. Sanitary-phyto-sanitary barriers in trade: A caselet of Indian red chillies Sudan Red is a synthetic colorant which is used in red chilly powder to make the powder look red. There are three grades of Sudan Red colorant used in red chilly powder in India. Other grades have been found in Chinese duck eggs in the recent times. Sudan Red is a carcinogenic material. Indian red chilly powders containing Sudan Red has been banned in European Union countries. In October 2003, the European Union has specified the requirements of Sudanfree certificates for all spices imported into Europe. Accordingly; inspection agencies in India namely Spice Board & Export Inspection Agency has been communicated and notified for the same by European Union. Now, the inspection of red chilli has been made compulsory by Spice Board and each consignment exported must comply to the EU guidleines. The Spice Board inpects all consignments on sample basis
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of red chillies. For exporters, it has become an additional transactioncal cost to exports as it is estimated that Sudan tests cost as much as Rs. 2,000 per sample and several samples are drawn from a container load. Total cost of such Sudan test is estimated to be around 3% of CIF value.
Source: www.indianspices.com
7.3.5 Issues The issues related to WTO are: Trend towards unilateral action by some developed countries in disregard of the provisions laid down in the Uruguay Round. Developing countries and least-developed countries have to overcome issues like constraints of resources, skills shortage and expertise in these areas. The unilateral action can disgrace the entire multilateral trading system. This slows down the motivation for reform in all developing countries. Another issue is the favour of regionalism. Third world countries can face discrimination as regional economic groupings have resulted in more trade between countries in the region. The Agreement on Agriculture has number of inequities in the implementation of the Agreement. Most developing countries cannot provide export subsidies. However, developed countries can resort to such subsidies. Thus, countries that have been previously distorting the market can continue to maintain subsidy regimes. Other countries are banned from utilising these measures. The WTOs current position on trade, environment and sustainable development faces criticism. Liberalisation of trade leads to larger growth, higher incomes and increased consumption. However, it affects production which in turn has an adverse effect on the environment. Though the WTO trading system creates growth, it also causes pollution. The WTO trade and growth policies are responsible for environment degradation. The other issues are green room negotiations. Green room negotiations are the informal negotiation meetings at the WTO in which 35 countries are chosen by the Director General.
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Activity 1 Refer to any website and create a report on the principles laid down by GATT to the member countries on anti-dumping measures. Refer to the following link for guidance http://commerce.nic.in/wto-feb.pdf Self Assessment Questions 2 4. The WTO is the successor to the _____________ . 5. Majority of the WTO members belong to developed countries. (True/False) 6. The main objective of _____________ agreement is to establish framework for liberalising trade in services. a) GATT. b) NAFTA. c) TRIPS. d) GATS. 7. The WTO agreements are a set of rules that are followed by the governments while formulating policies and practices in the area of international trade. (True/False) 8. The highest authority of WTO is the _____________.
7.4 International Labour Organisation (ILO)

International Labour Organisation (ILO) is a specialised agency of the United Nations which deals with labour issues. The headquarters is situated in Geneva, Switzerland. The secretariat comprises of the people employed by the organisation throughout the world. The secretariat is known as the International Labour Office. The ILO manages work through three main bodies. They are: International Labour Conference The members of the ILO meet at the International Labour Conference every year in June, in Geneva. Two government delegates along with an employer delegate and a worker delegate represents their respective member state. The technical advisors also accompany the delegates. The Cabinet Ministers are usually responsible for labour affairs, head the delegations and present
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the viewpoint of their government. The Conference creates and implements standards for international labour. Social and labour issues are discussed in the Conference. It also assigns the budget of the organisation and elects the Governing Body. Governing Body The executive council of the ILO is known as the Governing Body. It meets thrice a year in Geneva and takes decisions on the ILO policies. It forms programmes and budgets which are submitted to the Conference for adoption. The Governing Body has 28 government members, 14 employer members and 14 worker members. Ten government seats are permanently held by states of chief industrial importance. Taking into consideration the geographical distribution, representatives of other member countries are elected at the Conference once in every three years. The representatives are elected by the employers and workers. International Labour Office The permanent secretariat of the International Labour Organisation is the International Labour Office. It is the central point for all activities that are administered by the governing body. The Office is a center for administration, research and documentation. It employs more than 1,700 officials from 110 nationalities. The Office also organises certain programmes to extend technical help to all member nations. Under this programme of technical cooperation, around 600 experts undertake missions in all regions of the world.
7.4.1 History Following the Treaty of Versailles, the ILO was established as an agency of the League of Nations. The ILO was created in 1919, after the First World War. The ideas of the International Association for Labour Legislation were incorporated in the Constitution of the International Labour Organisation. The initial motivation of the ILO was humanitarian because the workers were exploited without any improvement in their health and family. The preamble of the constitution of the ILO states the conditions of labour and the injustice and privation to large number of people. The economic factor was the second motivation as it has a certain effect on the cost of production. The failure of a nation to adopt humane conditions of labour affects the economic situation of the country adversely.
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The ILO constitution was written in April 1919 by the Labour Commission that was set up by the Peace Conference. The first annual International Labour Conference had two representatives from the government. It included one representative from the employers organisations and another representative from the workers organisations of each member state. The first six International Labour Conventions that dealt with working hours in industry, minimum age, unemployment, maternity protection and night work for women and night work for young persons in was implemented in the first annual International Labour Conference. Albert Thomas was chosen as the first Director of the International Labour Office by the Governing Body. From the beginning, he drove organisation with a strong motivation. 16 International Labour Conventions and 18 Recommendations were adopted in 2 years. In 1920, the ILO headquarters was set up in Geneva. 7.4.2 International Labour Code The International Labour Code is composed of Conventions and Recommendations adopted by the International Labour Conference. In 1997, the Code contained 181 conventions and 188 recommendations that covered important subjects in labour and social fields. The main function of the ILO is to set international labour standards by adopting conventions and recommendations covering the major labour-related issues which are referred to as the International Labour Code. The Conference adopts conventions and recommendations which is prepared by the International Labour Office and the governing body. The representatives of the member nations bring the conventions and recommendations to the notice of the authorities. Conventions These treaties are not bound to a country unless they are approved by that country. ILO conventions that have secured a twothird majority should be presented by the member country in the Conference. The ILO conventions are approved as written and without reservations. Flexibility clauses are included in the conventions to accommodate different climatic conditions or states of development of particular countries. Recommendations When state practices vary largely, non-binding guidelines known as recommendations are issued. Recommendations are issued when the subject is:
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Very technical and cannot be handled by a convention. Already covered by a convention but needs to be addressed in more detail.
Member states are required to bring recommendations to the attention of their governments. Activity 2 On February 2010, India signed the Decent Work Country Programme (DWCP) document. Refer to any business magazine or website and discuss the main objectives of DWCP. Refer to the following link for guidance http://www.ilo.org/public/english/bureau/program/dwcp/
Self Assessment Questions 3 9. The _____________ establishes and implements international labour standards. 10. The Governing Body meets once a year in Geneva and takes decisions on the ILO policies. (True/False) 11. The ILO was created in: a) 1920. b) 1919. c) 1929. d) 1991. 12. The body of ILO Conventions and Recommendations is commonly known as the International Labour Conference. (True/False) 13. The executive council of the ILO is known as the _____________.
7.5 Summary
Let us now summarise the salient points you learnt about support systems for international business: International business is the process of conducting business in multiple countries. Multinational corporations (MNCs) and international business companies (IBCs) conduct business between different countries. The major support systems for international business are WTO (World Trade Organisation), World Bank, and International Monetary Fund (IMF).
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WTO (World Trade Organisation) was established on 1st January 1995. In April 1994, the Final Act was signed at a meeting in Marrakesh, Morocco. The major agreements of WTO are GATS, TRIPS, and GATT. International Labour Organisation (ILO) is a specialised agency of the United Nations which deals with labour issues. The ILO manages work through three main bodies, namely International Labour Conference, Governing Body and International Labour Office. The International Labour Code is composed of conventions and recommendations adopted by the International Labour Conference.
7.6 Glossary
League of Nations: An intergovernmental organisation founded as a result if the Treaty of Versailles in 1919-1920. Red tape: A sequence of forms and procedures required to gain bureaucratic approval for something. It is an obstructive and time consuming official routine. Tariff bindings: A ceiling level above which a member cannot apply a tariff. It is the maximum tariff that can be applied by a Member. Treaty of Versailles: One of the peace treaties at the end of World War I.

1. Describe the international organisations working to facilitate international trade. 2. Evaluate the role of WTO. 3. Discuss the major agreements in WTO. 4. Interpret the scope of ILO. 5. Explain the international labour code.
7.8 Answers
Self 1. 2. 3. Assessment Questions 1 International business. a) International Monetary Fund. False.
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Self Assessment Questions 2 4. GATT. 5. False. 6. d) GATS. 7. True. 8. Ministerial Conference. Self Assessment Questions 3 9. International Labour Conference. 10. False. 11. b) 1919. 12. False. 13. Governing body. Terminal questions 1. The major support systems for international business are WTO (World Trade Organisation), World Bank, and International Monetary Fund (IMF). Refer to section 7.2 of this unit for details. 2. WTO represents the latest attempts to create an organisational focal point for liberal trade management and to consolidate a global organisational structure to govern world affairs. Refer to section 7.3 of this unit for details. 3. The WTO agreements are a set of rules that are followed by the member governments while formulating policies and practices in the area of international trade. Refer to section 7.3.4 of this unit for details. 4. International Labour Organisation (ILO) is a specialised agency of the United Nations which deals with labour issues. Refer to section 7.4 of this unit for details. 5. The International Labour Code is composed of conventions and recommendations adopted by the International Labour Conference. Refer to section 7.4.2 of this unit for details.
7.9 Caselet
WTO and the Challenges Faced by Indian Pharmaceutical Companies India is favourable location for big pharmaceutical companies because of its cheap and educated labor force. The major concern of the WTO is to
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take care of the poor, especially in the area of health care. The TRIPS Agreement of the WTO in pharmaceuticals brought the health care issue to the forefront. According to the agreement, developing countries had to revise their patent laws to conform to WTO requirements by 2006. The success or failure of the TRIPS Agreement depends on countries like India. Indias pharmaceutical industry is highly efficient and India needs to implement the IPR (Intellectual Property Rights) laws to simultaneously maintain its position in the pharmaceutical sector. The challenge for India is to maintain its international obligations and to satisfy domestic interest that includes consequent access to cheap medicine. Indian pharmaceutical companies are using adaptive strategies to cope up with the WTO product patent law. In order to adapt and benefit from the opportunities created by the new patent system, firms are adapting a combination of cooperative and competitive strategies. Indian pharma companies face international competition. Companies that get huge profits from exports spend huge amount on R&D (Research & Development). Large companies such as Ranbaxy and Cipla were preparing for the new patent regime since 1995. A company can lose market share on a patent expired product. However, the cost of developing the product can be recovered even after the expiration date of the patent if the marketing strategies are well planned. Visionary strategies such as drug discovery, focus on production of high quantum and moderately priced generics, outsourcing to MNC's upgrading manufacturing facilities, etc., are also being adopted by Indian pharma companies. India can be the top global pharma Industry with the help of these facilities and pharma support services such as clinical research operations, diagnostic services and data management services. Discussion question 1. Discuss the adaptive strategies of Indian pharmaceutical companies to cope up with the WTO product patent law. (Hint: Cooperative and competitive strategies)
Source: http://www.eurojournals.com/ejefas_13_04.pdf retrieved on 10th November 2010
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Reference: Walter Carlsnaes, Thomas Rissee and Beth A Simmons. (2006): Handbook of International Relations. Sage Publications Ltd.
E-References: www.indianspices.com, retrieved on 20 April 2012 www.wto.org, retrieved on 21 April 2012 http://www.indianembassy.org, retrieved on 2 Feb 2009
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Unit 8
Unit 8
International Financial Management
Structure: 8.1 Introduction Objectives 8.2 Overview of International Financial Management Evolution Domestic versus International Financial Management 8.3 Components of International Financial Management Foreign exchange market Foreign currency derivatives International monetary systems International financial markets 8.4 Scope of International Financial Management Management of working capital Financing decisions Taxation 8.5 Summary 8.6 Glossary 8.7 Terminal Questions 8.8 Answers 8.9 Caselet
8.1 Introduction
Understanding the role of financial management for international business is of immense importance Overseas business operations may require funding of a new venture as the firm has been planning to extend its business basically from a domestically focused business model to the one that is internationally oriented. In the globalised era; each firm wishes to extend its activity to various markets due to a variety of reasons such as generating economies of scale; higher profit margins; better returns; increased productivity; technological development and enhanced experiences from international buyers. This can be achieved by ensuring the proper planning and execution of a financial plan for the successful conduct of international business.
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The main aim of international finance management is to maximise the organisations value that in turn will increase the impact on the wealth of the stockholders. When the doors of liberalisation opened, entrepreneurs capitalised on the opportunity to step out to conduct business in different parts of the world. International trade gave way for the growth of international business. For a corporation to be successful, it is vital to manage the finance and business accounts appropriately. The rise in significance and complexity of financial administration in a global environment creates a great challenge for financial managers. The contributions of different financial innovations like currency derivative, international stock listing, and multicurrency bonds have necessitated the accurate management of the flow of international funds through the study of international financial management. In this unit, you will study about international financial management, covering in brief the components of international financial management. We will also study about its scope covering the aspects of financial decisions, taxation and management of working capital. Objectives: After studying this unit, you should be able to: differentiate between domestic and international financial management. describe the various components involved in international financial management. discuss the scope of international financial management.
8.2 Overview of International Financial Management

In this section we will discuss the evolution of international financial management and also distinguish between domestic and international financial management. The term Financial Management refers to the proper maintenance of all monetary transactions of the organisation. It also means recording of transactions in a standard manner that will show the financial position and performance of the organisation. Financial Management can be categorised into domestic and international financial management.
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Domestic financial management refers to managing financial services within the country. International financial management refers to managing and sharing finance between the countries. 8.2.1 Evolution International Financial Management (IFM) came into existence when the countries all over the world started opening their doors to each other. This phenomenon is also called liberalisation. Since the end of the Second World War, the integration in terms of foreign activities has grown substantially. Firms of all types are now opting to operate their business and deploy their resources abroad. However, differences between countries have persisted giving rise to the prevalence of market imperfections. As a result, the fundamental financial decisions have now advanced to cross-border complexities. The choices to be made with respect to investment, capital raise, acquisition activity, restructuring as well as various aspects of financial policy requires financial considerations. Whenever decisions are taken, the managers must analyse difference in tax rules, country risk factors, exchange rates and variation in legal rules. IFM has four distinct modules as follows: Currencies and asset prices The basic mechanisms of exchange rates, assets prices in global markets and currencies that influence stock prices are explained in his module. Multinational financial decision making The decisions of multinational firms pertaining to capital structure, tax optimisation and risk management are clarified. In addition, this module covers the following aspects: The way in which the firms take advantage of subsidiaries around the world. The association of firms with local firms. The exposure of firms to the trade rates. The tax considerations feature into internal financial decisionmaking.
Cross-border valuation and financing The financial decisions and valuation techniques to be modified in a cross-border setting is covered in this module.
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In addition, this module covers the following aspects: The consideration on the price of capital around the world. The assessment of investments in order to raise the markets. The profit made by the firms through their financing and investment decisions as a result of market imperfection. Institutions and finance The inconsistent formal and informal institutional arrangements will result in a major impact on financial decision making. It focuses on the differences in legal rules, particularly variation in the legal protection of creditors and shareholders affecting investment and reforming decisions. In addition, the emphasis on the significance of informal institutional arrangements and relationship building, emerging markets using cases on merger and acquisition is also covered. 8.2.2 Domestic versus international financial management The management of finance in domestic and international business is considerably different. The four major aspects which distinguish international management from domestic financial management are the introduction of foreign exchange, political risks, market imperfection and enhanced opportunity set. They are explained as follows: Foreign exchange risks The foreign exchange risks states the fluctuation or variation in the prices of currency which will have a tendency to convert a profitable deal to a loss making one. This creates a situation of additional risk to the finance manager. Political risks The political risks may include any changes that will impact the economic environment of the country. For example, Taxation rules, Contract Act and so on. This pertains to the management of the country which can alter the rules of the game in an unanticipated manner. Market imperfection The integration of countries in the world economy, has resulted in differences in transportation costs and different tax rates. Inadequate markets can force a finance manager to struggle for best opportunities across the countrys border. Enhanced opportunity set When business is undertaken in a country other than native country, it will help expand their chances in business. In addition, it will enhance the opportunity for the business and diversify the overall risk.
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The goal of international financial management is to increase the wealth of shareholders just like in domestic financial management. The goals are not only limited to the shareholders, but also to the suppliers, customers and employees. It is also understood that any goal cannot be achieved without achieving the welfare of the shareholders. Increasing the price of the share would mean maximising shareholders wealth. The management of the organisation must decide the currency in which the value of the shares are maximised. The international trade is being promoted and shaped by international institutions called the Bretton Woods Institutions: International Monetary Fund (IMF), World Bank and World Trade Organisation (WTO) through its legal initiatives such as the General Agreement of Trade and Tariffs (GATT), General Agreement on Trade in Services (GATS) and so on. Multi-National Corporations (MNC) have come into existence due to liberalisation and international agreements. The MNCs enjoy greater freedom when compared to the normal companies because of international setting and best opportunities. Without the knowledge in International Financial Management, it can be hard for MNCs let alone any international business entity, to continue in the market because international financial markets have a totally diverse shape and analytics in contrast to the domestic financial markets. A sound knowledge in International Financial Management can assist an organisation to accomplish similar competence and effectiveness in all markets. Activity 1 Play the role of a financial manager of XYZ company and describe the way you would manage the finance and accounting of your company. Hint: The four major aspects. Self Assessment Questions 1 1. International financial management started with ______. 2. The management of finance in domestic and international business is considerably different. (True/False)
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3. The _______ may include any changes that will impact the economic environment of the country. a) Foreign exchange b) Political risks c) Market imperfection d) Enhance opportunity set
8.3 Components of International Financial Management

The components like foreign exchange market, foreign currency derivatives, international monetary markets and international financial markets which are essential to the international financial management, are discussed in this section. 8.3.1 Foreign exchange market The foreign exchange or the forex markets facilitates the participants to obtain, trade, exchange and speculate foreign currency. The foreign exchange market consists of banks, central banks, commercial companies, hedge funds, investment management firms and retail foreign exchange brokers and investors. It is considered to be the leading financial market in the world. It is vital to realise that the foreign exchange is not a single exchange, but is created from a global network of computers that connects the participants from all over the world. The foreign exchange market is quite big and includes various functions including funding of cross-border investment, loans, trade in goods, trade in services and currency speculation. The participant in a foreign exchange market will normally ask for a price. The trading in the foreign exchange market may take place in the following forms: Outright cash or ready foreign exchange currency deals that take place on the date of the deal. Next day foreign exchange currency deals that take place on the next working day. Swap Simultaneous sale and purchase of identical amounts of currency for different maturities.
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Spot and Forward contracts A spot contract is a binding obligation to buy or sell a definite amount of foreign currency at the existing or spot market rate. A forward contract is a binding obligation to buy or sell a definite amount of foreign currency at the pre-agreed rate of exchange, on or before a certain date. Depreciating Rupee Bleed Indian company in Overseas Debt Servicing Depreciation of Indian rupee in the recent months has made Indian banks jittery about companies that have substantial overseas payments coming due. Companies, which have not hedged themselves against such volatility and resultant increased payments are sweating in accessing the loans from Indian banks as they dont want to default in the overseas market. Tight monetary policy coupled with reduced liquidity in system has made their job worse as Indian banks are overstretching themselves to help such companies restructure their debt. Indian companies owe overseas loans and borrowing worth $5 billion or 280000 crore rupees. The problem is that a majority of them are foreign currency convertible bonds and if they are converted into equity, Indian companies shall be in long-term loss as they have to issue more shares due to a depreciated value of the rupee. Most companies are interested in redeeming their FCCBs by accessing finances from domestic markets. In such a scenario, Indian banks are quite wary as more and more companies are seeking to enter corporate debt restructuring (CDR) programmes, which involves renegotiating repayments and interest rates.
8.3.2 Foreign currency derivatives Currency derivative is defined as a financial contract that seeks to swap two currencies at a predestermined rate. It can also be termed as the agreement where the value can be determined from the rate of exchange of two currencies at the spot. The currency derivative trades in markets that correspond to the spot (cash) market. Hence, the spot market exposures can be enclosed with the currency derivatives. The main advantage from derivative hedging is the basket of currency available. Figure 8.1 describes the examples of currency derivatives. The derivatives can be hedged with other derivatives. In the foreign exchange market,
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currency derivatives like the currency features, currency options and currency swaps are usually traded. The standard agreement made in order to buy or sell foreign currencies in future is termed as currency futures. These are usually traded through organised exchanges. The authority to buy or sell the foreign currencies in future at a specified rate is provided by currency option. These will help the businessmen to enhance their foreign exchange dealings. The agreement undertaken to exchange cash flow streams in one currency for cash flow streams in another currency in future is provided by currency swaps. These will help to increase the funds of foreign currency from the cheapest sources.
Figure 8.1: Example for Foreign Currency Derivatives
Some of the risks associated with currency derivatives are: Credit risk takes place, arising from the parties involved in a contract. Market risk occurs due to adverse moves in the overall market. Liquidity risks occur due to the requirement of available counterparties to take the other side of the trade. Settlement risks similar to the credit risks occur when the parties involved in the contract fail to provide the currency at the agreed time.
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Operational risks are one of the biggest risks that occur in trading derivatives due to human error. Legal risks pertain to the counterparties of currency swaps that go into receivership while the swap is taking place.
8.3.3 International monetary systems The international monetary systems represent the set of rules that are agreed internationally along with its conventions. It also consists of set of rules that govern international scenario, supporting institutions which will facilitate the worldwide trade, the investment across cross-borders and the reallocation of capital between the states. International monetary systems provide the mode of payment acceptable between buyers and sellers of different nationality, with addition to deferred payment. The global balance can be corrected by providing sufficient liquidity for the variations occurring in trade. Thereby it can be operated successfully. The gold and gold bullion standards The first modern international system was the gold standard, which operated between the late 19th and early 20th centuries. It enabled nations using gold coins of standard specification to enjoy free circulation. Under the system, the gold happened to be the only standard. The stabilising influence of gold is what gives the system its advantages. Any nation which had more exports than imports would be paid in gold for its balance payment. This in turn has resulted in the lowered value of domestic currency. The higher prices lead to the decreased demands for exports. The sudden increase in the supply of gold may be due to the discovery of rich deposit, which in turn will result in the increase of price abruptly. In the 1920s the gold bullion standard replaced the gold standard leading to the cessation of gold coins being minted. Their currencies instead were with gold bullion which was bought and sold at a fixed price. This system was ended by the next decade. The gold-exchange system Trading was conducted internationally with respect to the gold-exchange standard following World War II. In this system, the value of the currency is fixed by the nations with respect to some foreign currency but not with
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respect to gold. Most of the nations fixed their currency to the US dollar funds in the United States. With a view to maintain a stable exchange rate at the global level, the International Monetary Fund (IMF) was created at the Bretton Woods International Conference held in 1944. Uptil the 1970s the US gold reserves continued to be drained. When the US discarded the gold convertibility in 1971, the world was devoid of a single international monetary system. Floating exchange rates and recent development After the abundance of the gold convertibility by the US, the IMF in 1976 decided to be in agreement on the float exchange rates. The gold standard was suspended and the values of different currencies were determined in the market. The Japanese Yen and the German Deutschmark strengthened and turned out to be increasingly important in international financial market; at the same time the US dollar diminished in importance. In 1999 the Euro replaced the currencies and became the most commonly used currency in the international market second only to the dollar. The better exchange rates enticed many large companies to choose the Euro over the Dollar when in bond trading. Very recently some of the members of Organisation of Petroleum Exporting Countries (OPEC) such as Saudi Arabia, Iraq have opted to trade petroleum in Euro than in Dollar. 8.3.4 International financial markets Independent markets that are not under the authority of any one country and the financial markets of each country are linked by international foreign markets. What governs the heart of the international financial market is the market where international trade and investment dominates foreign currencyAs a result the purchase of currency preceeds the purchase of services and goods. The purpose of international securities markets, international capital markets, international money markets and foreign currency markets is stated below: The foreign currency markets An international market that has no central place for trading to take place or is familiar in structure may be also called a foreign currency market. The market is actually the telecommunications like among financial institutions around the globe and opens for business at any time. The greater part of the worlds that
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deal in foreign currencies is still taking position in the cities where international financial activity is centred. International money markets A market for accounts, deposits or deposits that include maturities of one year or less may be conventionally said to be an international money market. An example of this is the Euro currency markets which make up a huge financial market that does not fall under the governance and supervision of world governmental and financial authorities.. The Euro currency market is a money market for depositing and borrowing money located outside the country where that money is officially permitted tender. Further, Euro currencies are bank deposits and loans existing outside any particular country. International capital markets The capital markets of individual countries are linked by international capital. . It also comprises a separate market of their own, the capital market that flows in to the Euro markets. The firms enjoy the freedom to raise capital, debit, fixed or floating interest rates and maturities varying from one month to thirty years in an international capital markets. International security markets The continued opportunity to provide large portion of the international financial needs of the government and business have allowed the banks to experience the greatest growth in the past decade. The international security market includes private placements, bonds and equities.
The enormous growth in the trading of foreign currency can be attributed to the following: Deregulation of international capital flows Most of the deregulation that has characterised the past ten to fifteen years has made the movement of currencies and capital around the globe very easy. Gain in technology and transaction cost efficiency In addition to the performance of exchange and trading, advancements in technology is also taking place in the distribution of information. This has greatly impacted the capacity of individuals in these markets to accomplish instantaneous arbitrage. Market upswings Over recent years the financial markets have become increasingly volatile., Adding to the enthusiasm for moving
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further capital at faster rates are the faster swings in interest rates and faster swings in the stock values. Self Assessment Questions 2 4. A _______ needs a more complex calculation. 5. The greater part of the worlds deal in foreign currencies is still taking place in the cities where international financial activity is centered. (True/False) 6. The ________ provides links among the capital markets of individual countries. a) Foreign currency markets b) International security markets c) International capital markets d) International money markets
8.4 Scope of International Financial Management

The list of all functions, activities and the decision regarding the management of international business defines the scope of IFM. 8.4.1 Management of working capital The device of finance is the working capital management. The management of current assets and current liabilities is associated with the working capital. The main goal of working capital management is to guarantee that the firms maintain their operations normally and have adequate cash flow to satisfy short-term debt and forthcoming operational expenses. Let us discuss some of the working capital policies which serve as guidelines to business. They are as follows: Liquidity policy The manager can increase the amount of liquidity in order to reduce the risk of business. If the production has high amount of cash and bank balance, then business can simply pay its dues at maturity. It is the responsibility of the finance manager to know that the excess cash will not produce the required earnings but willInstead, decrease return on investment. Therefore liquidity policy should be optimised. Profitability policy In this case the finance manager will maintain a low amount of cash in business and aim to invest maximum amount of
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cash and bank balance. It will guarantee that the profit of business will rise due to the increase of investment in the correct way. But the risk of business will also increase because liquidity of business will reduce and can ruin the business. So, profitability policy must be done following the liquidity policy and provide for proper management of the working capital. Need for working capital management After understanding the nature of production, we can make an estimation of the working capital. For exampleIf the company produces under a large scale and continues producing goods, tit will need a high amount of working capital. The high amount of working capital will decrease the return on investment, whereas low amount will increase the risk of business. Therefore it is necessary to get optimum level of working capital where both the profit and risk will be balanced. If the manager supervises the cash, nonpayer and inventory, then the working capital will repeatedly optimise. 8.4.2 Financing decisions The way of arranging finance refers to the raising of capital. The financing decision has to consider the following factors: Flexibility The financing decisions made today will have an impact on the future. If the business anticipates increasing its capital in the future, it cannot exploit the use of debt today. Hence correct flexibility with future financing decisions must be taken. Risk There are chances to increase risk by financing with the use of debt. There exists a limit on the amount of debt to be used to finance our business. A high amount of debt can result in economic failure. Income Financing can persuade earnings and thus influence return on equity. If we are anxious concerning returns to equity shareholders, then the financing decision will require an adjustment. Income is also influenced by the capability to receive benefit of tax deductions for interest on debt. Control If we have concerns regarding control over the organisation, we will need to judge how financing will change control. Financing decisions are associated with either ownership (equity) or creditors (debt).
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Time To take the advantage of market place, the financing decision needs to be timed. The type of securities to be sold, length of maturity to be used for debt financing should be decided.
Refinancing risk One of the main aims of financing decisions is to go with the maturity of liabilities with the life expectancy of assets. This will allow the liabilities to be self-liquidating. There are chances of facing refinancing risk if the maturity of liabilities is less than the life expectancy of assets. Here, the capital has to be raised to pay off liabilities. In either case there will be abundance of assets around to pay off debts if the maturity of liabilities is longer than the life expectancy of assets. Inflation As a result of using debt financing in periods of high inflation, one will pay back the debt with currencies that are worthless. While expectations of inflation increase, the rate of borrowing will be raised since creditors must be compensated for a loss in value. Since inflation is a main motivating force behind interest rates, the financing decision should be aware of inflationary development. 8.4.3 Taxation Taxation plays a vital role for the worldwide operation of firms. The tax decision or taxation which is relevant in domestic firms has become central to various financing decisions involving fund raising decisions, international investment decisions, international working capital decisions and decisions related to dividend and other payments. The various reasons why international corporations find managing taxation an extremely difficult issue are stated below: Multiple tax jurisdictions or authorities with diverse tax rates and irregular administration of the tax system in areas firms are expected to work in. A more complex interaction of varying descriptions of the tax base determine the ultimate tax load in the framework of international firms. The difference in tax treatment in different nations will direct to distortions in worldwide trade and investment. The companies which are situated in the low-tax country can have a periphery over other firms in worldwide market. There are possibilities to divert the investment to those countries that have low cost rates.
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Internation firms overlap with different tax jurisdictions and this enables them to utilise the arbitrage opportunities which helps them retain an edge over the domestic firms.
The bases of international tax system are: Tax neutrality To keep the economic efficiency from being affected the international tax system should remain neutral.For the nationality of the invester or the locality of the investment not to be influenced, a neutral tax is important. . Such an environment will allow capital to move from a nation with lesser return to a nation with higher return, resulting in well allocated resourses that will ensure a high gross world output.. Tax equity The principle of tax equity states that all equally positioned tax players contribute in the cost of operating the government according to the equal rules. The concept of equity can be perceived in two ways. It is assert by the first view that the input of each tax player must be consistent with the amount of public services as received. The second maintains that the contribution of each tax player must be in terms of their ability to pay. The ability to pay means the one with greater ability is likely to pay a larger amount of tax. Avoidance of double taxation The avoidance of double income asserts that one must not be taxed twice for the same income. However, double taxation occurs if the recipient of post-tax income in a foreign country is taxed again. As an alternative, the requirements of foreign tax credits may be formed in the domestic tax system.
There also exist some tax laws which prevent the tax through artificial transactions such as transfer pricing. In addition, the corporate structures will help to reduce the overall tax burden to the enterprise. Self Assessment Questions 3 7. The device of finance is the ______ management. 8. The financing decisions made today will have an impact on the future. (True/False) 9. The principle of _______ states that all equally positioned tax payers should contribute in the cost of operating the government according to the equal rules. a) Tax equity.
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b) Tax neutrality. c) Avoidance of double taxation. d) Taxation. Activity 2 Using resources on internet analyse how the financial management takes place in different countries. Hint: www.bjreview.com
8.5 Summary
Let us summarise the points covered in this unit about international financial management: The International Financial Management came to its existence when the countries all over the world started opening their doors to each other. This phenomenon is also called as liberalisation. The four major aspects which distinguish international management from domestic financial management are introduction of foreign exchange, political risks, market imperfection and enhanced opportunity set. Components of International Financial Management are foreign exchange markets, foreign currency derivatives, international monetary system and international financial markets. The scope of international financial management includes management of working capital, financing decisions and taxation. The policies of working capital management are the liquidity and profitability policy. The financing decisions consider the factors like flexibility, risk, income, control and time. The bases of international tax system include the tax neutrality, tax equity and avoidance of double taxation.
8.6 Glossary
Arbitrage: The purchase of securities on one market for immediate resale on another market in order to profit from a price difference. Denominated: To express in terms of the monetary unit.
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Equity: Funds provided to the business by the sale of stock. Hedging: It is the method of reducing the risk of loss caused by price variations. Inflation: The term refers to a persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money, caused by an increase in available currency and credit beyond the proportion of available goods and services. Liquidity: The term refers to the volume of transactions. With sufficient buyers and sellers, a market enjoys continuous offers, bidding, and consummated transactions, thus achieving market liquidity.

1. 2. 3. 4. 5. Explain domestic versus international financial management. Discuss about the foreign currency derivatives. Explain the need for international financial market. State the management of working capital. Explain the importance of taxation.
8.8 Answers
Self Assessment Questions 1 1. Liberalisation 2. True 3. Political risks Self Assessment Questions 2 4. Forward market 5. True 6. International capital markets Self Assessment Questions 3 7. Working capital 8. True 9. Tax equity
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Terminal Questions 1. Foreign exchange, political risks, market imperfection and enhance opportunity set are the four major aspects which distinguish international management from domestic financial management. These are explained in the subsection 8.2.2. Refer the same for details. 2. A currency derivative as a financial contract in order to swap two currencies at a predetermined rate. These are explained in the subsection 8.3.2. Refer the same for details. 3. Deregulation of international capital flows, gain in technology and transaction are the causes normally given for the enormous growth in the trading of foreign currency. These are explained in the subsection 8.3.4. Refer the same for details. 4. The working capital policy which serves as guidelines to business are liquidity policy, profitability policy and the need of working capital management. These are explained in the subsection 8.4.1. Refer the same for details. 5. The managing of taxation is an extremely difficult issue for the international corporations. The basis of international tax system includes tax neutrality, tax equity and avoidance of double integration. These are explained in the subsection 8.4.3. Refer the same for details.
8.9 Case-let
XYZ Fruit Beverage Company M/s. XYZ Company was in the business of making fruit beverages. The said M/s. XYZ intended to expand its market and started exporting fruit beverages to Japan. Subsequently, it so happened that the Japanese Government, imposed higher tax on the fruit beverages imported from other countries into Japan. The Japanese Government with intention to protect its own domestic market imposed a lesser tax to domestic producers compared to the foreign producers. Discussion Questions 1. What do you think would be the strategy of XYZ Company in protecting their business interests?
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(Hint: The XYZ Company can work out a possible option of a joint venture with the domestic producer which would help them pay similar tax to that of domestic producers.) 2. How relevant is the concept of political risk to the managerial decisions of a Company and whether sufficient recourse is available in the international forum to mitigate such risks? (Hint: The Japanese Government introduced new tax rules for foreign alcohol. However the countries do not have the liberty to impose unfair rules rather every country has to treat everybody equally. As a risk mitigation strategy, the XYZ Company through its country can approach the WTO Dispute Settling Union (DSU) against such discriminatory rules.
Source: http://www.nuigalway.ie/law/GSLR/1998/case6.html
References: Sharan, Vyuptakesh. (1998). International Financial Management, Fifth edition. PHI learning Private Limited. Kevin. (2009). Fundamentals of International Financial Management. Pearson Publications. Gary Shoup.(1998).The International Guide to Foreign Currency Management.
E-References: http://www. brainmass.com, retrieved on 5th November 2010 http://finance.mapsofworld.com/foreign-exchange-market/ retrieved on 1st November 2010
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Unit 9
Unit 9
International Accounting Practices
Structure: 9.1 Introduction Objectives 9.2 International Accounting Standards Domestic vs. international accounting National differences in accounting Legal systems 9.3 Accounting for International Business Classification of accounting systems Harmonising of accounting systems 9.4 International Regulatory Bodies 9.5 International Financial Reporting Standards 9.6 Summary 9.7 Glossary 9.8 Terminal Questions 9.9 Answers 9.10 Caselet
9.1 Introduction
In the previous unit you studied about international financial management and forex market. In this unit you will learn about international accounting standards, regulatory bodies, and international financial reporting standards. While presenting financial statements, publicly-traded companies should follow some rules for international accounting practices so that the reader can easily compare between different companies. This unit covers various factors involved in accounting practices followed by MNCs. It explains various regulators and accounting standards followed by different countries and regions. It also includes international regulatory bodies and the international financial reporting standards. Objectives: After studying this unit, you should be able to: explain international accounting practices. differentiate between domestic and international accounting practices.
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describe the international regulatory bodies. discuss the international financial reporting standards.
9.2 International Accounting Standards

Accounting is understood as the language of business. International Accounting Standards state how should different types of transactions and events be recorded in financial statements. International accounting refers to international comparative analysis, accounting measurements, and reporting issues distinctive to multinational business connections. It also refers to harmonisation of global accounting and financial reporting through political, organisational, professional, and standard-setting activities. Accounting Standards are the key mandatory and regulatory mechanisms for training on financial reports and conducting successful audit for the same. It is used almost in all countries throughout the world. They are concerned with the structure of measurement, rules for preparation and arrangement of financial statements. They emerge as a set of authoritative statements related to exact type of transactions, events, and other costs that are recognised and reported in the financial statements. They are designed to supply practical information to diverse users of the financial statements such as shareholders, creditors, lenders, organisation, investors, suppliers, competitors, researchers, regulatory bodies. These statements are designed and approved to develop and benchmark the quality of financial reporting. A financial reporting system of international standard is required to attract foreign and present and potential investors at home, which can be achieved by harmonising the accounting standards. 9.2.1 Domestic vs. international accounting Different countries whether domestic or international, have different accounting standards. A common belief is that these differences reduce the quality and importance of accounting information. Accounting standards determine the financial reporting quality and provides separately verified information about an organisation's financial performance to investors creditors. Though there are differences in accounting methods, domestic businesses are not affected. The accounting system of a domestic organisation must
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meet the specialised and regulatory standards of its home country. But, an MNC and its subsidiaries must meet differing accounting and auditing standards of all the countries in which it operates. This leads to a need for comparability between businesses in the group. In order to successfully manage and organise their operations, local managers require accounting information, which should be prepared according to the local accounting concepts and denomination in the local currency. Yet, for financial controllers, to measure the foreign subsidiarys performance and worth, the subsidiarys accounts must be translated into the organisations home currency. This translation is done using accounting concepts and measures, which are detailed by the organisation. Investors worldwide look for the highest possible returns on their capital, in order to interpret the track record, though they use a currency and an accounting system of their own. The organisation also has to pay taxes to the countries where it does business, based on the accounting statements prepared in these countries. Besides this, when a parent corporation tries to combine the accounting records of its subsidiaries to produce consolidated financial statements, extra complexities occur because of the changes in the value of the host and home currencies. There are many differences between International Accounting Standards (IAS) and Domestic Accounting Standards (DAS). On the basis of difference between the two, two indices, namely 'divergence' and 'absence', are created. Absence is the difference between DAS and IAS; the rules on certain accounting issues are missed out in DAS and covered in IAS. Divergence represents the differences between DAS and IAS; the rules on the same accounting issue differ in DAS and IAS. Measurement of differences between IAS and DAS You can measure the differences between IAS and DAS in the following way: Literature on international accounting differences Referring to earlier reports on international accounting could give more information about the subject. Most of the earlier reports understand international accounting differences as various options adopted by nations for the similar accounting problems, which correspond to divergence concept.
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Framework of analysis Links between variations in accounting standards and financial reporting quality of various countries could be clearly seen from the reports published earlier. We should consider the institutional determinants of accounting differences such as legal origin, governance structure, economic development, and equity market.
9.2.2 National differences in accounting One of the major problems encountered by an international business is lack of consistency in accounting standards in various countries. Organisations show opposite financial results because of the differences in accounting standards. Differences in accounting standards exist because of diverse political, legal, economic, and cultural systems of the countries. Accounting standards and practices are also prejudiced by the sources of capital used to fund business. Figure 9.1 shows the influencing factors on a countrys accounting practices.
Figure 9.1: Influences on a Countrys Accounting System
You might think that accounting systems in the world were uniformly influenced by a few historical developments. There could be some similarities but no two countries and their systems are alike. Accounting systems are developed suiting the countrys specific needs. It is a fact that different countries evolved in different ways. Accounting systems were influenced by private ownership, industrialisation, inflation, and so on. When there are differences in economic conditions, it is not surprising to find differences in accounting practices. However, there are other influencing elements apart from economic factors. These are legal systems, educational systems, socio cultural features, and political systems. These also influence the need for accounting, speed and direction of its development. Due to the
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increasing trend in globalisation of business, understanding various accounting systems is important. 9.2.3 Legal systems Law system is divided into civil law and common law in countries worldwide. In countries like US, Australia, UK and New Zealand accounting procedures originate from decisions of independent standards setting boards, such as US Financial Accounting Standards Board (FASB). Each board works with professional accounting groups. In countries, which follow common law, accountants follow Generally Accepted Accounting Principles (GAAP), which provides a 'true and fair view' of the organisation's performance, based on the standards approved by these professional boards. Many civil law countries also have a similar approach as that of GAAP. Functioning within the limitations of these standards, accountants have freedom to implement their professional judgment in reporting a 'true and fair' representation of the organisation's performance. Countries following civil law are likely to codify their national accounting measures and standards. In these countries, accounting practices are determined by the law. To assist the legal role, all business accounting records must be officially registered with the government. The way in which the accounting practices are imposed depends on the legal system. Most of the developed countries depend on both private and public enforcement of business performance, though the public or private combination varies from country to country. The difference of legal system is a major restriction in the growth of accounting standards. In some countries, the accounting policies are restricted to detailed legislation, which is passed by governments. This restriction forms a major problem to international accounting bodies that are created to increase harmonisation of national accounting frameworks. This is because, such government-controlled regimes are inclined to be less flexible, and perceive private sector influences as less acceptable. Self Assessment Questions 1 1. Accounting Standards are the key mandatory and regulatory mechanisms for training on financial reports and succeeding audit of the same. (True/False)
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2. __________ and ___________ are the two indices created based on the differences between IAS and DAS. 3. GAAP stands for generally accepted accounting principle. (True/False) Activity 1 The link below provides an article on International Accounting Standards. Find out how standards help to bring financial stability in the market and discuss how it affect companies. Hint: Refer link: www.iasplus.com/dttpubs/dtiias.pdf
9.3 Accounting for International Business

In the previous section you learnt about international accounting standards and differences between accounting standards in different countries. In this section you will cover accounting for international business. It is through import or export that an organisation gets more practical knowledge about international accounting. In exports, an organisation may either receive an unwanted inquiry or get an order from a foreign company/buyer. If this foreign buyer needs an addition of credit, the buyer is examined once before exporting. This process may look easy but it is not so. The buyer is not always a scheduled buyer in the international credit rating directories. Either the seller should ask its bank to have foreign affiliations to check the buyer's credibility or the seller can ask the buyer to provide financial information. Though the buyer could provide the required information, it might be difficult for the selling organisation to understand the complicated financial statements. Those statements could be in a foreign language, based on accounting assumptions and measures that are alien to the organisation's accountants. Organisations new to international business should take the help of banks or accounting agencies who are experts in international accounting. When foreign companies/buyers use their currency for transactions, the exporting organisation gets to know about possible profit and loss from the changes in exchange rates. This is due to the change in currency rate which happens between the time of placing the order and time at which the payment is made.
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The organisation selling the product has to have many documents like customers declaration forms, special international shipping and insurance documents and international legal documents. The orgsanisation should take the help of bankers, shippers, lawyers and accountants. Responsibilities lie with the foreign company if the product is being imported. In this case international accouting is unaffected. But international bank or accounting agency or lawyer should be consulted when the foreign company demands for payment in their currency or when the buying company needs to be sure about the credibility of the foreign company. 9.3.1 Classification of accounting systems It is important to classify accounting systems because these are developed to provide information to the decision makers. The classification of accounting systems in financial and cost systems leads to difference of opinion between the decision makers. Creditors, investors, tax authorities, government agencies, and others are people who are involved in the making of accounting systems, but are outside the organisation. Whereas, managers are within the organisation and they also take part in the accounting decisions. Financial accounting The information provided in financial accounting is not for organisation managers but for the decision makers. Managers are normally outside the organisation. The information for public organisations is available on the websites of the organisations. Managers in the organisation are sincerely concerned about reports that produce financial accounting, but the information would not be sufficient for making operational decisions of the organisation. Individuals, who depend on information from the financial accounts, usually compare their organisation with others. For example, comparing Apple Computer and Microsoft for investment. Information obtained after financial accounting can be compared between organisations. This means that when an investor looks at revenues of Apple Computers and then looks at the revenues of Microsoft signify the same thing. Because of this, financial accounting systems are characterised by a series of regulations that explain how to check transactions.
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Cost accounting Cost accounting information is planned for managers. The need for comparison between different organisations does not arise in case of managers as they take decisions only for their organisation. But The significant principle is that the information must be appropriately decided. Though information on cost accounting is usually used in financial accounting, it should be determined whether this is beneficial for managers to take decisions. The accountants add value by giving the cost accounting information to managers so that they can take appropriate decisions. The cost accounting system results from the decisions made by managers about an organisation. Some aspects of cost accounting in regard to its clients, with GAAP and ethics are given below: Cost accounting and GAAP The key principle of financial accounting is to supply information about the organisation and the performance of the management to the investors or creditors. The financial information for this purpose is overseen by Generally Accepted Accounting Principles (GAAP). GAAP maintain consistency in the accountancy data used for reporting information between organisations. The cost accounting information used to evaluate the expenditure of goods sold, inventory assessment, accounting used for external reports should be in accordance with GAAP. Clients of cost accounting The administration must consider customer as important out of all the participants in a business. Without customers, the organisation loses its capability and reason to exist. The cost information itself is a product with its individual customers. The major problem with accounting system occurs when managers utilise accounting information that was designed for external reporting, in decision-making. Cost accounting and ethics The format of costing systems is finally about the payment of costs to various activities, products, projects and corporate units, and people. The method in which this is done, affects prices, reimbursement and payment. Based on the events, the cost accounting systems plan the potential to misuse and fraud the shareholders, employees or customers. As user or preparer of the cost information, you should be aware of what it means, and how it could be
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utilised. Most importantly you should be aware of when the system has the potential to be misused. 9.3.2 Harmonising of accounting systems Though there are many differences in accounting standards and practices, a number of forces are leading to harmonisation. Some of these forces are: A movement to present requirements of investors. information well-matched with the
The global mixing of capital markets, which means that investors have easier and quicker access to investment opportunities around the world, and thus require financial information that is more equivalent to other accounting standards. The need of MNCs to increase the capital outside their home-country capital markets, while generating few diverse financial statements. Regional, political and economic harmonisation, such as, the initiatives by the European Union (EU) influence accounting, trade and investment issues. Pressure from MNCs for consistent standards, which allows for reduced costs in each country, and in reporting that is used by investors in the organisations home-country.
Differences in accounting systems are confusing and expensive to international business. Superiority in these systems makes it complex for organisations to examine their foreign operations and for investors to understand the relative performance of organisations that are based in different countries. To help in solving such problems, many accounting professionals and national regulatory bodies are trying to harmonise diverse accounting practices. It is also important to understand the arguments in favour of harmonisation. Arguments supporting harmonisation Harmonisation of accounting and exterior financial reporting assists in the optimal global delivery of private-sector finance. Harmonisation means to bring down the gap between accounting practices so that comparability between financial reports from various countries can be improved. Investors should be able to realise a more proficient portfolio of organisations on national, as well as, international scale. This will benefit the investor. When
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global capital markets operate properly, the financial information disclosed to the market-place must be global. Figure 9.2 highlights for and against harmonisation.
Figure 9.2: Arguments for and Against Harmonisation
The standard of accounting disclosure needs and auditing vary in different countries, and makes cross-border investigation very difficult. It is difficult for investors to understand the information presented, which is very different from what exists in their home-country. Harmonisation of accounting and auditing practices help to reduce the difficulty. Investors must deal with diverse accounting practices and disclosures, and have trust in the figures presented by accepting the standard of auditing. Self Assessment Questions 2 4. Information in _______________ is planned for decision makers and who are not involved in the daily management of the organisation. 5. Cost accounting information is planned for _________. 6. Customer is the most important participant in a business who should be given importance by the administration. (True/False)
9.4 International Regulatory Bodies

In the previous section, we covered accounting for international business. In this section you will learn about various international regulatory bodies. Certain regulatory bodies are active in bringing out harmonisation of accounting standards. Efforts of some of the bodies are explained here.
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European Union European Union is pro-active in the harmonisation process. European Commission sets directives, which are orders to the member countries, to bring their laws inline with EU needs, within some transition period. The earlier accounting directives are: The nature and design of financial statements. The measurement support on which the financial statements are to be organised. The significance of consolidated financial statements. The need that auditors should ensure that the financial statements reflect a true perspective of the organisations operations.
Though the EU has enhanced the comparability of financial statements, the directives do not cover several essential issues. Additionally, some directives provide options, but member countries understand the directives differently. Thus, EU organisations listing outside their home-countries must supply the following two sets of financial statements, they are: Home-country statements. Reconciliation statements. United Nations The United Nations is interested in international accounting since the early 1970s and has been operating under a 'Group of Eminent Persons'. This further led to the establishment of Intergovernmental Working Group of Experts on International Standards of Accounting and Reporting (ISAR) by the UN Economic and Social Council. The ISAR attempts to support the developing countries, by creating recommendations on the accessibility and comparability of information disclosed by international businesses. The discussions of the ISAR are reported in annual publications. Publications cover accounting developments worldwide, and reports on issues significant to global accounting. The ISAR is presently concerned about developing discussions on the international environment reporting, and the role and responsibilities of accountants and auditors.
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Organisation for Economic Cooperation and Development (OECD) The OECD was established by world's 24 developed countries, of which some are Australia, Austria, Belgium, and Canada. This was set up for promoting world trade and international economic growth. This looks at matters from the perspective of economically developed countries. The council of OECD has established a committee on International Investment and Multinational Enterprises (MNEs). This committee in turn has established a Working Group on Accounting Standards. The Working Group has recently published a 'Clarification of the OECD Guidelines', and published reports as an element of an 'Accounting Standards Harmonisation' series. Most recently, the OECD has established a 'Centre for European Economies in Transition', which along with Working Group has prepared workshops, seminars, and meetings, to recognise the purpose and constituents of accounting systems in these countries. International Accounting Standards Committee (IASC) International Accounting Standards Committee was created in the year 1973. It has issued a series of standards to harmonise management of accounting issues globally. The chief objective of IASC is the encouragement of comparability of financial statements between countries, by establishing standards for inventory assessment, depreciation, delayed income taxes, and so on. An important accomplishment of the IASC has been the creation of the International Accounting Standards (IAS). The publication and global recognition of these standards is necessary for the harmonisation efforts of the IASC. The International Federation of Accountants (IFA) The International Federation of Accountants was founded in the year 1977. It completely supports the work of the IASC, and recognises the IASC as having responsibility and authority to issue rules on international accounting standards. IFA has parallel responsibility of IASCs objective of developing international guidelines for auditing, ethics, education and management accounting. Some of the other international regulatory bodies are: Governmental Accounting Standards Board. Independence Standards Board.
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International Accounting Standards Board. International Organisation for Securities Commission. National Association of State Boards of Accountancy. Public Company Accounting Oversight Board. UK Accounting Standards Board.
Self Assessment Questions 3 7. The European Commission sets directives which are orders to member countries to bring their laws inline with EU needs within some transition period. (True/False) 8. _____________________considers the matters from the perspective of economically developed countries. 9. The International Federation of Accountants was founded in the year ______________. Activity 2 The link below provides an article on various International Regulatory Bodies. Find out the responsibilities of OECD and WHO. Hint: Refer link: http://www.iraup.com/results.php?page_name=int_org
9.5 International Financial Reporting Standards

After learning about different international regulatory bodies, we shall now discuss about reporting standards used in international finance. International Financial Reporting Standards (IFRS) are principle-based values, interpretations and the structure followed by the International Accounting Standards Board (IASB). Structure of IFRS International Financial Reporting Standards comprise of the following: International Financial Reporting Standards (IFRS) (Standards issued after 2001). International Accounting Standards (IAS) (Standards issued before 2001). Interpretations developed from the International Financial Reporting Interpretations Committee (IFRIC) (Issued after 2001). Standing Interpretations Committee (SIC) (Issued before 2001).
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Framework for the Preparation and Presentation of Financial Statements (1989).
Framework The framework used for the preparation and presentation of financial statements states the basic rules for IFRS. Objective of financial statements A financial statement should reproduce true and fair view of the business dealings of the organisation, because these statements are used by different constituents of the society. Underlying assumptions IFRS approved two basic accounting models, which are: Financial capital preservation in nominal monetary units. Financial capital preservation in units of invariable purchasing power. The four underlying assumptions in IFRS are given below: Accrual basis The result of dealings and other measures are recognised when they happen. Going concern An entity for the predictable future. Stable measuring unit assumption - The assumption that financial capital is measured in nominal monetary units. This is the historical cost accounting in which assets and liabilities are recorded at their values when first acquired and not generally restated for changes in values.. That is, accountants believe that it would not be sufficient for them to take decisions when variations in the purchasing power of functional currency changes is up. Taking decisions, here, imply for financial capital safeguarding in the units of regular purchasing power during low inflation and deflation as authorised in IFRS, in the Framework. Units of constant purchasing power - Financial capital preservation in units of regular purchasing power during low inflation and deflation, that is, the denial of the constant measuring unit statement. Measurement in units of constant purchasing power (inflation - adjustment) helps to sort out the loss due to historical cost accounting.
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Qualitative characteristics of financial statements There are some qualitative characteristics of financial statements. These are as given below: Comparability. Reliability. True and fair view or fair presentation. Relevance. Understandability. Elements of financial statements The financial position of an enterprise is mainly provided in the Statement of Financial Position. The fundamentals of financial statements are given below: Asset An asset is a resource guarded by the enterprise as an effect of past procedures, from which potential economic benefits are likely to flow. Liability A liability is a present requirement of the enterprise that is rising from past procedures, the closure of which is likely to result in an outflow from the enterprise' possessions (assets). Equity Equity is the outstanding concentration on the assets of the enterprise after subtracting all the liabilities under the historical cost accounting model. Equity is well-known as owner's equity. Under the units of invariable purchasing power model, equity is the regular real value of shareholders equity.
The financial performance of an enterprise is mainly provided in an income statement or profit and loss statement. The elements of an income statement or the elements that determine the financial performance are as follows: Revenues It is the increase in economic profit during an accounting period, in the type of inflows or enhancements of assets, or diminishing of liabilities that results in the increase of equity. But it does not comprise the contributions made by the equity participants, like owners, partners and shareholders.
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Expenses It is the reduction in economic benefits in an accounting period, in the form of outflows, or reduction of assets or committing to liabilities that results in decreasing equity.
Measurement of the elements of financial statements Measurement is the method of determining the monetary amounts. But it does not comprise the contributions made by the equity participants, that is, owners, partners and shareholders. The components of the financial statements are documented and approved in the balance sheet and income statement. A number of diverse measurement bases are engaged in various degrees, and in changing combinations in financial statements. These measurements include the following: Historical cost Assets are entered as the amount of cash or cash equivalents paid or the fair cost of the consideration given to obtain them at the time of purchase. Liabilities are recorded as the amount of earnings received in exchange for the commitment, or in some situations (for example, income taxes), as the amounts of cash or cash equivalents likely to be paid to convince the liability in the normal course of business. Current cost Assets are approved at the amount of cash or cash equivalents that needs to be paid, if the similar or an equivalent asset was acquired at present. Liabilities are approved at the undiscounted amount of cash or cash equivalents that would be necessary to settle the requirement at present. Realisable (settlement) value Assets are approved at the amount of cash or cash equivalents that could, at present, be obtained by exchanging the asset in a methodical removal. Assets are accepted at the current discounted value of the future net cash inflows that the item is likely to produce in the typical course of business. Liabilities are carried at the current discounted value of the future net cash outflows that are likely to be essential to resolve the liabilities in the typical course of business.
The measurement basis that is generally adopted by entities in preparing their financial statements is historical cost. This is generally combined with other measurement bases.
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Self Assessment Questions 4 10. Accrual basis is one of the underlying assumptions of _____________. 11. Equity is the outstanding concentration on the assets of the enterprise after subtracting all the liabilities under the historical cost accounting model. (True/ False) 12. Which among the following is not an element of financial statements? a) Asset. b) Liability. c) Equity. d) Accountability.
9.6 Summary
Let us now summarise the salient points you learnt in this unit on the international accounting practices: Accounting standards are the type of compulsory and regulatory mechanisms for training on financial reports and conducting successful audit for the same. It is used in almost all countries. International businesses meet number of accounting problems that do not stop domestic businesses. There are many differences between both Domestic Accounting Standards (DAS) and International Accounting Standards (IAS). Considering the list of differences, two indices are created-'absence' and 'divergence'. Law system is divided into civil law and common law in countries worldwide. Harmonisation of accounting and exterior financial reporting helps in the best international delivery of private-sector finance. Harmonisation of accounting and auditing practices help to diminish the size of the barrier. Certain regulatory bodies are dynamic in bringing harmonisation of accounting standards. Some of them are European Union, United Nations, and so on. International Financial Reporting Standards (IFRS) are principle-based values; interpretations and the arrangement followed by the International Accounting Standards Board (IASB).
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9.7 Glossary
Benchmark: It is used to evaluate performance in the organisation. Depreciation: It refers to the decrease in price or value. Harmonisation: It refers to the process of making a pleasing or consistent whole.

1. Explain briefly how the differences between IAS and DAS can be measured. 2. Explain briefly about accounting for international business. 3. Explain the factors that lead to harmonisation of accounting system. 4. Explain briefly the work of United Nation as one of the international regulatory bodies. 5. How do you measure the elements of financial statements of IFRS?
9.9 Answers
Self Assessment Questions 1 1. True 2. Absence, divergence 3. True Self Assessment Questions 2 4. Financial accounting 5. Managers 6. True Self Assessment Questions 3 7. True 8. OECD 9. 1977 Self Assessment Questions 4 10. IFRS 11. True 12. Accountability
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Terminal Questions 1. You can measure the differences between IAS and DAS in the following way: Literature on international accounting differences. Framework of analysis. These are explained in sub section 9.2.1 of this unit. Refer the same for details. Export or import of a shipment gives an organisation the opportunity to be exposed to international accounting process. In exports, an organisation may receive an unwanted inquiry or obtain order from a foreign company. This is explained in the section 9.3 of this unit. Refer the same for details. Though there are many differences in accounting standards and practices, a number of forces are leading to harmonisation. It is a movement to present information well-matched with the requirements of investors. These are explained in sub-section 9.3.2 of this unit. Refer the same for details. The United Nations is interested in international accounting since the early 1970s under a 'Group of Eminent Persons'. This further led to the establishment of Intergovernmental Working Group of Experts on International Standards of Accounting and Reporting (ISAR) by the UN Economic and Social Council. These are explained in the section 9.4 of this unit. Refer the same for details. Measurement is the method of determining the monetary amounts at which the elements of the financial statements are to be documented and approved in the balance sheet and income statement. A number of diverse measurement bases are engaged in various degrees and in changing combinations in financial statements. They include historical cost, current cost, and realisable (settlement) value. These are explained in the section 9.5 of this unit. Refer the same for details.
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9.10 Caselet
Application of International Accounting Standards to Central Banks As the financial markets are becoming internationalised, the international accounting standards are applied to central banks. The primary objective
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of these entities is to maintain the value of the country's currency. The idea of applying IAS is to guarantee high level transparency and comparability among financial reports and find an efficient operation of the Community's capital market and the domestic market. A sample of accounting and financial information were published on the websites of 19 central banks to know as to how the IASs are being applied to the accounting policies and practices used by central banks in the region. The findings of the analysis are described as follows: 1. Accounting standards governing the preparation of financial statements - It was found that there was a beginning of an alignment with International Accounting Standards. 2. Publication of financial statements - IAS states that a total set of financial statements should include an income statement, a balance sheet, changes in equity statement, and a summary of accounting policies and a cash flow statement. It was found out that the biggest problem for central banks was to prepare statements of changes in equity and cash flow statements. 3. Proper disclosure of information - According to IAS, a business is appreciative to disclose the accounting policies used and other explanatory notes. The study show that the central banks reveal accounting policies and practices in their notes. 4. Use of ultimate exchange rates and fair value - AS states that in each balance sheet, the dates of the items in foreign currency must be reported at closing rate. The findings about central bank focuses on the use of closing rates for assets and liabilities decreased in foreign currency and on the use of reasonable values for portfolios in both foreign and domestic currency. 5. Reporting changes in the exchange rate - According to IAS, exchange differences that happen when monetary items are developed, must be reported as fixed cost or income for the phase in which they appeared. Through the study, it was found out that the central banks apply diverse policies and procedures to proof their exchange differences. All these helped in internationalisation of central banks and helped in maintaining the international accounting standards on the domestic currency.
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Discussion Question 1. Discuss the application of international accounting standards to central bank. (Hint: Accounting Standards Governing the Preparation of Financial Statements)
Source: www.cemla.org/pdf/acp/acp_9_Jairo_Contreras.pdf retrieved on 30 october 2010
References: Aswathappa. K. (2008). International Business. Tata McGraw Hill Education: New Delhi. Paul Rodgers (2007), International Accounting Standards, From UK Standards to IAS An Accelerated Route for Understanding the Key Principles, Elsevier Ltd. International Accounting Standards Committee (2000), International Accounting Standards Explained, Chichester: Wiley.
E-References: media.wiley.com/product_data/excerpt/22/EHEP0005/EHEP000522.pdf, retrieved on 31 october 2010 http://www.indianmba.com/faculty_column/fc137/fc137.html, retrived on 30 october 2010 http://www.loscostos.info/english/accsyst.html, retrieved on October 31st, 2010
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Unit 10
International Marketing
Structure: 10.1 Introduction Objectives 10.2 Scanning interntional markets 10.3 Mode of entering into potential 10.4 Global marketing strategies Segmentation Market positioning International product policy International pricing decisions Transfer pricing International advertising International promotion and distribution 10.5 Branding for international markets Valuation of brands Challenges of international branding 10.6 Summary 10.7 Glossary 10.8 Terminal questions 10.9 Answers 10.10 Case-let
10.1 Introduction
In the previous unit, we learnt about finance management at an international level. We learnt the differences between domestic and international financing. The unit also familiarised us with the components of international financial management and the scope of these components. International marketing refers to marketing of goods and products by companies overseas or across national borderlines. The techniques used while dealing overseas is an extension of the techniques used in the home country by the company.
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In this unit, you will cover all the aspects of international marketing like strategies, policies, valuation of brands and the different ways of circumventing the difficulties and challenges. Objectives: After studying this unit, you should be able to: describe international marketing process. understand scanning of interntional markets. discuss the process of entering into interntional markets. discuss global marketing strategies. explain branding for international markets. discuss the challenges of international branding.
10.2 Scanning Interntional Markets

The firms sustainable competitive advantages shall be based on the assessment and appraisal that how effectively such facets of competitive advances shall synchronise with key and important features of that market. Scanning the global markets as per the key competitive strength of the firm will be the key decision, as it will provide firm sustainable environment for growth expansion and diversification. It is difficult to analyse and generalise the factors which may be of help for the firm in an international market, but a reference can essentially be made to the following elements while arriving on decision to enter into that market for international trade. These elements of information are as follows:
Table: Factors governing decision criteria for getting started in international trade The decision element for getting started 1. The decision to go international or not Decision criteria Assessment of international market keeping in mind the competitive advantages and synergy with overall competitive strategy in light of local and international competition compared to domestic opportunities. Economy rate of growth and structure, bureaucracy, capital, economic and trading bloc, legal system, political regime and laws, regulation for investment and operations, political ideology and stability, type and structure of competition, etc. Page No. 199
2. Scanning the market
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3. Modes of entering into markets 4. Targeting the markets 5. Competition in international markets 6. Regulatory formalities for getting started
Political/legallaws, regulations, investment, climate, government ideology, stability. Competitiontype, structure, operations, strategy plans, programmes, acquisitions, mergers. Analysing various elements which define the nature of competition in target market. Formalities to be completed for getting export-import license, registration cum membership certificate, excise code, etc.
Source: Adapted from S. Carter, Global Agricultural Marketing Management
A major mistake which Indian firm usually make is that they try to replicate home success in international markets which is a laid back approach. The market fundamentals in the foreign market may be completely different from the home market, for example Indian prefer cheaper and cost effective product as they have low per capital income, while europeans prefer high quality durable product. Hence the comprehensive analysis of following aspect must be done while devising the firm competitive strategy for getting started in international trade in globalised era.
Table: Scanning information for decision to go international General information Economic Political Fiscal Social Technology Resources Institutions Managerial Specific information GDP growth, level of inflation, per capita income, disposable incomes Risk, instability, attitudes towards foreigners Taxes, exchange rates, financial architecture, current account deficit People, demographics, culture, subculture, pressure groups, interest groups Current technological stage, rate of change, available infrastructure for research and innovation Money, manpower, materials, acquisitions, joint ventures Capital and money markets, regulation for accessing capital Skilled manpower, management practices, etc.
Source: Adapted from, S. Carter, Global Agricultural Marketing Management
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An organisation aspiring to get started in international marketing should address, appraise and analyse the issues in advance in a careful and comprehensive way. The success in international marketing largely depends on the fact that firm shall exploit its opportunities handsomely, use its strengths smartly and address and improve its weakness patiently which may come on its way. While scanning the international markets, the firms shall properly study all the aspects of economic data which may be specific or general or both and can be effectively used for making decisions on whether to enter markets or not. Such data analysis can also help the firm to understand the various aspects of risks and can guide in the degree of its engagement in that market. The general and specific information which can be of use is as follows:
Table: Specific information to be scanned for getting started in international marketing 1. Market information Marketing decision statistics and potential of market Physical features of target market Kind of channels of distribution Availability, effectiveness and cost of media for accessing buyers Resources need for doing business Economic factors Attitudes and behavior of consumers, disposable income, per capita income, size of family, purchase frequency. Available infrastructure, communication facilities, money markets, banks, etc. Their type, availability, effectiveness and cost factors influencing distribution channel. Various information sources, quality, availability and cost factors in media, such as newspaper, television, telecommunication, internet cost, etc. Money, manpower, materials, their availability, cost, quality, development. Rate of economic growth, economy structure, i.e. share of agriculture, manufacturing and services, competitiveness and conduct, capital adequacy, economic blocsand regional integration. Role of cartel, trade practices, inflation rates. Customs, culture, attitudes, preferences for products and services. Legislation governing business and trade, such as rules, regulations acts and overall laws friendliness with business, investment climate, government and Page No. 201
2. Overall business environments
Social factors Political/legal factors
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opposition ideology on trade and investment, political stability. Technological factors Competition factors Trading partner and their role in target market Management capability State funding for research and innovation, trends development in country research. Type, structure, operations, strategy plans, programme, acquisitions, mergers. Trade openness, trade propensity, regional intensity and orientation, trade intensity product and market diversification. Country diplomatic reach and activeness foreign embassies, role of NGOs and other developmental thrust. Quotas, tariffs and non tariff barriers, various duties, SPS and technical barriers to trade. Fiscal and current account deficit, trade balance, balance of payments, foreign exchange reserves, interest rates, ease in accessing funds. Investors, economic STS, bankers, business people. Legislation governing foreign exchange, rigidity issues, exchange rate system, i.e. free float, managed float, dirty float, fixed float and frequency of regulatory interference. Legislation governing the trade and business incentives, dividends tax rules, earnings, repatriation of profits. Level of developed, stage of maturity. IMF or world bank and their effect on county economic policy.
3. Financial factors Market access issues Monetary and fiscal policy Expectations of players Commodity exchanges
Taxes
Spot forward market Intervention by outside bodies
Source: Adapted from, S. Carter, Global Agricultural Marketing Management
The important guiding factors in analysing the specific information while selecting international markets,is the demographic features of the markets, such as consumer attitudes towards products, consumer behavior, disposable income and per capita income. Cultural aspects like the design of the product as per local requirements and needs. The physical and natural features of the country, such as its climate, environment, topography, seasons and issues involved in working under such circumstances are also of prime importance as it helps the marketer to calculate the various cost involved in doing business in that country.
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Activity 1 How can one find out the data for the potential markets for export and import? Hint: www.trademap.org
10.3 Mode of entering into potential markets

Having scanned the best potential international markets which meet the corporate competitiveness criteria of the firm, it has to evaluate the most profitable way of market entry so as to sell its products and services to potential customers in these markets. There are several methods used in globalised era for international market entry, such as exporting, franchising, licensing, joint venture and wholly owned subsidiary. The entry method suitable to firm requirement shall depend on a variety of factors, such as the nature of firm product or service, the conditions for market penetration, entry and exit barriers and financial commitment required for getting into international markets. Exporting, which is widely used for the first time traders is accomplished by selling the products or services directly to a foreign firm or customer. Alternatively, firm can export through an export intermediary, such as a commissioned agent, an export management company or a trading company. International joint ventures are very effective means of entry into potential markets as it provides the firm to share domestic knowledge with the aligned firm and can use partner strengths effectively and hedge its risks. Joint ventures are good means for market entry in those markets where there are entry barriers like capital limit requirement. Licensing, another wieldy used method by firm getting started involves a contractual agreement whereby firm assign the rights to distribute or manufacture its product or service to a foreign company. Wholly owned subsidiary requires either setting up its own production or manufacturing facility or subcontracting the manufacturing of its product to an assembly operator, such as Coca Cola which uses fobo method for bottling in india.
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Table: Comparison of foreign market entry modes Sl. no. 1. Mode Factors favoring the entry mode in target market Advantages Disadvantage s 1. Trade barriers and tariffs and other cost make products and services uncompetiti ve. 2. In case of far away market, transport, packaging and logistics costs put additional burden. 3. Problems in accessing the local market information. 4. Firm is viewed and regarded as an alien and outsider.
Exporting
1. Opportunities for limited sales in the target country. 2. Chances for little product, new product and adaptation. 3. Distribution 1. Minimises the channels are potential risk in usually close trade as firms to need not invest manufacturing in target market. sites. 2. Ease in market 4. Economies of entry scale cannot 3. Better utilisation be attained in of production production and facility and logistics, resources. hence high production cost in domestic market Liberal import policies of target country. 5. High political risk in target country. 1. Firms are facing import control and investment barriers for entry. 2. Country provides protection to domestic industry and
2.
Licensing
1. Licensing 1. In licensing, minimises risk firm lack and investment the control of licensor, i.e. of market exporter. and use of assets in 2. Ensures speed target in entering the market. target market. 2. Sometimes, 3. Licensing help licensee in circumventing becomes the various Page No. 204
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allows foreign firms through licensing or franchising only. 3. If the firms foresee low sales potential in target market. 4. If the firms foresee large cultural distance in potential market. 5. Firm foresee that licensee lacks ability to become a potential competitor in future.
trade barriers 4. Licensing offers higher return on investments as investment from firms is virtually zero as product technology offering.
potential competitor. 3. When we give license to other companies we have share our technical know how and R&D with them This results in proliferation as the licensee may use the knowledge for other purpose. 4. Usually, the license period is limited and offsets firms chances for long term flows of profits.
3.
Joint ventures
1. When there are import barriers in target market. 2. When firm have large cultural distance from target markets and its way of functioning. 3. Firms itself can employ all resources needed to tap
1. This method 1. Joint overcomes the ventures problem of are prone ownership to disputes restrictions and and are cultural distance difficult to in target manage as markets. power and authority is 2. Joint venture diluted. helps in combining the 2. It is tough resources of to control foreign and local the companies. administrative, 3. Joint ventures Page No. 205
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market. provide chances strategic for learning from and 4. Country partner. operational prescribes decisions. certain percent 4. Firm is viewed of equity and regarded as 3. Joint participation. insider ventures has higher 5. There are 5. Firm require risk potential less finances as exposure chances of local firm also than some political contribute. exporting risk and and expropriation. licensing 6. A local partner 4. Firms is better in technical distribution and knowledge, scientific technical skills, knowledge natural get resources, spilledover brand name, to local etc. partners and they may eventually become competitor for the firm. 4. Wholly owned subsidiary 1. High import barriers in firms and foreign ownership is allowed. 2. There is little cultural distance in target country. 3. The firm has good sales potential in target market. 4. There is low political risk for the firm. 1. Firm has good 1. This knowledge of method has local market and greater risk accordingly than other devise modes of strategies. entry. 2. Firm can apply 2. It requires specialised skills more in good manner. financial and non 3. Chances of financial know-how resources proliferation get and minimised. commitmen 4. The firm is t from firm. viewed as an 3. It is insider. possible that firm could not Page No. 206
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manage the local resources due to change in working conditions and technology. Source: Adapted from James Foley. The global entrepreneur: Taking your business international
1. Exporting Of the various methods of foreign market entry, exporting is most commonly used by small and first time businesses as exporting involves limited startup costs and risks and profit under this method can be realised as early as firm gets started. The most advantageous aspect of market entry through exporting is that it involves minimal preliminary expenditures except some which incur on market research and product promotion. Getting through export into international market can be by two basic ways, namely: a. Direct export. b. Indirect export. The direct exporting requires the firm/company to find a potential foreign buyer and then the firm is supposed to make all necessary arrangements for transporting the products into destined market. The firms which cannot locate the direct buyers for the product can export indirectly by using an export intermediary. Several types of export intermediaries whom the firm can use are as follows. a. commissioned agents. b. export management companies (EMCS). c. export trading companies (ETCS). d. foreign trading companies. e. export merchants/export agents/buying houses. f. piggyback exporting. 2. Licensing Licensing is also an easy, risk free and costless method to enter into international markets. Licensing operate in a way that it permits another
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company in the target country to use its property as a licensee and in exchange, pays a fee or royalty on sales so incurred. The property of licensor is intangible, such as trademarks, patents, copy rights, technical know-how and production techniques. The licensee has to pay the fee in exchange for the rights to use the intangible property as granted by the licensor. Licensing is very preferred way of market entry into international market in globalised era as it requires little investment on the part of the licensor. Licensing, if effectively used as an entry mode, has the potential to provide good return to the licensor, but usually it has been seen that licensee who produces and markets the product takes away returns from manufacturing and marketing activities due to vague regulatory law in developing countries. 3. Joint ventures Joint ventures are market entry options whereby firm and another company or firm in target market may join together to form a new incorporated company for business operations in that market. In joint ventures, both the parties are supposed to provide capital and resources in the agreed proportion and accordingly they will represent and share profits and loses. Such mode of entry is popular in countries where there are restrictions on foreign ownership. For example Venezuela, China, Vietnam. Joint venture is also a preferred way of market entry as it is good tradeoff between potential risks and returns and usually joint ventures is manifested with the following common objectives for market entry in globalised era. They are: a. Market entry into potential market. b. Risk/reward sharing between parties. c. Technology sharing between parties. d. Joint product development between parties. e. Conforming to government regulations. f. Possible advantages from political connections.
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Following are advantages and disadvantages of joint ventures: Advantages of joint ventures 1. Helps to acquire new competencies or skills which are not domestically available. 2. Helps in quick penetration of the market and also helpful in rapid implementation of technological change. 3. Reducing the firm risks by sharing it with one or more than one firms. 4. Helpful in easy and faster entry into target market and also enable quick payback. 5. Pooling of firm resources, such as capital, technical know-how and manpower with partner firms. 6. Help in avoiding the tariff barriers and non tariff barriers. 7. Helpful in satisfying local content requirements due to partnering with local firm. Disadvantages of joint ventures 1. Lack of full control on management of the firm. 2. Sharing of profit may make it impossible to recover capital invested. 3. Potential risk of disagreement with partner organisation on exploring new markets, new operations, etc. 4. Blocking firm chances of other joint ventures as existing partners may have different views. 5. Fear in partner mind that other may not take unwanted advantage out of existing operations.
Source: Adapted from about exporting, Austrade 2008
4. Wholly Owned Subsidiary (WOS) Wholly owned subsidiary, as the name suggest, is the direct ownership of production facilities in the potential international market. It requires a long term commitment on the part of firm as it involves transfer of resources, such as capital, technology and personnel to the potential market. Wholly owned subsidiary can also be made through the acquisition of an existing firm or the establishment in the target market. WOS has several advantages as it provides high degree of administrative control in the business operations of the firm and the firm has better chances to understand and analyse the consumers and competitive environment in the target market.
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On the other hand, such entry strategy requires a high level of physical and capital resources to run the business in the target market. Activity 2 What can be the best possible way for entering into China and India for getting started in business? Which method of entry will be suitable? Hint: Read the case drivers of success for market entry into china and india at weblink www.bus.miami.edu Self Assessment Questions 1 1. For a firm to be successful internationally, it is not necessary to be successful locally. (true/false) 2. Culture of a country influences the marketing strategy of the firm. (true/false) 3. _________________ involves a firm, shipping goods directly to a foreign market. 4. Direct investment involves ________________ in the overseas market. 5. A joint venture is an understanding between a. Two or more firms. b. Two or more countries. c. The firm and its subsidiary. d. two or more parties. Activity 1 Find out few countries where direct foreign investment is not entertained. Hint: China, Saudi Arabia.
10.4 Global Marketing Strategies

After getting an overview of international marketing, we shall now discuss the strategies followed in global marketing. Taking into account the various conditions on which markets vary and depend, appropriate marketing strategies should be devised and adopted. Some countries prevent foreign firms from entering into its market space through protective legislation. Protectionism on the long run results in
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inefficiency of local firms as it is inept towards competition from foreign firms and other technological advancements. It also increases the living costs and protects inefficient domestic firms. To counter this scenario, firms must learn how to enter foreign markets and increase their global competitiveness. Firms that plan to do business in foreign land find the marketplace different from the domestic one. Market sizes, customer preferences and marketing practices all vary, therefore the firms planning to venture abroad must analyse all segments of the market in which they expect to compete. The decision of a firm to compete internationally is strategic; it will have an effect on the firm, including its management and operations locally. The decision of a firm to compete in foreign markets has many reasons. Some firms go abroad as the result of potential opportunities to exploit the market and grow globally. And for some it is a policy driven decision to globalise and to take advantage by pressurising competitors. But, the decision to compete abroad is always a strategic down to business decision rather than simply a reaction. Strategic reasons for global expansion are: Diversifying markets that provide opportunistic global market development. Following customers abroad (customer satisfaction). Exploiting different economic growth rates. Pursuing a global logic or imperative to harvest new markets and profits. Pursuing geographic diversification. Globalising for defensive reasons. Exploiting product life cycle differences (technology). Pursuing potential abroad. Likewise, there can be other reasons like competition at home, tax structures, comparative advantage, economic trends, demographic conditions and the stage in the product life cycle. In order to succeed, a firm should carefully look at their geographic expansion and global marketing strategy. To a certain extent, a firm makes a decision about its extent of globalisation by taking a stance that may span from entirely domestic to a global reach where the company devotes its entire marketing strategy to
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global competition. In the process of developing an international marketing strategy, the firm may decide to do business in its home-country (domestic operations) only or host-country (foreign country) only. 10.4.1 Segmentation Firms that serve global markets can be segregated into several clusters based on their similarities. Each such cluster is termed as a segment. Segmentation helps the firms to serve the markets in an improved way. Markets can be segmented into nine categories, but the most common method of segmentation is on the basis of individual characteristics, which include the behavioural, psychographic and demographic segmentations. The basis of behavioural segmentation is the general behavioural aspects of the customers. Demographic segmentation considers the factors like age, culture, income, education and gender. Psychographic segmentation takes into accountbeliefs, values, attitudes, personalities, opinions, lifestyles and so on. Once you are done with the segmentation of market, you can choose one or more segments to carry out trade. This process of selecting or choosing the potential market segment is known as targeting. The three basic criteria for targeting are potential competition, the current size and growth rate of the market and compatibility and feasibility. After the target market has been ascertained, firms should select a global marketing strategy. Marketing in less developed countries offers several advantages to organisations. They can take advantage of the huge unexploited markets and avail tax benefits. By focusing on less-developed countries, firms can increase their market share and become market leaders. Less-developed countries usually offer special benefits for the firms who are willing to establish their operations in their countries. Thus, for firms marketing at a global level, less-developed countries provide them with advantage. 10.4.2 Market positioning The next step in the marketing process is, the firms should position their product in the global market. Product positioning is the process of creating a favourable image of the product against the competitor's products. In global markets, product positioning is categorised as high-tech or high touch positioning. The classification of high-tech and high-touch products is shown in figure 8.1.
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The classification of high-touch products is shown in figure 8.2.
Figure 10.1: classification of high-tech and high-touch products
One challenge that firms face is to make a tradeoff between adjusting their products to the specific demands of a country and gaining advantage of standardisation, such as the maintenance of a consistent global brand image and cost savings. 10.4.3 International product policy Some theorists of the industry feel that there is a difference between conventional products and services, stressing on service characteristics, such as heterogeneity (variation in standards among providers and different locations of the same firm), inseparability from consumption, intangibility and perishability. Typically, products are composed of some service component like documentation, warranty and distribution. These service components are an integral part of the product and its positioning. We often think of a product in terms of fulfilling the need of our own culture. However, the functions served by that product may be very different in other cultures, for example cars play a large transportation role in the U.S., but they are impractical to drive in Japan and thus, there cars are used for individual indulgence or act as a status symbol. Thus, it is important to consider the findings of marketing research and determine customers desires, motives and expectations in buying a product. Firms have a choice in marketing their products across markets. Many a times firms opt for a strategy which involves customisation through which the firm introduces a unique product in each country. On the other hand,
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standardisation proposes the marketing of one global product with the belief that the same product can be sold in different countries without significant changes. For example intel microprocessors are the same irrespective of the country in which they are sold. Finally, in most cases, firms will go for some kind of adaptation. When moving a product between markets, minor modifications are made to the product. For example in the U.S., fuel is relatively cheap, therefore cars have larger engines than the cars in Asia and Europe. 10.4.4 International pricing decisions Pricing is the process of ascertaining the value for the product or service that will be offered for sale. In international markets, various factors like different currencies, greater distances and barriers to trade make the pricing decisions more difficult. It is vital to analyse the target market before establishing the price. It is also to be in line with firms objective. Their could be pricing objectives like return on investments, profit, market share, quality of product or sometimes existence itself. The strategies for international pricing can be classified into the following three types: Market penetration: It is the technique of selling a new product at a lower price than the current market price. Market holding: It is a strategy to maintain buy orders in order to maintain stability in a downward trend. Market skimming: It is a pricing strategy where price of the goods are set high initially to skim the revenue from the market layer by layer. The factors that influence pricing decisions are inflation, devaluation and revaluation, nature of product or industry and competitive behaviour, market demand and transfer pricing. There could be various approaches of company towards pricing when working in international markets ethnocentric, polycentric and geocentric. A company following an ethnocentric approach will maintain the same price throughout the world. In the polycentric approach, the regional managers of the company are allowed to decide on product prices depending upon the situations in which they are operating. While in the geocentric approach, the company takes a middle position and decides on a price somewhere
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between global price and subsidiary requirement. Price can be defined by the following equation:
Price
Resource given up Goods received
The pricing decision enables us to change the price in many ways, some of them are: Sticker price changes The simplest way of changing the price is by changing the price tag. By doing this, you are going to get the same thing, but for a different amount. Change quantity When sticker prices are increased, the response of consumers is unfavourable and usually changes in quantity are noticed less. Change quality Another way to effectively increase profit is through reducing the quality of the product. Change terms For a firm it is a possible to save money by altering the terms of operations or transactions with consumers. For example earlier most software manufacturers provided free support for their programmes but now services are being charged. 10.4.5 Transfer pricing Transfer pricing is the process of setting a price for inter unit sale of goods or services of a firm. Transfer pricing is an important issue for a firm having global operations. It is determined in three ways Market based pricing, transfer at cost and cost-plus pricing. For transfer pricing, arms length pricing rule is used. Transfer pricing can also be defined as the rates or prices that are utilised when selling goods or services between a parent company and a subsidiary or company divisions and departments that may be across many countries. The price that is set for the exchange in the process of transfer pricing may be a rate that is reduced due to internal depreciation or the original purchase price of the goods in question. When properly used, transfer pricing helps to efficiently manage the ratio of profit and loss within the company. Transfer pricing assists in saving the organisations tax by shifting accounting profits from high tax to low tax jurisdictions. It also enables to fix transfer price on a non-market basis and thus enables to save tax. This
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method facilitates in moving the tax revenues of one country to another. A similar trend can be observed in domestic markets where different states try to attract investment by reducing the sales tax rates and this leads in an outflow from one state to another. Therefore, the government is trying to implement a taxing system in order to curb tax evasion. 10.4.6 International advertising International advertising is usually associated with using the same brand name all over the world. However, a firm can use different brand names for historic reasons. The acquisition of local firms by global players has resulted in a number of local brands. A firm may find it unfavourable to change those names as these local brands have their own distinctive market. Therefore, the company may want to come up with a certain advertising approach or theme that has been developed as a result of extensive global customer research. Global advertising themes are advisable for marketing across the world with customers having similar tastes. The purpose of international advertising is to reach and communicate to target audiences in more than one country. The target audience differ from country to country in terms of the response towards humour or emotional appeals, perception or interpretation of symbols and stimuli and level of literacy. Sometimes, globalised firms use the same advertising agencies and centralise the advertising decisions and budgets. In other cases, local subsidiaries handle their budget, resulting in greater use of local advertising agencies. International advertising can be thought of as a communication process that transpires in multiple cultures that vary in terms of communication styles, values and consumption patterns. International advertising is a business activity and not just a communication process. It involves advertisers and advertising agencies that create advertisements and buy media in different countries. This industry is growing worldwide. International advertising is also considered as a major force that mirrors both social values and propagates certain values worldwide. 10.4.7 International promotion and distribution Distribution of goods from manufacturer to the end user is an important aspect of business. Companies have their own ways of distribution. Some companies directly perform the distribution service by contacting others,
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whereas a few companies take help from other companies who perform the distribution services. The distribution services include: The purchase of goods. The assembly of an attractive assortment of goods. Holding stocks. Promoting sale of goods to the customer. The physical movement of goods. In international marketing, companies usually take the advantage of other countries for the distribution of their products. The selection of distribution channel is helpful to gain the competitive advantage. The distribution channel is also dependent on the way to manage and control the channel. Selecting the distribution channel is very important for agents and distributors. In order to reach its target markets, a company utilises a combination of sales promotion, personal selling, advertising and public relations, which is collectively called as promotion. Advertising is a non-personal form of communication about an organisation or its products that is propagated to a target audience through a broadcast medium. A firm can focus on a small, clearly defined market segment by employing this type of promotion. This promotional method is also cost efficient. A large number of prospective customers can be reached at a minimal cost per person. The activity of catching the attention of prospects is known as sales promotion. It involves activities and materials that are meant to attract customers. One motive of promotion is to gain a competitive edge, other is to concentrate on this method as it provides quick return. The consumers also look forward for sales promotions before purchasing a product. People interested in a particular industry can be brought together by organising overseas product exhibitions. These events have the potential to attract important visitors, such as distributors, agents, journalists, potential customers, politicians and competitors. These events also provide us with an ideal opportunity to get attention.
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Self Assessment Questions 2 6. Firms that serve global markets cannot be segregated into several clusters based on their similarities. (True/False) 7. Advertising is a paid form of ______________ communication about an organisation or its products. 8. Promotional mix is a blend of advertising, personal selling, sales promotion and ___________. 9. Globalised advertising is associated with the use of the same ______ name across the world. 10. Transfer pricing is considered to be a relatively simple method of moving goods and services among the overall corporate family. (true/false) 11. __________ is the process of ascertaining the value for the product or service. Activity 2 Find out the stages in the process of international promotions and distributions of a multinational company. Hint: http:// www. Ehow. Com /list _ 6781615_ examples - advertisingtrade-show- exhibitions.html
10.5 Branding for International Markets

Global marketing strategies provide techniques and methods to sell a product. Once the product is sold, the image of the product has to be maintained. We will discuss about this branding here in this section. With the spread of markets and the increase in competition on a global scale, firms are expanding their operations overseas either through investments or acquiring firms in other countries. Firms are also entering into strategic alliances with firms in other countries or exporting directly or indirectly to target countries. At the same time markets are getting more integrated due to the spread of media, the expansion of international retailers and the mobility of people, goods and firms across national borders. To respond to this global market, international firms need to have coordinated and integrated international branding strategy in place.
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International branding is different from marketing in domestic markets in a number of ways. The macro-marketing environment, such as legal, cultural, technological and economic aspects in which a firm operates in the overseas market is different. The intended audience must be considered while developing an intraorganisational marketing communication strategy. A successful promotional strategy is one which is communicated clearly and distributed thoroughly to their intended audience. In addition, it is important to ensure that consistent branding and non-contradictory messages are eliminated. 10.5.1 Valuation of brands Brand value can be defined as the branding efforts that build customer confidence and loyalty by adding unique advantages to the firms product or service. The concept of brand value surpasses the concepts of tangible product and basic brand. This facet of brand value distinguishes a brand from a product. The three levels of brand value are: Core functionality. Emotional values. Added value services. The core functionality deals with the core physical product and its features., Emotional value is characterised by the intangible aspects of a brand that fits the psychological profile of the target customer. Added values concentrate on bringing in extra futures and are critical to the brand which would enhance the usage of the brand for the customers. 10.5.2 Challenges of international branding A challenge to international branding is to maintain a balance between being global and being local. Brand ideas, values and concepts have to remain the same, but the methods to communicate them and to make them familiar to customers have to vary. Brand values and ideas can principally be same, but the propagating methods cannot. The task of building a strong brand is hard and complicated. The firm has to honour the promises made by the marketing theme. Two conflicting challenges an international brand has to face is to remain easily recognised at any global location and simultaneously should be able to blend with the local culture, traditions and customers' way of perception.
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In the international branding process, the challenges increase many fold. Therefore, the process of building a strong brand is a complicated and challenging task. Self Assessment Questions 3 12. Brand value builds customer confidence and loyalty. (true/false) 13. International branding is all about differentiating between being global and being local. (true/false) 14. The task of building a brand is: A) Complicated. B) Easy. C) Critical. D) Moderate.
10.6 Summary
Let us summarise the points covered in this unit about international marketing: Selling a product involves considering the need of the customers. In order to build the customer base, the firms have to take up an advertising activity. Firms, both global and local have to advertise their products in order to inform the customers about the benefits and features of the product. International marketing or advertising differs from domestic or local marketing as the communication process is across cultures, geographic conditions and tastes and preferences of the people. A firm has to develop global marketing strategies in order to deal with protectionism. The goal of a firm to move to a foreign country is to exploit the market there. The different approaches for global marketing are segmentation, market positioning, branding, promotions, competitive pricing and so on. Segmentation is the process of dividing the market into clusters and then positioning the product with respect to the segment and target audience. The pricing decision has to be competitive as there could be local firms competing.
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10.7 Glossary
Arms length pricing rule: This is defined as the price a buyer is willing to pay for an identical item under identical terms and conditions. Foreign investment: It is the long term participation of a firm in a foreign country to do business. Non-current asset: It is an asset that will not convert to cash within the next year. Piggyback exporting: Practice of a foreign seller representing complementary, non-competing lines. Here an exporter is using another exporter as an intermediary

1. Discuss the process of scnanning the gloal markets for interntional marketing opportunities. 2. Elaborate the various methods of entering into interntional markets. 3. Write a short note on two of the following: a. Joint ventuers. b. Licensing. c. Wholly owned subsidiary. d. Direct exporting. 4. Write a note on global marketing strategies. 5. What is transfer pricing? 6. What are the factors considered while branding a product or service in an international market?
10.9 Answers
Self Assessment Questions 1 1. False 2. True 3. Exporting 4. Manufacturing 5. a) two or more firms
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Self Assessment Questions 2 6. False 7. Non-personal 8. Public relations 9. Brand 10. True 11. Pricing Self Assessment Questions 3 12. True 13. False 14. A) Complicated Terminal Questions 1. International marketing is different from domestic marketing in a sense that the customer preferences and tastes are not known. There are cultural differences and other issues. These are explained in sub-section 8.2.1. Refer the same for details. 2. Different global marketing strategies are market segmentation, market positioning, advertising and so on. These are explained in section 8.3. Refer the same for details. 3. Transfer pricing is usually used by companies to reduce the tax levied on them. This is explained in sub-section 8.3.4.1. Refer the same for details. 4. Branding must not have contradictory messages, the intended audience must always be kept in mind. The branding process is a complicated task. These are explained in section 8.4. Refer the same for details.
10.10 Caselet
Flatbread goes around the world ABC Ltd. is located near El Mante, Mexico and produces corn flour and other flour products which it processes into tortillas and related snacks for markets worldwide. Its brand names include X, Y and Z. Its customers include supermarkets, mass merchandisers, smaller independent stores,
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restaurant chains, food service distributors and schools. The company was established in 1949. In the early 1970s, ABC Ltd. introduced its product on the central american markets, specifically in Costa Rica. In 1976, it expanded to the United States and in 1987 it began expanding its operations across the globe, opening plants in Honduras, El Salvador, Guatemala and Venezuela. It now has plants in Europe and most recently China. The Asian market presents a very exciting development for ABC Ltd. The company established their presence on continental China in the first instance and then gradually expanded their penetration of markets across Asia to the middle east. It has already established distributorships in Japan, Korea, Singapore, Hong Kong, Thailand, the Philippines, Taiwan and India. How has a mexican company with a niche food product like corn flour succeed so well in international markets? The answer is that the firm has focused on emerging markets which follows the same path of development. In these emerging markets, the customer demand is predictable as it follows a pattern and this is evident in every major economic segment. What ABC Ltd. is following in their international expansion is the tried and tested method of leveraging the similarities across from market to market and growing their company accordingly. The root of the success of ABC Ltd. has been their ability to observe the life cycle of emerging markets around the world and expertly time their entry into these markets. However, the other key factor has been their ability to adapt their products to local market tastes. Their key competitive advantage in international markets is based not on their product, but the ability to roll any kind of flour from rice to corn to wheat into viable flatbread. In India, many people eat a flatbread made form wheat called naan, but do not eat corn tortillas. So, ABC Ltd. plans to sell corn tortillas in India. The Chinese do not eat many corn tortillas, but they buy wraps made by ABC Ltd. for Peking duck. Also follows a policy of deploying a senior beachhead team to enter the new market in which they are building a presence. In China, the beachhead team had enhanced their skills through many years of experience in Latin America and was already
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primed to develop the necessary market insights to feed into their marketing campaign. some of the observed trends in China are decrease in home cooking among dual-career couples, increase in the number of fast food chains, increase in cold storage refrigeration in supermarkets and rapid improvements in the logistics and distribution channels were all utilised in thinking through the ABC Ltd. market-building strategy in China. Discussion question 1. Evaluate the reasons behind the success of abc ltd. (Hint: focusing on emerging markets) Source: http://estore.bized.co.uk/freecontent/300081f9.pdf References: Colin Gilligan, Martin Hird (1986). International marketing: Strategy and Management. Kumar N (2002). International marketing, first edition. Anmol publication. Roger Bennett, Jim Blythe (2002). International marketing: Strategy planning, market entry. Sean De Burca, Richard Fletcher And Linden Brown (2004), international marketing: an SME perspective, London: Ft - Prentice Hall. Michael R. Czinkota, Ilkka A. Ronkainen.(2001), International marketing, Fort Worth; London: Harcourt college publishers. Vern Terpstra, Ravi Sarathy (2000), international marketing, Dryden press. Michael R. Czinkota, best practices in international marketing, the Harcourt college publishers series in marketing.
E-References: Http://www.consumerpsychologist.com/international_marketing.html, retrieved on 2nd November, 2010 Http://www.slideshare.net/chanvich/international-pricing-decisions-forupload, retrieved on 31st October 2010
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Unit 11
International Strategic Management
Structure: 11.1 Introduction Objectives 11.2 Strategic Management Nature of international strategic management Advantages and disadvantages of formulating strategy 11.3 Strategic Planning Types of planning GAP analysis Top-down vs. bottom-up planning 11.4 Strategic Management Process Strategy formulation Strategic implementation 11.5 Summary 11.6 Glossary 11.7 Terminal Questions 11.8 Answers 11.9 Caselet
11.1 Introduction
In the previous unit, you learned about international marketing and scanning the market. You also learned about various modes of entry into the international market. The global marketing strategies were also highlighted for your understanding. In this unit, we will discuss more about international strategic management.International strategic management refers to strategy planning in international business to compete and ensure that they have a long-term strategy for survival. Strategic management focuses on developing a strong structure for an organisations business that will gradually be changed by combining the efforts of each individual that the organisation employs. Objectives: After studying this unit, you should be able to: explain the nature of international strategic management.
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list the advantages and disadvantages of strategy in international business. discuss strategic planning and its types. evaluate the role of strategic management in international business. describe strategic management process.
11.2 Strategic Management

The nature of strategic management plays a vital role in the international business world. It is important to understand the term strategic management before discussing itsnature. The term strategic management refers to the complete range of strategicdecision making activity in an organisation. Strategic management identifies and comprehends the environmental factors to control the plans accordingly. It has evolved as a concept over time and will continue to evolve. 11.2.1 Nature of international strategic management Strategic management focuses on the process of formulating, implementing, and evaluating strategies, to achieve the objectives of an organisation. The concept of strategic management process in an MNC is similar to that of any other organisation. However,amajor complicating factor is that before considering various strategic options, the strategic management process has to analyse and understand the environmental needs from a regional and country perspective. Both time and effort is requiredto identify and evaluate external trends and events in MNCs. Communication between home offices and overseas operations become complicated because of cultural and national differences, geographic distances and variations in business practices. The strategy implementation becomes difficult as different cultures have different norm values and work ethics. Strategic management holds significance in international business. An MNC has to keep track of their various operations in a continuously altering international environment. Strategic objectives Strategic objectives assist in the implementation process of the organisations objectives or goals. While implementing an inter national
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strategy, an organisation has to identify the opportunities present in these countries, explore the various resources available, their strengths and capabilities and plan to work on their core competencies. The objective should be formed in a way that it is not deficient or immeasurable. The strategic objectives must help the organisation to achieve their mission and vision. Most strategic objectives focus on generatinggreater profits and returns for the business owners; others focus on customers or society at large. The strategic objectives(SMART) are as follows: Specific: A clear message as to what needs to be achieved must be provided. Measurable: There must be at least one indicator to measure progress against fulfilling the objective. Appropriate: The objectives must be consistent with the given vision and mission of the organisation. Realistic: The objectives must be achievable given the organisations abilities and opportunities in the environment. This means that the objectives must be challenging and attainable. Timely: To accomplish the objective there must be a time frame. Two more aspects have been added to the objectives and it has now become SMARTER. They are Ethical and Recorded. When strategic objectives are thoroughly implemented, it will result in strategic competitiveness that improves the performance and innovation of these organisations. The advantages of preparing strategic objectives are: First, they guide employees of an organisation towards achieving the common goals. This aids the organisation to concentrate and conserve valuable resources and work together in a timely manner. Second, challenging objectives encourage and inspire employees to demonstrate higher levels of commitment and effort. A research has supported the concept that individuals work harder when they are motivated towards a specific goal, rather than being asked to simply do their best. Third, different parts of an organisation always have the potential to follow their own goals rather than the overall company goals. Though the intentions are good, they may work at cross purposes to the
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organisation as a whole. Thus, meaningful objectives help resolve divergence in such instances. Finally, appropriate objectives offer a standard for rewards and incentives. They not only result in higher levels of motivation for employees but they also ensure a greater sense of equalityor fairness when rewards are allocated.
There are other objectives that are more specific. These are commonly referred to as short-term objectives that are essential components of action plans. They play a critical role in implementing an organisations chosen strategy. Strategic alliances In todays trade, the increasing number of strategic alliances stands as one among the fast growing developments. According to Booz-Allen and Hamilton,strategic alliances are far-reaching through nearly every industry and are becoming an important driver of higher growth. Alliances vary in scope from an informal business association based on a simple contract to a joint project agreement. To manage the alliance for legal and tax purposes either a corporation or partnership is set up. Strategic alliances involve organisations working together towards a common goal for small businesses, without losing their individuality. Forming strategic alliances helps one reap considerable profits as well as obtain rewards of team effort. Statistical studies claim, organisations that take part in alliances account for 18 percent of their profits that come from their alliances. But it is not just profit that encourages the increase in alliances. The other factors are: a growing intensity of competition, a rising need to operate on a global scale, a fast varying marketplace, and an industry union in many markets. Particularly in a time when upcoming international marketing is becoming the standard, these alliances and partnerships can influence the growth. Instead of taking the risk and expense that international expansion requires, any organisation can enter the international market by identifying a suitable alliance with a business operating in the marketplace that the organisation wants to enter.
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A strategic alliance is basically a partnership in which the organisations unite by entrusting efforts on a certainproject. The efforts exerted on the project includegetting a better price for supplies, purchasingbulk products and building them with each of the organisations that are a part of its production. The goal of alliances is to reduce risk while increasing the power and profit. Alliances should not be confused with acquisitions, mergers and outsourcing. However,there are some similarities in the situation in which a business may consider one of these solutions. Mergers and acquisitions are everlasting and determine the survival of the organisation. Outsourcing is just a way of attaining a functional service for the company. An alliance is basically a business-to-business partnership. Another term that is commonly used in combination with alliances is establishing a business network. Alliances are formed for joint production, design collaboration, joint marketing, joint sales or distribution, technology licensing, and research and development. Relationship between a vendor and a customer is vertical, while the relationship between vendors situated locally or globally is horizontal. Alliances are established formally in a joint project or partnership. Strategic alliances are used in businesses to: Attain advantages of scope and speed. Boost market access. Improve competitiveness in domestic or global markets. Improve product development. Increase new business opportunities through new products and services. Enlarge market development. Enhance exports. Diversify. Make new businesses. Minimise costs. Strategic alliances are becoming a common tool for increasing the reach of the organisation without exerting organisation to expensive internal expansions beyond the core business.
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11.2.2 Advantages and disadvantages of formulating strategy The advantages of a well structured strategy in international business are: It provides proper guidance in business. It alerts the manager aboutnew opportunities and threats. It aligns members to work towards common goals that are set. It facilitates to make management become more proactive than reactive. It helps the decision making course of assigning resources. The problems in strategic management are: As it is tough to predict the future, it becomes difficult to anticipate the forthcoming environment for developing plans or strategies. It is expensive to hire an external consultant to develop strategies.It is prudent to address the immediate crisis before allocating resources (like opportunity cost, people, money, time) to strategic management process. Sometimes few opportunities might be available in firms after completinga strategic management process. The firm may want to consider them which becomes difficult then.
Self Assessment Questions 1 1. The nature of ________________ plays a vital role in the international business world. 2. The strategic objectives should be measurable, appropriate, realistic, specific, and timely. (True/False) 3. _____________ is a way of attaining a functional service for the company. Activity 1 Assume that you own a company that manufacturestoys for the international market. Your specialty lies in integrating the cultural and religious aspects into toys. Mention in terms of strategic objectives, how you would frameyour objectives, and what steps you would take to be better accepted internationally. Hint: Identify cultural differences, plan strategy to combat the same and for alliances.
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11.3 Strategic Planning

We had discussed about strategic management in the previous section. In this section we will learn about the key components of strategic management that is strategic planning and its types. Strategic planning involves the structured efforts of an organisation to effectively recognise its purposes for existing, the direction that the organisation will pursue, and how that direction will allow the entity to achieve its short-term and long-term goals. Strategic planning is an important element in all kinds of organisations and is applied by governments, non-profit agencies, individuals and businesses. A simple approach to strategic planning is as discussed below: 1. The first step is to accurately assess where the entity is today, with respect to its ability and resources. 2. The second step is to recognise where the organisation would like to reachat some specificpoint of time in the future, by efficiently setting goals and objectives that it needs to accomplish. 3. The third and final step engages choosing how to successfully progress from the conditions of today and methodically work toward those goals in a structured and logical manner. During the strategic planning process, experts employ many ways, and sometimes break down each process into a series of steps. The complexity of the exact approach used frequently comprises of the nature of the organisation, the kind of goals laid down and the resources needed to attain those goals. 11.3.1 Types of planning Strategic planning process involves allocation of resources to firms to fulfil their long-term goals. Any business plan can be classified into three types. They are: Strategic planning: This planning process is the best among the three business planning processes. It is a long-term process thatthe business owners utilise to unveil their business vision and mission. It also determines a gateway for business owners for achieving their goals. Strategic planning fulfills the mission and the overall goals of the firm. Whereas, the other two are rather more short-term and are used
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sometimes without any relation to the long-term business goals. However these three kinds of planning work well when used within a strategic plan. Intermediate planning: This planning process is for six months to two years. They outline the manner in which the strategic plan is pursued. Intermediate plans are often used for campaigns with the purpose and goal of supporting the trades long-term goals. Short-term planning: This planning process involves planning for few weeks or at least for a year. It involvesdetailing out the functioning of a strategic plan on a daily basis. Resources are allocated for business management and development that takes place daily within the strategic plan.
11.3.2 GAP analysis A GAP analysis is a simple tool that helps the planning team to identify methods to close the performance gaps. The current affairs and the required future state must be considered by the planning team. It must be made clear whether or not the gap can feasibly be closed by the planning team. The performance gap is closed by modifying resources from activities to be terminated to activities to be started. If there is uncertainty that the initial gap cannot be closed, then the feasibility of the required future state must be reconsidered. Businesses implementgap analysis to accomplish company-wide goals, or those for a specific department or area. For example, a firm that wishes to reduce overhead costs createsa financial gap analysis. Or an organisation that wants to enlarge its product distribution might come up witha marketing analysis. Gap analysis help businesses measure their possible profitability of a goal. This helps the management and staff to understand the plans laid out in the analysis as well as stay eager about it. 11.3.3 Top-down vs. bottom-up planning Top-down planning Top-down planning is a common strategy that is used for project planning. It helps maintain the decision making process at the senior level. Goals and allowances are established at the highest level. Senior-level managers have to be very specific when laying out expectations because the people following the plan are not involved in the planning process. It is very
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important to keep the morale of the employees high and motivate them to perform the job.Since employees are not included in any of the decision making processes, they are motivated only through fear or incentives. Management must choose techniques to align projects and goals with topdown planning. Management alone is held responsible for the plans set and the end result. The benefit of talented employees with prior experience on definite aspects of the project are not utilised based on the assumption that the management can plan and perform a project better without the inputs from these employees. Some think that the top-down planning process is the rightway to make a plan, and that the plan development is not important. It permits the management to segregate a project into steps, and then break the work into smaller executable parts of the project. Simultaneously, the work that is broken down is analysed until all the steps could be studied, due-dates are precisely assigned, and then parts of the project are given to employees. However, the focus is on long-term goals and the short-term and uncertain goals can get lost. This approach is best applicable for small projects. Bottom-up planning Bottom-up planning is commonly referred to as tactics. With bottom-up planning, an organisation gives its project deeper focus because each organisation has a huge number of employees involved, and each employee is an expert in their own area. Team members work side-by-side and contribute during each stage of the process. Plans are developed at the lowest levels, and then passed on to each of the subsequent higher levels. Finally, it then reaches the senior management for approval. Lower-level employees take personal interest in a plan that they are involved in planning. Employees are more encouraged which in turn improves their morale. Project managers are responsible for the successful completion of the project. Let us now consider the key points of top-down and bottom-up planning. Top-down planning Top-down planning helps: Determine all the goals at the initial stage of the process. Identify the lack of ground level staff participation. Estimate the inflexibility.
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Find how management imposes the processes. Determine the lack of motivation. Find whether the staffs feel that their input is valued or not.
Bottom-up planning Bottom-up planning helps: As there are no long term vision here. Encourage teamwork. Estimate flexibility. Determine whether team motivation is of high level. Identify whether the project is team driven. Find whether the staff feels valued or not. Finally, a combination of these two project management methods is most effective. Using the positive aspects of each, the organisation can align each step so that the requirements of the project are met. An organisation can determine the top requirements of the project and allow accountability to get down with the lower levels. With this combination, the vision of senior management with the skills of lower level employees is merged. This helps in completion of the project more efficientlyusing the best employees of the organisation. Self Assessment Questions 2 4. A _____________ is a simple tool that helps the planning team identify methods to close the performance gaps that has been identified. 5. Top-down planning encourages team work. (True/False) 6. ________________ are responsible for the successful completion of the project. Activity 2 Assume that you are the manager of an international chemical dyeing firm that is undergoing a technological change in one of its main units. How will you implement your strategic planning so that employees accept and adopt change? Hint: Use Bottom-up planning.
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11.4 Strategic Management Process

In the previous section we learnt about strategic planning and its types. In this section, we will discuss strategic management process. Strategic management process is a way businesses build strategies that help firms respond quickly to the new challenges. This process helps organisations to find new and more efficient ways to do business. The organisation should have a good strategic planning that clearly describes objectives and evaluates both the internal and external situation to establish the strategy, implement, evaluate, and make necessary changes to stay as per the vision and mission of the organisation. A pictorial representation of strategic planning process is shown in figure 10.1.
Figure 10.1: Strategic Management Process
The five levels of strategic management process are: 1. Mission and objectives: The mission defines the organisations existence. The purpose of the organisation is stated by a mission statement. The mission statement projects the organisations image to customers and conveys a purpose to its employees. The goals of the organisation are called objectives. These objectives are challenging by nature but achievable. Objectives should be measurable so that the company can keep a track of its progress and make modifications, if necessary. 2. Situation analysis: After specifying the objectives, the organisation must devise a strategic plan to attain them. New opportunities and methods are adopted to attain the objectives when there are changes in the external environment. Thereby, an environmental scan is conducted to find the opportunities. To select opportunities, the organisation has to know its own abilities and limitations. Situation analysis includes analysis of both external and internal environment. The external environment consists of political, social, technological and other factors. It also analysis the functionality of the organisation. The internal environment consists of situations like organisational structure, market share, operational efficiency and others. Situation analysis
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provides huge amounts of information. To efficiently manage this information, the internal factors should be categorised into strengths and weaknesses of the organisation and external factors should be categorised into opportunities and threats. 3. Strategy formulation: After having a clear picture of the organisation, the strategic alternatives are developed. Depending on the organisations situations, different organisations adopt different alternatives. Michael Porters identified generic strategies could be applied to all organisations with includes cost leadership, differentiation, cost focus and differentiation focus. All these can be considered while defining strategic alternatives. 4. Implementation: The strategy is expressed in high-level conceptual terms. The conceptual terms should be translated into detailed policies for effective implementation and also for the understanding of the functional level of the organisation. The functional policies should also state practical issues clearly. The strategy must be translated into specific policies for functional areas like marketing, production, research and development, human resources, information system and others. The implementation stage also involves finding the required resources and categorising organisational changes. 5. Evaluation and control:After implementation, the outcome of the strategy must be measured and evaluated along with the changes that have been made. To do this, monitoring control-systems are developed and implemented. The steps involved in evaluation and control are to: 1. Describe the parameters to be measured. 2. Describe the target values for those parameters. 3. Carry out measurements. 4. Compare the measured results to the pre-defined standard. 5. Make necessary changes. 11.4.1 Strategy formulation Strategy formulation is the second phase in the strategic management process. It is the process of deciding the best course of action for accomplishing organisational objectives and achieving organisational purpose.. In fact, objectives and strategies are modified many timesto make
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the organisation more successful. This includes creating sustainable competitive advantages though most of them are swept out gradually by the competitors efforts. There are three aspects of strategy formulation. Each aspect has a different focus that includes requirements to be met within the formulation stage of strategic management. The three aspects of recommendations must be internally steady and match together in a jointly supportive manner that outlines an integrated hierarchy of strategy. The three aspects are: Corporate level strategy. Business level strategy or competitive strategy. Functional strategy. Corporate level strategy: This aspect of strategy is concerned with the broads decisions about the total organisation's scope and direction. Basically, the changes which should be made in the growth objective and strategy for achieving the objective is considered, the lines of business at present and how these lines of business go together. The three components of corporate level strategy are: Directional or growth strategy: This designs the organisations growth objective. The objectives range from cutback through stability to altering levels of growth and how the organisation accomplishes them. Portfolio strategy: This strategic activity plans the organisations portfolio in line with those businessess, which needs reconsidering and, if so, how much concentration or diversification the organisation should have. Parenting strategy: This defines the way the organisation assigns resources and manages abilities and activities across the portfolio, where to emphasise, and how much the organisation should integrate into its various lines of business.
Business level strategy orcompetitive strategy: This is also called business level strategy. It involves deciding how the organisation would compete within each line of business or strategic business unit. Functional strategy: Functional strategies are more localised with shorterhorizon activities. They deal with how each functional area and unit
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performs its functional activities to be effective and increase resource productivity. 11.4.2 Strategic implementation Strategy implementation is one of the stages of strategic management. It refers to decisions that are made to lay out a new strategy or reinforce present strategies. The basic activities of strategic implementation are to establish annual objectives, devise policies and allocate resources. In addition, strategy implementation also include decision making with respect to strategy and organisational structure, develop budgets and motivational systems. The features of strategic implementation are to: Establish annual objectives. Devise policies. Motivate employees. Allocate resources. Develop strategy-supportive culture. Create organisational structure. Redirect the marketing efforts. Prepare budgets. Develop information system. Activity 3 A firm is in the business of detergent production which caters to the rural and suburban areas of Uttar Pradesh. Due to the entry of international players it is facing increasing competition from branded products.After review meetings, the management decides to concentrate on controlling costs. It is decided to recast/reengineer the full production and marketing processes so as to reduce waste. The firm is also planning to to renegotiate with its suppliers s to minimise cost of inputs. There are certain limittions to cost cutting as the firm cannot compromise on quality and social issues. Suppliers of inputs are also reluctant to yield to pressures of renegotiating the cost of raw materials. After some time, sales of the firm has started declining very fast. What other steps can the management of the firm plan in order to cope with the growing competition? Hint: Read the success story of Ghari Detergent at http://www.businessstandard.com/india/news/watch-out-for-ghari-express/413280/
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Self Assessment Questions 3 7. The __________________ process is a way businesses build strategies that help firms respond quickly to new challenges. 8. The kind of strategy concerned with broad decisions about the total organisation's scope and direction is _____. a) Business level strategy b) Corporate level strategy c) Functional strategy d) Competitive strategy 9. One of the phases of strategic management process which includes decision making with respect to strategy and organisational structure; develop budgets and motivational systems is _____.
11.5 Summary
Let us summarise the points covered in this unit about international strategic management: International strategic management refers to planning the strategy in international business to compete and also ensure that they have a long-term strategy for survival. Strategic management focuses on the process of formulating, implementing and evaluating strategies to achieve the objectives of an organisation. Strategic objectives assist in the implementation process of the organisations objectives or goals. Most strategic objectives focus on producing greater profits and returns for the business owners; others focus on customers or society at large. Strategic alliances are the means to work together with others towards a common goal for small businesses without losing their individuality. Alliances are a way to obtain the rewards of team effort and one can reap considerable profits from forming strategic alliances. Strategy in international business has various advantages and disadvantages. Strategic planning involves the structured efforts of an organisation to effectively recognise its purposes for existing, the direction that the
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organisation will pursue and how that direction will allow the entity to achieve its short-term and long-term goals. The strategic planning process involves allocation of resources to firms to fulfill their long-term goals. The three types of planning are strategic planning, intermediate planning and and short term planning. A GAP analysis is a simple tool that helps the planning team to identify methods to close performance gaps. Gap analysis help businesses measure their possible profitability of a goal. Top-down planning is a common strategy that is used for project planning. It helps maintain the decision making process at the senior level. Goals and allowances are established at the highest level. In bottom-up planning, an organisation gives its project deeper focus because organisation has a huge number of employees involved and each employee is an expert in their own area. Team members work side-by-side and they contribute during each stage of the process. The concept of strategic management is still evolving and will continue to undergo changes. Thus, understanding and following the process of strategic management in international business is helpful to practicing managers in achieving the organisations' objectives.
11.6 Glossary
Regulatory bodies: These are professional bodies established on the basis of legal mandate to protect the public. Uncertainty: It is the situation where the consequences of events are unpredictable. MNC: Acronym for multinational company. Strategy: Plan of action designed to achieve a specific objective. Alliances: An agreement between two or more entities to achieve a common goal. Partnership: An arrangement where individuals agree to cooperate towards a common goal.
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Mergers: Combination of two or more companies, usually by offering the stockholders of one company securities in the acquiring company for the surrender of their stock. Acquisitions: Corporate action in which a company buys most or all the target company's ownership stakes to assume control of the target firm.

1. 2. 3. 4. 5. Explain strategic objectives and alliances. What is strategic planning? Explain top-down and bottom up planning. What is Strategic management process? Explain strategy formulation and implementation.
11.8 Answers
Self Assessment Questions 1 1. Strategic management. 2. True. 3. Outsourcing. Self Assessment Questions 2 4. GAP analysis. 5. False. 6. Project managers. Self Assessment Questions 3 7. Strategic management. 8. b) Corporate level strategy. 9. Strategy implementation. Terminal Questions 1. In order to measure the fulfilment of the objectives, strategic objectives need to be implemented. Strategic alliances are far-reaching through nearly every industry. These are explained in sub-section 11.2 of this unit. Refer the same for details. 2. Strategic planning involves the structured efforts of an organisation to effectively recognise its purposes for existing, the direction that the organisation will pursue and how that direction will allow the entity to
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achieve its short-term and long-term goals. These are explained in subsection 11.3 of this unit. Refer the same for details. 3. Top-down planning is commonly referred to as strategy. Bottom-up planning is commonly referred to as tactics. These are explained in subsection 11.3.3 of this unit. Refer the same for details. 4. The strategic management process is a way businesses build strategies that help the company respond quickly to new challenges. The five levels of management process are explained in sub-section 11.4 of this unit. Refer the same for details. 5. Strategy formulation is the second phase in the strategic management process. Strategy implementation is one of the stages of strategic management. These are explained in sub-section 11.4.1 and 11.4.2 of this unit. Refer the same for details.
11.9 Case-let
Magazine Distribution GAP Analysis Company PQR is the top bio-medical magazine in Pune. The vision of Company PQR was to be the top distributor throughout India and also expand their operation abroad. Company PQR initially completed an analysis showing how it got to be the top regional, then top national magazine distributor. This includes an overview of every aspect of the business that contributes to the Company PQR's success, including marketing, accounting, information technology, management and other departments. Company PQR outlined the advantages of achieving its goal of becoming the top distributor country as well as internationally. Goals were designed that were specific and measurable. There was a time frame set for regional supremacy. In this case, Company PQR planned to become the top nationwide magazine distributor within two years. They achieved their primary goal of nationwide popularity by bringing innovative schemes that attracted consumers to buy the same. They brought out an exclusive section for researchers who were in the field. Company PQR then researched as to how they would achieve international distributor and what it requires to do to arrive at this goal. The outcome of Company PQR's analysis was a complete plan that analysed the competitor
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analysis using Porters model as to what they required to do so that they can see their goal of international distribution. The aim was to achieve international reach as they co-ordinated with scientists abroad. They shared information on various aspects of the bio-medical field. There were many seminars organised and eminent scientists were recognised. At the next step, they gathered information and conducted GAP analysis to see where they lacked. The analysis includes a review of competitors, knowing the needs of the foreign customers, and also interviews with staff members to know the strengths. After gathering all the information, a gap analysis report was tabulated. The report provided a summary of the present situation, the goals the company wishes to achieve and the steps they had to implement to achieve these goals. The steps were analysed into strategic planning. This plan includes detailed action steps of the business for each area, an agenda to complete each step and a plan that outlines how much the plan will cost. The next and final step was for the management to approve and support the action plan and confirm on the budget. The plan was put into action. Each step was tracked to assure that the plan stays as per the agenda and within the allotted budget. The success of the Indian bio-medical magazine in foreign shores was the talk of the town that year. Discussion Questions 1. What did the initial analysis include? (Hint: Review of current system) 2. What does the gap analysis report include (Hint: Refer the steps, summary, plan)
Sources: http://www.wisegeek.com/what-is-gap-analysis.htm retrieved on 15 November 2010
th
References: K.Aswathappa (2008). International Business. Tata McGraw Hill Publishing Company Limited. Geoff Goldman, Cecile Nieuwenhuizen (2006). Strategy: Sustaining Competitive Advantage in a Globalised Context. Juta and Co. Mike W Peng (2009), Global Strategic Management, Cengage, London.
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Phillippe Lesserre (2007), Global Strategic Management, Palgrave Macmillan. Gerardo R Ungson & Yim Yu Wang, (2008), Global Strategic Management, Library of Congress Cataloging in Publication Data. Abbass F Alkhafaji, (2003), Strategic Management, Formulation Implementation in dynamic environment, Haworth Press.
E-Reference: http://www.smallbusinessnotes.com/operating/leadership/strategi calliances.html, retrieved on 10th November, 2010 http://www.referenceforbusiness.com/management/Sc-Str/StrategyFormulation.html, retrieved on 5th November, 2010 http://ezinearticles.com/?Types-of-Strategic-PlanningModels&id=4892128, retrieved on 5th November, 2010 http://www.brighthub.com/office/project-management/articles/8542.aspx, retrieved on 10th November, 2010 http://www.strategicmarketsegmentation.com/strategic-planningprocess-types-and-elements-of-plans/ retrieved on 10th November, 2010
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Unit 12
Ethics in International Business
Structure: 12.1 Introduction Objectives 12.2 Business Ethics Factors Importance of business ethics 12.3 International Business and Ethics Managing ethics Free market ethics 12.4 National Differences in Ethics Negotiating across cultures Ethical issues 12.5 Corporate Governance Code of conduct for MNCs Corporate ethical programmes Social responsibility and ethics 12.6 Summary 12.7 Glossary 12.8 Terminal Questions 12.9 Answers 12.10 Caselet
12.1 Introduction
In the previous unit, you studied about the various aspects of human resource management in an international organisation. You also came to know about the organisational structure and managing expatriate. While managing resources and earning profit is necessary for an organisation, we should not forget that any business cannot run for long without following ethical practices. In this unit, we will discuss about ethics which is an important part of managing an organisation. Ethics can be defined as the evaluation of moral values, principles, and standards of human conduct and its application in daily life to determine acceptable human behaviour.
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Business ethics pertains to the application of ethics to business, and it is a matter of concern in the corporate world. It is almost similar to the generally accepted norms and principles. Behaviour that is considered unethical and immoral in society, for example dishonesty, applies to business as well. This unit covers various topics on workplace ethics, its importance and application in a global business environment. It also gives a perspective of business ethics practised in different countries. It includes the code of ethics, policies and procedures, and the general code of conduct followed by multinational companies. Objectives: After studying this unit, you should be able to: explain business ethics. evaluate the importance in an international context across cultures. describe the national differences in ethics. analyse the corporate governance of an international business.
12.2 Business Ethics Factors

During the mid 1960s and 1970s, social awareness movements raised expectations of businesses to use their financial and social influence to address social issues such as poverty, literacy, women rights, public health, and environmental protection. It was argued that these businesses used community resources and profits generated by public participation to address social issues. Hence, there arose a need for managers to take up the responsibility to understand and address social issues guided by high ethical standards. In this unit, let us learn the different factors that influence the ethics of a business and its managers. Managers are influenced by three factors affecting ethical values. These factors have unique value systems that have varying degrees of control over managers. Religion Religion is one of the oldest factors affecting ethics. Despite the differences in religious teachings, all religions agree on the fundamental principles and ethics. All major religions preach the need for high ethical standards, an orderly social system, and stress on social responsibility as contributing factors to the general well-being.
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Culture Culture refers to a set of values and standards that defines acceptable behaviour passed on to generations. These values and standards are important because the code of conduct of people reflects on the culture they belong to. Civilisation is the collective experience that people have passed on through three distinct phases: the hunting and gathering phase, agriculture phase, and the industrial phase. These phases reflect the changing economic and social arrangements in human history. Law Law refers to the rules of conduct, approved by the legal system of a country or state that guides human behaviour. Laws change and evolve with emerging and changing issues. Every organisation is expected to abide the law, but in the pursuit of profit, laws are frequently violated. The most common breach of law in business is tax evasion, producing inferior quality goods, and disregard for environmental protection laws. 12.2.1 Importance of business ethics Ethics is significant in all areas of business and plays an important role in ensuring a successful business. The role of business ethics is evident from the conception of an idea to the sale of a product. In an organisation, every division such as sales and marketing, customer service, finance, and accounting and taxation has to follow certain ethics. Public image In order to gain public confidence and respect, organisations must ascertain that they are honest in their transactions. The services or products of a business affect the lives of thousands of people. It is important for the top management to impart high ethical standards to their employees, who develop these services or products. A company that is ethically and socially responsible has a better public image. People tend to favour the products and services of such organisations. This in turn will help gain investors trusta company that practices good ethical creates a positive impression among its stakeholders. Managements credibility with employees Common goals and values are developed when employees feel that the management is ethical and genuine. Managements credibility with employees and the public are interrelated. Employees feel proud to be a part of an organisation that is respected by the public. Generous compensations and effective business strategies do not always guarantee employee loyalty, organisational ethics
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is equally significant. Thus, companies benefit from being ethical because they attract and retain good and loyal employees. Better decision-making Decisions made by an ethical management are in the best interest of the organisation, its employees, and the public. Ethical decisions take into account various social, economic and ethical factors. Profit maximisation Companies that emphasise on ethical conduct are successful in the long run, even though they lose money in the short run. Hence, a business that is inspired by ethics is a profitable business. Costs of audit and investigation are lower in an ethical company. Protection of society In the absence of proper enforcement, organisations are responsible to practice ethics and ensure mechanisms to prevent unlawful events. Thus, by propagating ethical values, a business organisation can save the resources of the government and protect the society from exploitation. Self Assessment Questions 1 1. The three factors governing ethical values are ____________, ___________, and ____________. 2. _______________ is the collective experience that people have passed on through the hunting and gathering phase, agriculture phase, and the industrial phase. 3. A company can maximise its profits by being ethical. (True/False)
12.3 International Business and Ethics

In the previous section, you learned about ethics and its importance in business. Now let us discuss the effects of ethics in international business. Most countries have similar ethical values, but are practiced differently. This section deals with the way individuals in different countries approach ethical issues, and their ethically acceptable behaviour. With the rise in global firms, issues related to ethical values and traditions become more common. These ethical issues create complications to Multi-National Companies (MNCs) while dealing with other countries for business. Hence, many companies have formulated well-designed codes of conduct to help their employees.
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Two of the most prominent issues that managers in MNCs operating in foreign countries face are bribery and corruption and worker compensation. Bribery and corruption Bribery can be defined as the act of offering, accepting, or soliciting something of value for the purpose of influencing the action of officials in the discharge of their duties. Corruption is the abuse of public office for personal gain. The issue arises when there are differences in perception in different countries. For example, in the Middle East, it is perfectly acceptable to gift an official, whereas in Britain it is considered as an attempt to bribe the official, and hence, considered unlawful. Worker compensation Businesses invest in production facilities abroad because of the availability of low-cost labour, which enables them to offer goods and services at a lower price than their competitors. The issue arises when workers are exploited and are underpaid compared to the workers in the parent country who are paid more for the same job. The disparity arises due to the differences in the regulatory standards in the two countries. 12.3.1 Managing ethics Earlier, ethics was considered to be the exclusive perquisite of individuals. However, this view has changed now. Many companies encourage ethical behaviour in the organisation with the help of appropriate management techniques. Different techniques of managing ethics like practicing ethics at the top level management, special training on ethics, forming committees to oversee ethical issues, and defining and implementing code of ethics are illustrated in figure 12.1.
Figure 12.1: Techniques of Managing Ethics
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Let us discuss each technique in detail. Top management It is important that the senior management is committed to ensure that the company is meeting the ethical standards. The management must not engage in business practices that will be harmful to the employees, or the society. The top management must focus on ethical practices while informing employees of their intention. Code of ethics Forming a corporate ethical statement and communicating it within the company is one of the best practices for ethics. This will help in enhancing the companys public image. Almost all Fortune 500 companies have such codes. Ethics committee Ethics committees are formed to help the company deal with and advise on issues related to professional ethics. The Chief Executive Officer (CEO) can head the committee that includes the Board of Directors. Such a committee answers employees queries, helps the company to establish policies in uncertain areas, advises the Board on ethical issues, and oversees the enforcement of the code of ethics. Ethics hotline Many companies have ethical hotline to help the employees report any ethical issues faced at work. The ethics committee then investigates these issues. Such calls are treated confidentially, where the callers identity is protected. This will encourage employees to bring such issues to the managements notice. The act of reporting illegal, immoral, or illegitimate practices by former or current employees involving its employees is known as whistle-blowing. Whistle-blowing is favourable to a company because employees can alert the management on possibly irregular and unusual behaviour rather than reporting it to the media, which adversely affects the company. A case of whistle-blowing in Xerox corporation (a pioneer in copier machines), led its Chief Financial Officer to be fined $ 5.5 million and be banned from practicing accountancy after reports of falsified financial statements emerged. Ethics training programmes Most firms take ethics seriously and provide training for its managers and employees. Such training programmes demonstrate the use of official policies in everyday decision-making which will help the employees become familiar with the policies. Ethics training is
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most effective when conducted by managers and when focused on work environment. Ethics and law Both law and ethics, though different, focus on defining the perfect human behaviour. Law is the governments attempt to formalise rightful behaviour. But the written laws are hardly enforced. It depends on individuals or business ethics to reduce unlawful incidents. Ethical concepts are more complex than written rules since it deals with human dilemmas that go beyond the formal language of law. Legal rules seek to promote ethical behaviour in companies. The following are some of the Acts which seek to ensure fair business practices in India: Foreign Exchange Management Act (FEMA) of 1999 FEMA regulates the cross border movement of foreign and local currencies. Companies Act of 1956 Companies Act provides the complete legal framework for the formation, running, and winding up of a company. Consumer Protection Act of 1986 (CPA) CPA provides and regulates the framework for the protection of consumer rights. Essential Commodities Act of 1955 This act defines the goods and services that are essential for the people at all times and provides a legal framework for the uninterrupted supply of the same. 12.3.2 Free market ethics In this section, we will discuss the ethical aspects of competition used to explain free market ethics. Competition is an important element that differentiates free market from command market. It is a mechanism for free market production and distribution of goods and services that are in demand. Competition in business is seen as an essential cultural trait of a free market society. Most activities of the free market can be viewed as a competitive contest in which businesses engage to provide products and services for profit. In addition to the economic nature of the free market system, there are ethic-related issues as well. The three widely accepted factors of ethics in the free market are market ethics, the protestant ethics, and the liberty ethics. These three ethics set the stage for the industrial revolution and the accompanying growth in business. During this period, industrial capitalists were allowed to freely operate businesses, build large organisations, exploit
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workers, and engage in fiercely competitive practices for profit and economic expansion. Market ethics Market ethics is the basic system of ethics followed by a business in a free market scenario. It covers the entire spectrum of business including sales, pricing, and competitor issues. The protestant ethics The protestant ethics consider ideology as an important factor along with the moral aspects in a capitalist scenario. As an ideology, this ethic served to legitimise the capitalistic system by providing a moral justification for the pursuit of profit and distribution of income. Liberty ethics Liberty ethics encourages a person to play a participatory role in the government, encourages private property, and introduces more freedom and individualism in all spheres of life. Self Assessment Questions 2 4. ________ is an example of whistle-blowing in corporations. 5. In an international business, _____________ and ____________ are the prominent ethical issues 6. ___________ is an important element that differentiates free market and command market.
12.4 National Differences in Ethics

In the previous section, we examined how ethics is significant internationally. In this section, let us consider the differences in understanding ethics across countries. The differences in national cultures have an impact on the social and ethical practices of multinational firms. Cultural norms and values that usually influence business practices are attitudes towards women, minorities, bribery, and law. Religion and law are the key social factors that influence the type of ethical issues. In MNCs, managers play a key role in managing ethics. While working in a foreign country, a manager may not have a comprehensive knowledge of that countrys culture and social factors that affect business. Therefore, the international manager needs to acquire adequate knowledge of a countrys cultural, legal, and social scenarios to ascertain the important ethical issues and to manage these issues. The approaches to understand national
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differences in ethics are ethical relativism, ethical universalism, and ethical convergence. Let us discuss each of them in detail. Ethical relativism and ethical universalism Ethical relativism means that each countrys outlook on ethics must be considered valid and ethical. This implies that if bribery is not unethical in a foreign country, then it is acceptable for an MNC to encourage bribery even if it is illegal in its home country. Ethical relativism means when a company deals with a host country for business, the international managers must follow the ethical norms of the host country. Another example is the attitude towards women employees in certain Arab countries. The attitude differs to a large extent compared to western countries. In Saudi Arabia, women employees are segregated from their male counterparts at the workplace. All companies, MNCs or local, must comply with these rules. The principle of ethical universalism states that there are basic moral principles that are valid across all cultural and political boundaries. For example, all countries forbid unethical accounting practices and tax evasion. Both these principles have drawbacks when in international business. Ethical relativism is a convenient way to indulge in unethical practices with cultural differences as an excuse. The universal approach can be perceived as cultural imperialism as business managers may regard business practices in some countries as inferior or immoral. Ethical convergence Ethical convergence is defined as the practice of a uniform system of ethical codes in different countries that are culturally and socially different. There is a growing pressure on international business to follow a uniform set of guidelines in managing ethical behaviour and social responsibility across the countries in which they operate. Some of the advantages of ethical convergence are: The growth of international trading blocks, such as North American Free Trade Agreement (NAFTA) and the European Union promotes common ethical practices across national cultures and borders to reduce institutional differences. Predictable interaction and behaviour among trading partners from different countries makes trade more efficient.
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People from different cultural backgrounds increase their interactions and exposure to varying ethical traditions. They adopt, adjust to, and imitate new behaviour and attitudes which leads to acceptance of best practices. International businesses have employees from different cultural backgrounds. The companies rely on their corporate culture to provide consistent norms and values that govern ethical issues to set common standards for employees from different cultural backgrounds.
12.4.1 Negotiating across cultures Negotiations in international businesses face cultural barriers. When people from two different countries try to discuss commercial issues, they have to understand and acknowledge any ethical issues that may come up. These standards of conduct and moral judgement are the basis of an outcome. They can create misunderstandings if the messages and views are misinterpreted. The basic concepts of fairness, dependability, politeness, and punctuality have to be followed at all times. Given below are the two models of negotiating as presented by Solomon and Bertrand: Linear model. Encompassing model. Linear model Linear model, illustrated by Figure 12.2, relates to the Chinese culture. The first stage is the discussion of the goals and principles. In China, this stage is emphasised so that foreigners understand their commitments. The second stage deals with bargaining positions, which are the offers that are proposed. The third stage clarifies details and the last stage involves implementing the process.
Figure 12.2: Linear Model of Negotiation Sikkim Manipal University Page No. 254
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Encompassing model The encompassing model, illustrated by Figure 12.3, is more descriptive and includes stages that are identical to the linear model, but focusses on the extent to which each stage is presented. The Chinese base their negotiations on improving their national goals which include national development, growth, and improvement of the overall quality of life in China. The western companies that operate in China are expected to sacrifice their goals whenever necessary, so that the Chinese goals are achieved. Firms base their negotiations on corporate objectives such as product quality, profit, and maximising shareholder value. Sacrificing such goals is against corporate responsibility, hence is the main reason for negotiations.
Figure 12.3: Encompassing Model of Negotiation
12.4.2 Ethical issues International business managers face ethical issues that vary based on the market and geography. Some of these issues have been widely publicised in the past. Most of these issues are related to the safety and compensation practices of manufacturing plants in emerging countries. Ethical considerations also tend to be connected to political situations. For example, the decision to move a companys headquarters elsewhere to reduce taxes becomes a political issue due to the potential loss of tax revenue for that country. Some other ethical issues are more subtle. Many firms forbid offering gifts in their home countries. But in Japan, offering gifts and entertaining guests
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play a key role in building trust and understanding with potential customers, suppliers, and government officials. While there will always be issues about moral and ethical appropriateness, the boundary between ethical and unethical business practices is reasonably clear in most societies. If the boundary is not clear, the law is vague on a certain point, or firms act in an unacceptable manner, then governments may have to take relevant actions against the erring parties. Businesses must refrain from engaging in illegal activities, but the legislature in some countries is not very clear and causes ambiguity. International business managers find it difficult because legally and culturally acceptable activities in the home country may be illegal and culturally unacceptable in the foreign country. The international manager has to make prudent decisions on such occasions. MNCs deal with issues related to ethics in foreign country. Some of the issues are the following: Conduct business in a country where the government violates human rights. Market a product in a country that lacks adequate consumer protection and product liability laws. Sell products with harmful side effects, where there is a high level of illiteracy that prevents the customers from following the directions for safe usage of a product. Be responsible for the end-user behaviour that may not be legal. Bribe officials in a country where corruption is widespread. Follow local laws in areas such as employee safety and environmental protection that are not as strict as in the home country. Change attitude towards female employees in a country where women do not enjoy the same rights as men. Use tax avoidance strategies. Accomplish business goals with a firm engaged in practices that are illegal in the home country. Multinational firms should have a moral and ethical responsibility to ensure safe, fair, environmentally sustainable, and legal work environment in emerging markets irrespective of the local laws.
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These are the issues that international businesses face when they conduct business in other parts of the world, where the laws are different from their home countries. Ethical decision making In the previous section, you learned about the various ethical issues to be considered in an international scenario, let us discuss the process of ethical decision making. The competitive nature of business and the emphasis on profit causes managers to violate business ethics. For example, employing workers in a foreign country, where wages are low and working conditions are substandard. Ideally, a manager must consider all the choices available to him and make a decision that does not violate the ethics of business. There are many differences in opinion concerning business ethics. The following are four approaches that help managers make the right decision. Utilitarian Maximum benefit to the most number of people is the basis of this approach. For example, in the case of low-wage foreign workers, the cost saving helps the company perform better, but results in layoffs in the home country. If the manager is not willing to employ low-wage workers, the company becomes uncompetitive which in turn results in both foreign and domestic workers being laid off. On the other hand, lower wages tend to bring down the level of wages for everyone, which decreases their purchasing power and affects the sale of the companys goods. Moral rights Morality is the basis of this approach without considering the consequences. Paying someone extremely low wages is morally wrong. Those who accept this approach believe that a business must not exist if the workers are not paid adequately. Universalism There are two steps in this approach. Firstly, one needs to decide if the action being considered has to apply to everyone under all situations. Secondly, the same action must be applied to the manager. Cost-benefit The profitability of every action is analysed. For example, the negative publicity of paying extremely low wages weighed against being more competitive.
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In conclusion, it is evident that a manager has several approaches to choose. The manager must take time to analyse all the possibilities, in order to make the right decision. Self Assessment Questions 3 7. Ethical business practice in one country might differ from another country in practice. (True/False) 8. _________ and ________ are the two models of negotiating. 9. _________ is defined as the practice of a uniform system of ethical codes in different countries that are culturally and socially different. 10. Utilitarian, moral rights, universalism, and cost-benefit are approaches to ____________. Activity 1 Compare and describe the cultural differences between the US and India that give rise to problems concerning business ethics. Hint: Refer this link for guidance: http://now2gether.org/submissions/Shen/DifferencebetweenAmerica& India.pdf
12.5 Corporate Governance

Corporate governance refers to the mechanism to monitor managers of a company to ensure that they fulfil the legal requirements of their role. Governance rests solely with the Board of Directors, but the composition of the Board differs across countries. Hence, various bodies from different countries have suggested methods of constituting a board. Some of these corporate bodies include the Cadbury Committee and the Veinot Report in France. Governance norms differ across countries, accounting standards, employment laws, and legal framework. Table 12.1 illustrates the differences in some of the important corporate governance issues in some of the developed countries.
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Table 12.1: Corporate governance practices in developed countries Practices Independent auditors Rotation of auditors Executive pay on shareholders approval Nomination of independent directors by shareholders Majority of independent directors on the Board Separate Chairman and CEO Britain Yes Every 57 years Advisory Germany No No Italy Yes Every 9 years Yes Japan Yes Every 7 years Yes USA Yes Every 5 years No
No
No
No
Yes
Yes
No
Recommended
Recommended
No
No
Yes
Recommended
Yes
Voluntary
Voluntary
Voluntary
12.5.1 Code of conduct for MNCs The code of conduct for MNCs refers to a set of rules that guides corporate behaviour. These rules prescribe the duties and limitations of all employees, including the manager. The top management must communicate the code of conduct to all members of the organisation along with their commitment in enforcing the code. Some of the ethical requirements for international companies are as follows: Respect basic human rights. Minimise any negative impact on local economic policies. Maintain high standards of local political involvement. Transfer technology. Protect the environment. Protect the consumer. Employ labour practices that are not exploitative.
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When a manager of an international firm faces an ethical problem, certain models help in solving these ethical issues. Figure 12.4 depicts the process flow for an ethical decision making in an MNC. The first task is to consider the ethical and legal consequences of the issue and whether the action or its consequences are in accordance with the law, both in the home and host country.
Figure 12.4: Steps in Ethical Decision Making
The second task is to perform an ethical analysis, followed by a cultural and a personal ethical analysis. An international manager begins with these analyses at different stages, but at some point a personal moral judgement is made. Iif the answer is negative to any of the first three questions, the decision making is deferred. 12.5.2 Corporate ethical programmes Multinational firms face a wide array of ethical challenges as a result of increased competition due to globalisation. A formal corporate ethical programme is important to any organisation. The following are some of the elements used by a corporate ethical programme:
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Formal ethical codes that articulate expectations about ethics. Ethics committees that are empowered with developing policy and evaluating actions of the company and its employees. Ethics communication systems where the employees report any misconduct. Ethics officers charged with coordinating policies, educating employees on ethics and investigating allegations. Training programmes aimed at helping employees recognise and respond to ethical issues.
Given the broad range of potential ethical issues a multinational firm may encounter, the code of conduct must meet the expectations of various parties involved. The code of conduct must fulfil the following requirements: Be economically viable. Address major issues that are important to the companys stakeholders. Engage important stakeholders in formulation and implementation. Specify performance standards that can be measured. 12.5.3 Social responsibility and ethics International businesses face many challenges while undertaking social actions as part of their corporate strategy. Corporate social strategy helps overcome such challenges. Starting a corporate social strategy includes the following: Be socially responsible. Be responsive to stakeholders in each country. Be able to treat employees, customers, suppliers. and the local community in a fair and just way. Abide by the host governments regulations and policies. Ensure that the employees and personnel of the company follow corporate policies. Recognise emerging issues in the host countries and communities. Conduct business in accordance with the values, customs, and moral principles of society. Organisations that adhere to these strategies are better equipped to react to global challenges and corporate responsibilities. They are better prepared to
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prevent crises, anticipate changes, and avoid situations that compromise the values and principles of the organisation. Self Assessment Questions 4 11. Social responsibility is an integral part of business ethics. (True/False) 12. Respecting human rights is not a basic ethical requirement for an MNC. (True/False) 13. Corporate _________ rests solely with Board of Directors. Activity 2 Devise a model for corporate governance for an Indian company that does business outside India, keeping in mind the current challenges that businesses face. Hint: Refer section 12.5.
12.6 Summary
Now let us summarise the salient features in this unit on ethics in international business: Ethics is significant in all areas of business and plays an important role in ensuring a successful business. People tend to favour the products and services of a company that is ethically and socially responsible. The different factors that influence the ethics of a business and its management are religion, culture, and law. With rise in global firms, issues related to ethical values and traditions have become more common. Bribery, corruption, and worker compensation related issues are the most common ethical issues that MNCs face. Negotiations across countries include the linear model where the principles are first agreed upon, then the various positions are negotiated and details of the agreement are finalised, followed by the process of implementation. The other model for negotiations is the encompassing model, which is more descriptive and includes the same stages as the linear model, but focuses on the extent to which each stage is presented.
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Four approaches that help managers make ethical decision include utilitarian, moral rights, universalism, and cost benefit approaches. The code of conduct for MNCs, refers to a set of rules that guides corporate behaviour. These rules prescribe the duties and limitations of a manager. Organisations that follow corporate social strategies like treating customers in the home and foreign country alike, recognising potential issues, and abiding by the host government regulations are better equipped to react to global challenges and corporate responsibilities.
12.7 Glossary
Bribery: The financial inducement offered to persuade someone to act improperly in favour of the person offering the bribe. Whistle-blowing: The act of reporting a wrongdoing by a current or former employee of a company.

1. 2. 3. 4. 5. Discuss the business ethic factors. Explain the importance of business ethics. Describe different techniques for managing ethics. Analyse different models of negotiating. Explain various steps involved in the ethical decision making process of an MNC.
12.9 Answers
Self Assessment Questions 1 1. Law, religion, and culture 2. Civilisation 3. True Self Assessment Questions 2 4. Xerox 5. Bribery and corruption and worker compensation 6. Competition
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Self Assessment Questions 3 7. True 8. Linear and encompassing model 9. Ethical convergence 10. Ethical decision making Self Assessment Questions 4 11. True 12. False 13. Governance Terminal Questions 1. Ethics is the system of moral values and principles of human conduct and its application in life. Religion, culture and law are the main factors governing business ethics. These are explained in sub-section 12.2.1 of this unit. Refer the same for details. 2. Business ethics is important to an organisation because it leads to better public image, increased credibility of management, helps in better decision making, and profit maximisation. These are explained in sub-section 12.2.1 of this unit. Refer the same for details. 3. The techniques that can be used for managing ethics at workplace include formation of ethics committee, implementation of code of ethics, setting up an ethics hotline and training programmes on ethics and so on. These are explained in sub-section 12.3.1 of this unit. Refer the same for details. 4. There are two types of negotiations widely used in business linear and encompassing model. These are explained in sub-section 12.4.1 of this unit. Refer the same for details. 5. Legal aspects are considered in the first step of decision making followed by a companys ethical code, cultural analysis and personal moral judgement. These are explained in sub-section 12.5.1 of this unit. Refer the same for details.
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12.10 Caselet
Satyam Computer Services Ltd. In December 2008, Satyam announced acquisition of two companies Maytas Properties and Maytas Infrastructure owned by the family members of Satyam's founder and Chairman Ramalinga Raju. Within a day of the announcement, the deal was withdrawn because of the adverse reaction from institutional investors and stock markets. Issues were raised on corporate governance practices of Satyam, with investors seeking answers from the Board about the acquisition because the transaction was evidently made within the promoters family. After the deal was aborted, four of the prominent independent directors resigned from the board of the company. In early January 2009, Ramalinga Raju confessed that the revenue and profit figures of Satyam had been inflated for the past several years. The revelation further deepened the concerns about poor corporate governance practices in the company. After this debacle, questions were raised about the corporate governance structure in Satyam, its code of conduct, roles and responsibilities of different committees under the Board, whistle-blower policy and so on. Several industry bodies questioned the role played by the independent directors of Satyam in approving the Maytas deal. The events that unfolded after Mr. Rajus confessions to his illegal activities placed the future of thousands of employees and the well-being of their dependents at risk, jeopardised projects worth millions of dollars, and portrayed Indian companies inherently corrupted. Regulators and several Indian corporate companies acted quickly to persuade clients and the business community to prove that Satyams case was an isolated event. People with vast experience and knowledge of Indian business processes were brought in to assist in preventing a total collapse of Satyam Computers, which was later bought by Tech Mahindra. Discussion Questions 1. Analyse the instances where the ethics system failed in preventing the fraud. (Hint: Auditing) 2. Formulate a sample code of conduct for Satyam Computers. (Hint: Refer discussions in Section 12.4 of this unit)
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References: Bhalla V. K. and Shiva Ramu S. (2008). International Business Environment and Management, Anmol Publications. Bhatia SK. (2004). Business Ethics and Corporate Governance, Deep and Deep Publications Ltd. Chauhan PL, KakkadRatish, Patel Rupal H. (2006). International Business, ShanthiPrakashan. Cherunilam Francis. (2010). International Business Environment, Himalaya Publishing House. K. Aswathappa. (2010). International Business, Tata McGraw-Hill Publications Co Ltd. McDonald Frank and Burton Fred. (2002) International Business, International Thomson Computer Press. Weiss Joseph. (2009). Business Ethics Concepts and Cases, Cengage Delmar learning India Pvt. Ltd.
E-References: www.managementhelp.org/ethics/ethics.htm, retrieved on 3rd October 2010
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Unit 13
International Human Resource Management
Structure: 13.1 Introduction Objectives 13.2 International Organisational Structures Factors influencing organisation structure Types of structures 13.3 Introduction to International Human Resource Management Managing international human resource activity Domestic versus international human resource management Expatriate staff 13.4 Scope of International Human Resource Management National differences in HRM practices Strategies for international human resources management International employee relations Staffing policies in international business 13.5 Summary 13.6 Glossary 13.7 Terminal Questions 13.8 Answers 13.9 Caselet
13.1 Introduction
In the previous unit you learned about strategic management and the role of strategy in firms success. You also learned about the strategic management process. In this unit you will learn about the structure of MNCs and various dimensions and strategies for international human resource management. As businesses metamorphoses into multinational companies and as the world evolves into a global marketplace, international firms need to be supported by adequate human resources. Human Resource Management (HRM) practices are necessary in order to procure, allocate, and utilise human resources particularly managerial manpower in an efficient manner. While many aspects of traditional HRM policies and procedures are applicable when a company operates abroad, the integration of the various
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regulatory aspects and diverse cultural dimensions makes it necessary for a company to dwell into international HRM to operate efficiently at an international level. Objectives: After studying this unit, you should be able to: interpret the types of international organisational structures. describe the international HRM process. examine the various aspects in expatriate employment. discuss the scope of HRM. explain the staffing policies of a multinational corporation.
13.2 International Organisational Structures

The structure of an organisation plays a vital role in HRM. It is important to understand the structure before getting into the discussion on HR practices. Organisational structure of an international business plays a very important role in realising the goals of the company. International companies need appropriate structure to conduct their business effectively in a competitive economy. The structure of an international business is more complex than in a purely domestic firm. The more assets and employees a firm has in its foreign offices, the more languages, cultures, and time zones it has to cope with resulting in a more complex structure. The structure has to be well-designed and should be based on the business strategy. It is important that various structural components are considered properly. The following are the objectives of a well designed organisational structure: Have the right people take right decisions at the right time. Establish reporting hierarchy and accountability. Facilitate easy flow of information in the organisation. Provide a positive work environment that encourages efficiency. Integrate and coordinate activities. A multinational firm shares large amounts of information between the headquarters and its various offices and subsidiaries across the world. Hence, integrating and coordinating organisational activities is imperative in the organisational structure.
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There are various factors that influence the design of organisational structures. Let us discuss some of these factors in detail. 13.2.1 Factors influencing organisation structure The major factors that influence organisational structure can be classified very broadly in two as follows: Environment. Technology. Environment Environmental factors include both internal and external factors affecting the organisational structure. Let us briefly discuss these factors. Internal environment Internal environment includes factors controlled by the management or based on the functions of management. The manner of functioning of the management contributes to the designing of the organisation structure. Some of the management approaches affecting organisational structure are as follows: Ethnocentric management Decision making is controlled by the head office and most of the managers are from the parent company. Polycentric management Decisions are largely decentralised and managers in the subsidiaries are mostly from the host country Geocentric management Decision making is decentralised and managers from across the globe make decisions affecting operations internationally. In this approach, manager in one country can make decisions affecting the operations in another country.
The size of an organisation influences its structure. Bigger companies with multiple divisions add to the level of complexity of the organisational structure. Increase in the organisation size prompts for an increasing number of employees to keep up with the organisations growing business. It also brings in the need for additional rules and regulations to maintain optimum levels of efficiency and productivity. The need for decentralisation increases when the company grows in size. External environment The external environment refers to a wide array of factors beyond the company's control. These factors can be classified as follows:
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Environmental risks The instability caused by the differences in culture, government policies, strength of the economy, and availability of qualified employees, industry cycle, and stability of the financial system constitute environmental risks. Strategy for expansion These include the strategies that a company adopts to enter new markets or expand its business. The structure of a business, in turn, depends on the strategy adopted by the company.
Technology Technology plays an important role in the designing of an organisation structure. The application of technology at different levels like employee, division and organisation determines the design of the structure. An organisation may use the technology at different stages like stage of procurement of inputs and raw material, production stage, and delivery stage. The sophistication of technology determines the design of a modern business organisation. Irrespective of the organisational structure, every firm uses technology and facilitates communication across job profiles in the organisational structure. Every department of the organisation uses technology and a many of these departments have technology experts among their employees. The technology experts and the professionals working in this field must support and connect every area of the organisation. The integration of Information Technology (IT) facilitates communication among employees. A conscious effort must be made to maintain relationships with each group. IT representatives must provide updates to the employees about their various products and applications. In return, the employees must provide feedback on these products and application to the IT department. These relationships within departments are often overlooked and are lost due to immediate organisational design challenges. Hence, relationships with all future participants must be maintained through well planned communication. Technology and the knowledge-based economy are not constrained by the physical objects and materials of an organisation. Information is flexible and can be structured and organised in a number of ways. For example, videoconferencing and telecommuting allow members of project teams from different departments to work together, regardless of their geographic
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location or department. Thus, technology enables departments within organisations with easier communication 13.2.2 Types of structures Organisations adopt the most suitable structure based on the various factors that we discussed in the previous section. Let us now discuss some of the most commonly used structures for international business. Export structure A domestic company has to make provisions for an exclusive export division. If the export division undertakes all the export activities instead of using an agent, then it needs to maintain a minimal staff for the following functions: Maintain export documentation like shipping, insurance, finance, and customs. Conduct international marketing research to understand procedures and regulations. Distribute products in the foreign markets. Indulge in sales and marketing, advertising, promotions, mail order catalogues and so on.
International division structure An international division is established in a company when there are substantial branches or subsidiaries operating in foreign countries. This division controls all the foreign operations of the organisation. Since all the foreign operations are under one authority, control and communication are easy. Figure 13.1 depicts an organisation with an international division.
Figure 13.1: International division structure
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Functional structure In this structure, each functional department is responsible for activities around the world. For example, the finance department is responsible for the organisations finance activities around the world. This is the case with all the other functional departments, such as marketing, manufacturing, and human resources management. This design is used by international firms that have a narrow product line with limited number of products. Figure 13.2 depicts an organisation with a functional structure.
Figure 13.2: Functional structure
From the figure you can see that each division directly deals with countries A and B. Regional structure In this structure, international operations are organised by dividing the entire globe into different geographic regions. Strategic decisions are made in the headquarters and the regional manager is responsible for all operational issues within the region. Figure 13.3 depicts the regional structure in an organisation.
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Figure 13.3: Regional structure
From the figure above, you can see that regional managers for Europe and Asia Pacific regions report directly to the company headquarters while taking charge of their respective countries. Foreign subsidiary structure In this structure, each of the companys foreign subsidiary reports directly to the headquarters. This structure eliminates the necessity of a regional manager. Though strategic decisions are taken at the headquarters, each subsidiary acts autonomously for their local operations. Figure 13.4 depicts the foreign subsidiary structure in an organisation.
Figure 13.4: Foreign subsidiary structure
From the figure you can see subsidiaries based in USA, UK, France, and Japan report directly to the headquarters in India. Product division structure International companies that have a diversified product range across diversified markets can opt for product based organisational structure. Global responsibility for a product or a group of products is on separate operational divisions within the company. This organisational structure, as depicted in figure 13.5, is followed most commonly by multinational consumer goods companies.
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Figure 13.5: Product division structure
From the figure above, you can see that the product managers report directly to the headquarters while they are responsible for all the operations in their respective countries. International matrix structure This structure is the most complex organisational structure. This form of structure is suitable where several functional divisions from across the globe performing related duties are grouped together into an international product division. These product divisions can then plan, design, develop, produce the products or services required. The product divisions are dissolved or the teams are assigned to some other division after the project is executed. Figure 13.6 gives you an idea of the international matrix structure.
Figure 13.6: International matrix structure
In the matrix structure, you can see that different product managers work with different departments across the globe, breaking all the divisional barriers.
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Self Assessment Questions 1 1. A well designed _______ facilitates efficient communication in an organisation. 2. Technology and the environment are factors that influence organisational structure. (True/false) 3. ________ is the most complex form of organisational structure. a) Product division structure b) Functional structure c) International matrix structure d) Foreign subsidiary structure
13.3 Introduction to International Human Resource Management

In the previous section you learned about international business organisational structures. In this section, you will learn about the ways in which HRM deals with workforce management and its relationship with the organisation. The purpose of HRM is to make the maximum utilisation of the firms human resources so that both employer and employee benefit from their association. The following are some of the functions of HRM: Plan, recruit and terminate employees. Educate and train employees for career development. Provide compensation and terms of employment for employees. Facilitate communication between employers and employees. Settle disputes and negotiate on wages and working conditions. International Human Resource Management (IHRM) is the process of recruiting and managing the services of an organisations personnel across the globe, to achieve its goals. 13.3.1 Managing international human resource activity Employees are an asset to the organisation. HRM activities need to be designed to utilise the employees potential to the maximum. This can be achieved through their involvement with the organisation and by increasing the employees commitment to the business objectives of the organisation. The employees are trained to accept change, be innovative, and become quality conscious and flexible. HRMs task is to integrate personnel into the organisations corporate ideologies and to constantly help the workforce to
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be more productive and efficient, thereby making the business more productive. Figure 13.7 illustrates some of the important activities involved in HRM.
Figure 13.7: HR Activities
As depicted in figure 13.7, human resource planning, recruitment and selection, training and development, performance management, remuneration, repatriation and employee relations play an active role in the organisations efficiency. Let us now discuss some of the important activities. Human Resource Planning (HRP) HRP is a very important aspect in the process of HRM. It is the process of assessing staffing requirement for the future and taking care of the adequate and timely supply of human resources for the same. In an international scenario, HRP plays a greater role in achieving the global objectives of the organisation, as the sourcing of HR is spread across countries. Some of the challenges in international HRP are as follows: Identify the key top management executives. Design organisational structure and responsibilities of international managers. Provide adequate training to managers and equip them for a multicultural experience. Maintain the career focus of the international managers by providing adequate developmental opportunities.
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Integrate multiple business units across the globe to a common strategic objective.
Recruitment and selection Hiring employees is a challenge for any international business. The international HR managers have to make sure that they hire the most suited candidates. This means that possessing the right skill is not the only criterion. They must also look at the adaptability of the potential employees to the corporate culture and beliefs of the organisation. The HR manager also needs to make sure the organisation hires new employees with flexibility to adapt to foreign cultures. 13.3.2 Domestic versus international human resource management Fundamentally, domestic HRM and IHRM have the same processes and objectives. IHRM differs from the domestic HRM in terms of its scope and its challenges because of the internationalisation of business and its managers. Let us discuss some of the factors that differentiate IHRM from domestic HRM. The scope of the HR activities is larger because the organisation deals with multiple countries and employees from several cultures. International workforce requires greater involvement of management at a personal level. The approach is complex because of the potential cultural mix in the workforce. Risk management is an integral part of the IHRM policies. Expatriates are subject to tax at home and in the host country. Hence, tax policies have to be devised in a way that they do not penalise the employee for moving to another country. Relocation of staff involves providing immigration and travel services, providing housing, medical care, and schooling for employees children, pre-departure training, international allowances and so on. The laws in the host country vary from those in the parent country. The human resource department must be equipped to deal with all potential issues and ensure that the newly relocated employees and their families are able to function properly in the foreign country.
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Differences in government policies of foreign countries requires the human resource team to ensure that all the expat employees adhere to the norms set by the government.
13.3.3 Expatriate staff Expatriates play a major role in international businesses. Multinational companies place a lot of effort in selecting employees. By employing staff from the parent country in the companys various international locations, the senior management ensures that the foreign subsidiary runs according to the requirements of the head office. The senior management also ensures that experienced employees with the right attitude and capabilities are involved with foreign operations and are fully aware of company policies. Expatriates also tend to have greater product knowledge and managerial expertise than the locals. The following are some of the disadvantages in employing expatriates: Problems with the local language, customs, culture, and business practices. Time to settle in the new environment, which has a negative impact on the employees productivity. Prejudices towards certain ethnic groups may arise during foreign posting. Imposed management style that the host country employees are not comfortable with and may find inappropriate. Obstruction of opportunities for local staff.
Expatriate selection Selection of expatriate employees is a highly specialised function in HRM. The following factors are important while recruiting an expat employee: Technical competency. Interpersonal skills. Ability to cope with the foreign environment. Ability of the expatriates family to adjust to the foreign environment. Figure 13.8 presents the different criteria for recruiting expatriate employees. The HR team must consider the candidates personal
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expectations, as well as the candidates family comfort, in moving to a foreign country.
Figure 13.8: Expat selection criteria
After the HR team selects the right candidate, they provide proper support and information to the employee and family for a smooth transition. This step is critical to the success of employing the expatriate and in turn the success of the international business unit. Before posting the newly recruited employee to the international location, the company must do the following: Provide the employee and family with cultural and language orientation with the intention of familiarising the new country to them. Make provision for pre-assignment visits so that the employee, spouse and family can find appropriate accommodation, schools, recreational options and so on. Assign mentors who are familiar with the experience of relocation, preferably from the home country. Counsel the family about the challenges of moving to a new country so that they can prepare themselves.
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Adjusting to expatriate life Managing the overseas employee has always been the tough job for the HR manager. Host country culture can be dramatically different from the way things are back home. Most of the times, new expatriate including their spouses and children feel overwhelmed and disoriented by the shock of a novel cultural environment. Possible ways of adjusting to new life as expatriates can be psychological adjustment to the new environment which is largely an internally oriented process of feeling of well-being or satisfaction of being abroad. Second method is the sociocultural adjustment process which is externally oriented and involves that how well one can adjust himself or can act with new team of unfamiliar people or community. One can find new friends and here are several general suggestions on how to find new friends: Expats with children have an opportunity to start or strike up a conversation with other parents at school, sporting activities, and social events. Cities especially in Europe and North America has networking groups for professional women. Even in developing countries respective embassies/cultural center have information about networking meeting or cultural events where expatriates can familiarise themselves. One can take a course in dance, music, painting, pottery and even the local language. This helps in getting people to know about expatriates choice and interests and interact. One can become a volunteer or even become a member of a local NGO. It is one of the most rewarding ways to meet new people as you contribute to the society. Expats can also mingle with their neighbours and make new friends especially if the area has predominantly expatriate population. For example, Geneva or New York One can join an athletic club or join a sport club which not only keeps him busy but makes him physical and emotionally strong. Spouse of the expatriates can even join a job which is considered least cost and most effective way of immersion in the host culture. Adapted from: How to Adjust to Expat Life, Maria Fole at www.suite101.com
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Expatriate failure Globally, there has been a failure rate of more than 25 percent amongst expat employees. Despite the training and efforts undertaken by the HRM, the expats underperformance and failure has been a matter of concern for the multinational companies. Most cases of expatriate failure have been due to the following reasons: Spouses inability to adjust. Marital stress. Employees inability to adjust. Home sickness. Hostility towards host nationals. Loss of confidence. Family tension and conflict. Personal or emotional maturity. Inability to cope with larger international responsibilities. Difficulties with new environment. Personal or emotional problems. Lack of technical competence. Self Assessment Questions 2 4. Planning, recruiting, and termination are some of the functions of the ______________ management. 5. The expats underperformance and failure is not a matter of concern for the multinational companies. (True/False) 6. HRM activities need to be designed to utilise the employees potential to the maximum. (True/False) 7. Which one of the following is not an important activity involved in HRM? a. Human resource planning. b. Recruitment and selection. c. Remuneration. d. Project planning. Activity 1 Play the role of an international HR manager and devise a plan in 500 words to help with the transition of an expatriate employee and his family to an Indian city. Hint: Domestic versus international human resource management
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13.4 Scope of International Human Resource Management

In the previous section we studied the role and other aspects of selecting expatriate employees. In this section, we will discuss the scope of IHRM. The three main dimensions of international human resources management are as follows: Human resource activities. Countries of operation. Origin of employees. Human resource activities HR activities in an IHRM context involves procurement, allocation, and utilisation of workforce. These functions in turn cover all the six activities of human resources management, that is, human resource planning, hiring, training and development, remuneration, performance management, and employee relations. Countries of operation The countries of operation in an IHRM perspective involves the host country in which the overseas operation is located, the home country that houses the headquarters of the company, and other countries that supply labour and finance. Origin of employees The origin of the workforce of an international business can be classified into three types parent country nationals, host country nationals, and third country nationals. 13.4.1 National differences in HRM practices In this section, let us discuss the factors that determine human resources management practices in each country. The different factors are economic, social, cultural, legal, labour market, business stakeholders, role of the state, the workforce and so on. Differences that arise at a national level are as follows: Degree of employee management. participation in decision-making by the
Legal regulations of employee relations and rights of employees. The importance of market forces when deciding remuneration and employment conditions. Cultural background of the key people involved in human resources management.
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Across various countries, the same jobs can vary with respect to motivation, commitment, pay scale, skill set, and education. Other factors that determine national differences are length of employment that has an effect on the attitude of personnel towards the organisation, age and gender, expectation regarding working hours, etc. The attitude of managers from different countries also varies in many aspects. Some of these aspects include the following: Management style. Values and ethics. Approach to decision making. Approach to problem solving. Expectations with respect to remuneration. Importance given to management models and techniques. Attitude to risk. 13.4.2 Strategies for international human resources management The success of a multinational company depends on the techniques and strategy adopted to select, train, develop, manage, and motivate its workforce. An organisation achieves its objectives only with competent employees. The main reasons for organisations to formulate a human resources strategy are as follows: Capable of competing on an international level with rivals when they have most efficient employees. Employee expense is a large part of the total spending of a multinational firm. Capacity to innovate, add new business lines, and enter new markets depends more on its employees than on capital investment. Emphasis on the computerisation of administrative and manufacturing functions has a large impact on the structure of employment within a business. There is lower demand or unskilled labour. Need for specialist skills, which are attained over time and experience, to increase organisational complexity. Employees have to be treated based on the specific labour laws that the host countries follow.
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A proper human resources strategy is needed if the management emphasises on human relations. It thus, encourages a professional approach to human resources management. Problems with the strategies discussed earlier include the following: The lack of genuine commitment to execute the strategy since strategies are sometimes formulated as a formal procedure based on the norms of the headquarters. The differences in opinion over a worthwhile human resources strategy may arise between the human resources department at the head office and the subsidiaries. The necessity for all the organisations employees to be aware of the human resource strategy through proper communication between management and the workforce. Without proper employee involvement, it is difficult to implement the HR strategies. Improper HR strategies lead to various organisational issues that are not obvious in the short term.
Influences on international human resources management External factors that influence human resources strategies are as follows: Legal factors related to the workforce on issues such as the right to strike, employee protection, participation in management decisions, setting of minimum wage levels, etc. Political environment, which refers to the attitude of the host country government, guidelines on employment, and industrial relations. Economic factors including inflation, unemployment, competition, and growth prospects. Social trends such as participation of women in the workforce, attitude towards working hours, demands for improvement of working life quality, changes in living standards, opportunities for education and so on. Technological factors that affect working methods, needs to impart new skills on the workforce, flexibility of labour, and the impact of new technologies on the management.
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The internal factors that affect the international human resources strategies are as follows: The level of decentralisation of the company. Morale of the employees. Ability of unskilled workers to complete jobs. Background, educational level, and technical skills of the local workforce. Trade union activity within the subsidiaries. Attitude of the important stakeholders towards employee relations. Perspectives of top managers.
13.4.3 International employee relations Employee relations deal with all the formal and informal relationships between employees and the management. There is a greater emphasis on cooperation than on conflict in the management of employee relations. It is important for the management to recognise the importance of harmony within the workforce across various countries. The management should credit increased competitiveness to employee relations policies for better employee cooperation. Some of the major decisions the management must consider while devising an employee relations strategy are as follows: Decide whether to recognise trade unions. Implement procedures that affect employee relations and the way managers approach employee relations. For example, selection, recruitment, appraisal, training, and promotion. Check if external agencies used by the management help in resolving conflicts. Divide the profit between the business owners and workers. Communicate effectively with employees. Know the extent to which employee representatives are involved in making decision at a management level. Generally, MNCs customise the employee relations policies for each subsidiary or country depending on that countrys labour laws and practices. Because of the differences in the approach by different countries,
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companies cannot use a standardised model across its international operations. The state of employee relations in the subsidiaries is important in controlling labour costs and helping the organisation grow. This is a cause of concern to the parent company. Headquarters advise on the following aspects: The firms philosophy on workers relation with the management and the role of trade unions. Various solutions to employee relations. Cost factors that arise due to the companys overall strategy. Comparison of success of employee relation policies in other countries. Pay scales and employment conditions in various countries. Measures to improve productivity in other countries. Management aims to apply consistent policies to its subsidiaries throughout the world, though such policies need not be identical. It is also vital for managers in subsidiaries to be completely aware of the relationship between management and employees to create harmony. Harmony results in greater competitiveness and efficiency. 13.4.4 Staffing policies in international business The international human resources manager needs to formulate staffing policies before starting of the process of hiring employees. The four main policies regarding staffing are explained as follows: Ethnocentric approach The key managers are from the parent country. The strategy is important during the early stages of the business because a part of the business that was successful in the home country needs to be transferred to the host country. Some of the reasons for this approach are as follows: The lack of qualified employees from the host country. The need for a united corporate culture. The maintenance of good communication, coordination, and control with headquarters. The following are the disadvantages of the ethnocentric approach: Host country employees being deprived of promotion. The time taken by the home country managers to adapt to the host countries.
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The sensitivity of the expatriates to the needs and expectations of their host country subordinates.
Polycentric approach This approach requires host country nationals to manage subsidiaries. The benefits of such a policy are that there are fewer possibilities of language issues, expensive training periods, and cultural adjustment issues. The disadvantage of this approach is that the local managers may find it hard to bridge the gap between the subsidiary and the parent company. There may also be language issues, loyalties to the host country that conflict with the needs of the multinational organisation, and cultural differences between the home country managers. Region-centric approach Managers from various countries in the region are employed within the geographic region of a business. Although they operate with a certain amount of independence, they are not moved to the home country. This is a flexible approach and locals are hired when regional expertise is needed whereas employees from the parent country are brought in if product knowledge is required. The disadvantage of this approach is that managers in the region may not understand those at the head office and adequate number of managers with international experience cannot be hired. This approach serves as a step towards a geocentric approach. Geocentric approach The best suited employees for vital positions are hired throughout the company without taking into account the nationality of the employees. The success of this approach is based on the following five assumptions: Availability of highly skilled employees at the subsidiaries. International experience required to succeed in top positions. Ambitious and promising managers who can be readily transferred from one country to another. Adaptability of managers to different countries after international exposure over a period of time.
This approach helps a company create a pool of efficient international managers, comfortably working in a number of cultures.
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Self Assessment Questions 3 8. The workforce of a multinational are of three types parent country nationals, host country nationals, and _____________. 9. Ethnocentric and polycentric approaches are examples of ____________ policies. 10. Remuneration is one of the key staffing policies in an international business. (True/False) 11. The nationality of the employees is not taken in to account while hiring for the company in geocentric approach. (True/False) 12. Which of the following is not an approach under staffing policy? a) Geocentric approach. b) Biometric approach. c) Polycentric approach. d) Ethnocentric approach. Activity 2 Using resources on the internet, analyse the HR practices that an Indian MNC employs to recruit and retain its expat employees. Hint: http://www.streetdirectory.com/travel_guide/183845/human_resources/ne ed_for_effecting_recruitment_and_hr_practices.html
13.5 Summary
Let us summarise the points covered in this unit on international human resource management: The structure of an organisation plays a vital role in HRM. Internal and external environment contribute the structure of an organisation. Business strategy plays an important role in the structure of an organisation. The different types of international organisational structures are export structure, international division structure, functional structure, regional structure, international subsidiary structure, product structure, and international matrix structure.
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IHRM is a vital component in the functioning of a multinational enterprise. IHRM helps deal with the factors that make the workforce more efficient and the organisation more competitive. Though there are many strategies and policies regarding the deployment of personnel across various countries, the one that best aligns the needs of the parent country and employees in foreign subsidiaries is the one that yields the best results. International staffing policies depend on the approach adopted by an organisation. The four approaches are ethnocentric, polycentric, regioncentric, and geocentric approach.
13.6 Glossary
Home country: The country where a companys headquarters is located. Host country: A country other than the home country where a company operates. Remuneration: The total package, which includes salary, bonuses, allowances, stock options and so on, that the employee receives from the employer.

1. 2. 3. 4. 5. Analyse different structures in an international organisation. Explain the function of human resource planning. List the key factors affecting the recruitment of expats. State the key national differences in HRM practices. Discuss the different approaches to staffing in an international business.
13.8 Answers
Self Assessment Questions 1 1. Organisational structure. 2. True. 3. c) International matrix structure.
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Self Assessment Questions 2 4. Human resource. 5. False. The expats underperformance and failure has been a matter of concern for the multinational companies. 6. True. 7. d) Project planning. Self Assessment Questions 3 8. Third country. 9. Staffing. 10. False. Remuneration is not one of the key staffing policies in an international business. 11. True. 12. b) Biometric approach. Terminal Questions 1. Export, international division, functional, regional, international subsidiary, product and international matrix are some of the organisational structures in the international business. These are explained in sub-section 13.2.2 of this unit. Refer the same for details. 2. Human resource planning is the process of assessing the staffing requirement for the future and taking care of the adequate and timely supply of human resources in an organisation. These are explained in sub-section 13.3.1 of this unit. Refer the same for details. 3. Technical competency, willingness to work in a foreign country, adequate growth opportunity, spouse and familys willingness to adapt in a new country are some of the factors affecting the recruitment of expats. These are explained in sub-section 13.3.3 of this unit. Refer the same for details. 4. Employee participation in decision making, legal framework of employee relations, individualism, collectivism, cultural background, and so on is the common national differences in HRM practices. These are explained in sub-section 13.4.1 of this unit. Refer the same for details. 5. Ethnocentric, polycentric, region-centric and geocentric are the approaches taken by HRM in an international business. These are explained in sub-section 13.4.4 of this unit. Refer the same for details.
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13.9 Caselet
IHRM at Unilever Unilever PLC. is the worlds largest Fast Moving Consumer Goods (FMCG) Company with a turnover of 39.8 billion and is the leader in Home and Personal Care Products, Foods and Beverages. It employs 1,63,000 people in more than 100 countries worldwide. Unilevers products are sold in over 170 countries around the world. Their manufacturing facilities are spread across many countries and they also export products to countries where they do not have manufacturing operations. Currently, they have 264 manufacturing sites worldwide, all of which strive for improved performance on safety, efficiency, quality and environmental impacts working to global Unilever standards and management systems. Hindustan Unilever Limited (HUL), a subsidiary of Unilever PLC. is India's largest FMCG company with around two thirds of the market share in its sector. HUL has several manufacturing plants spread across the country. The mission that inspires more than 15,000 employees, including over 1,400 managers of HUL group is to help people feel good, look good and get more out of life with brands and services that are good for them and good for others. It is a mission HUL shares with its parent company, Unilever. The fundamental principle determining the organisation structure is to infuse speed and flexibility in decision-making and implementation with empowered managers across the companys nationwide operations. HUL is known for its capability to appeal to and darn the right employees. Several Unilever India managers have taken senior level responsibilities in Unilever's worldwide system. In 2008, over 80 HUL managers held top positions in different Unilever companies or corporate functions. The management realised that to be competitive, they had to re-structure their hiring policies, and hence developed an international cadre of managers. The management posted its employees to various parts of the world after providing them intensive training on culture and countryspecific details. These managers are expected to work in any country with the same amount of efficiency as they would in any other.
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Discussion questions 1. Suggest the most appropriate organisational structure for HUL. (Hint: HUL has multiple global products and manufacturing plants across the globe) 2. What makes HULs managers most sought after in Unilever? (Hint: Refer HRP in section 13.2.1)
Source:http://www.unilever. com/ boutus/ introductiontounilever/ unileverataglance/?WT.LHNAV=Unilever_at_a_glance Retrieved on 8th October 2010 http://www.hul.co.in/aboutus/introductiontohul/HULataglance/default.aspx Retrieved on 8th October 2010
References: Bhalla, V. K. & Shiva Ramu, S. (2008). International Business Environment and Management. Anmol Publications. Brewster, Chris, Sparrow, Paul & Vernon, Guy. (2008). International Human Resource Management. Universities Press (India) Limited. Cherunilam, Francis. (2010). International Business Environment. Himalaya Publishing House. Harzing, Anne Will & Rusysseveldt, Joris Van. (2007). International Human Resource Management. Sage Publications India Pvt. Ltd. K., Aswathappa & Sadhna, Dash. (2009). International Human Resource Management Text and Cases. Tata McGraw-Hill Publications Co. Ltd. McDonald, Frank & Burton, Fred. (2002) International Business. International Thomson Computer Press.
E-References: http://managementhelp.org/hr_mgmnt/hr_mgmnt.htm, retrieved on 6th October 2010
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Unit 14
Finance and International Trade
Structure: 14.1 Introduction Objectives 14.2 Understanding Payment Mechanism in foreign trade Payment terms in foreign trade Letter of credit 14.3 Documentation in International Trade Commercial invocie Packing list Bill of lading Insurance certificate 14.4 Financing Techniques Bankers acceptance Factoring Forfaiting 14.5 Export Promotion Schemes 14.6 Export and Import Finance Short term credit Long term credit EXIM bank 14.7 Summary 14.8 Glossary 14.9 Terminal Questions 14.10 Answers 14.11 Caselet
14.1 Introduction
In the previous unit, we have studied about the importance of ethics in international business. We also learned the various methods adopted for formulating ethics and how the difference in culture affects the ethical practices around the world. Walk into any mall, you will come across Washington apples, cheap Chinese toys and plastics, South Korean and Japanese television sets, Brazilian coffee or South African wine. Today, Indian spices are popular all
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over the world. All these are the results of increasing international trade. International trade is a system, which deals with the exchange of goods and services between nations. As global citizens, International Trade shapes our lives and boosts the economy of the participating countries. There are various financing techniques that play a major role in international trade and finance. This unit covers the benefits, payment systems and arrangements related to international trade. We will discuss documentation required to make any foreign trade transaction. We will also learn about various export promotion schemes supported by the government and methods to avail finance as exporters and importers within India. Objectives: After studying this unit, you should be able to: describe the payment system facilitating the foreign trade. analyse the documentation required to facilitate international trade. explain various Government schemes to promote exports from India. explain different kinds of finance options available for international trade.
14.2 Understanding Payment Mechanism in Foreign Trade

For successfully conducting international trade in todays competitive international environment, it is essential for the exporters to offer attractive sales terms and payments to importers so as to woo them for business. One of the major concerns for en exporter is to choose the appropriate payment method in order to minimise risks related to payments of trade transaction. Payment should be done after understanding the economic scenario of importers country, importer credit worthiness and to certain extent accommodating the needs of the importer. Exporter can choose any mode of payment depending on risk perception, size of deal, importer credit worthiness and economic situation in importers country.
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Table 14.1: Factors to be considered for choosing payment terms Factor Type of the customer Relationship Economic stability Type of order Transaction Size Cash flow Require Letter of Credit Undetermined New Unstable Custom Large Always Consider Documentary Collection Against Payment Acceptable Established Stable Regular production Moderate Never Consider Open Account Excellent Established Very stable In stock Small Never
Source: John Michael Pierobon; How to Succeed In International Business
In case of domestic business, main factor driving salesmans decision criteria for realisation of payments is based on the buyer's ability, willingness and honesty to make payment coupled with exporter trust on buyer. Usually sale in domestic market are on open account and in certain cases it can be on cash in advance. Such methods also depend on buyers and sellers power to negotiate and nature of competition such as: Monopoly condition will favour to the seller. Perfect competition will favour to the buyers. However, in case of international trade, exporter has to take more precautions as some methods of payment are unique and usually used in case of international trade only. Key consideration while deciding upon a payment term in foreign trade is elaborated as under. A. Some of the major risks involved in realisation of payments in international trade can be either at importer, importer bank and importers country such as insolvency and default by importer, insolvency of importer bank and exchange control restrictions, inconvertibility issues with importers country. B. Some of the risks involved in international trade in Liberalisation, Privatisation and Globalisation era can be under control of exporter but some cannot be. For example, credit risk which arises from a change in
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the credit worthiness of importer can be covered by ECGC. Exchange Rate Fluctuation risk can be covered by hedging the currency invoiced in forward contract market but risk such as Force Majeure which arises from change in policy of a country, which in turn affects the trade capability, and by a natural disaster cannot be anticipated in complex international environments1. Other risks mainly arises due to a difference in culture, law, or language are also beyond exporter control.
Exhibit 14.1: Choice of payments method: Decision Matrix
1. 2. 3. 4. 5. 6. 7. 8. 9.
Buyer-Seller relationship. Competition. Buyers credit standing. Uniqueness of the product (Is it custom made?) Cash flow considerations. Country conditions (political, economic). Transaction costs. Risk tolerance/aversion. Other.
Source: Craig F. Schaffer, Inside Trade Finance
C. International Trade Operations offers different types, quantum and location of risks, thereby confusing the exporter with uncertainty over realisation of payments and timing of payments between the exporter and importer2. D. For exporters, any international sale will be equivalent to gift until he has not realised the payment from the importer. For importer any payment is donation until he has received the cargo as sent by exporter. E. Exporter will always be interested to receive the payments as soon as he/she sends the goods to importer through shipment. Importer will be willing to delay the payments as he/she will be interested to sell these goods in markets and then make the payments to exporter.
General Insurance Companies, in LPG&M era covers even the Force Majeure risks in international trade. 2 J. H. Rayners & Co., Ltd., and the Oilseeds Trading Company, Ltd. v.Hambros Bank Limited 1942 Sikkim Manipal University Page No. 296
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F. However, the selection criteria for mode of payment is based on mutual negotiation of exporter and importer and in LPG&M era there are other parties such as bank, credit insurer involved which helps in exporter in financing and assuring about the payment. G. Though safe mode of payment such as L/C is getting popular, this is not usually used by small exporters and importers due to heavy transaction costs. For example, L/C is used as mode of payment only in 14% trade transactions due to heavy transactions costs3. H. Exporter can alternatively divide the payment category into secure mode and unsecure mode. The secure mode of payment for exporter is cash in advance and letter of credit. Unsecure mode of payment are Open Account, Documents against Acceptance and Documents against Payments. 14.2.1 Payment terms in foreign trade Since international trade deals with exchange of goods, there are various ways in which the payment terms (finance) will be handled. Bothe seller and trader should be careful about the method of payment as they are at different locations and transactions happen without face-to-face interaction. There are four methods of payment for the international transactions. This includes the Cash-in-advance method, Letter of Credit, Documentary collections and the Open Account. These are shown in figure 14.1.
Figure 14.1: Payment Risk Diagram
Information accessed at www.wikipedia.com Page No. 297
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As shown in figure 14.1, there is uncertainty during the time when payment transactions happen between importer and exporter. The figure compares and contrasts the most suitable methodology from the perspective of importer and exporter. Apparently the most secure methodologies that work for the exporter is not safe for the importer. For exporters, documentary collection and open account are less secure and letter of credit and cash in advance are more secure methods. In the same way, with respect to the importer, the letter of credit and cash in advance are less secure and the documentary collection and open account are more secure. These terms are explained as follows. Cash-in-advance Cash-in-advance helps in removing the risks of credit by the exporter. By this method, exporter receives the payment before the transfer of goods. The options that are available with the cash-in-advance method include wire transfers and credit cards. This is the least attractive method for many of the buyers as it creates cash flow problems. The buyers are concerned about the quality/quantity and delivery of the goods that are not sent if the payment is made in advance. Letters of credit The letter of credit is the most secure instrument available for international traders. This is the commitment made by the bank that the payment will be made to the exporter if the terms and conditions are met. The terms and conditions of the payment are explained in the required documents. Documentary collections Documentary collection is a transaction in which, the exporter's bank (remitter bank) sends the documents to the importer's bank (collecting bank). The document contains information about the payment. The funds are collected from the importer and paid to the exporter through the banks involved in the collection, in exchange for the documents. Open account The open account transaction involves the shipping and delivery of goods in advance. The payment is due usually from 30 to 90 days. This is advantageous for the importer in cash flow and cost terms, but at the same time it is very risky for the exporters. Buyers from abroad stress on open accounts since the extension of credit from the seller to the buyer are more
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common in many countries. Exporters who avoid extending credit may face loss in the sale because of competitors in the market. 14.2.2 Letter of credit International Trade is affected by distance, laws, political instability and lack of familiarity by the transacting parties. Letter of credit assumes significance since it can be used to mitigate risk. It is a document that is issued by the bank that guarantees payment to a beneficiary. It is written by the financial institution in favour of the importer of goods to the seller. In the letter, the bank promises that it will honour the drafts drawn on it if the seller confirms to the specific conditions that are set forth in the letter of credit. The process of letter of credit works as shown under:
Exhibit 14.2: Process of Execution for Payment under L/C Mode
Self Assessment Questions 1 1. The letter of credit is a letter that is benefial for both buyer and seller. (True/False) 2. The ________ transaction involves the shipping and delivery of goods in advance. a) Open account. b) Draft. c) Cash-in-advance. d) Letter of credit.
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14.3 Documentation in International Trade

Now, we will learn about documentation in international trade. A number of international trade documents are required at various stage of international trade transactions; process of trade begins with proforma Invoice and ends with negotiations of documents with the banks for payments of export deals. Documents are very important in international trade deals and fulfil the commercial as well as regulatory requirements of international trade transactions. Such documents may be aimed for various purposes such as bill of lading carries the title of goods. It is a contract of affreightment, proof of ownership and tells the origin and destination of goods. Hence sound knowledge of the International Trade Documentation is essential for a successful international marketer. Export imports documents are broadly classified into two; namely commercial and regulatory documents. Various commercial and regulatory documents that are used in India are tabled as under: COMMERCIAL DOCUMENTS Auxiliary Commercial Documents 1. Shipping Instruction 2. Pro-forma Invoice 3. Shipping Order 4. intimation of Inspection 5. Mates Receipt 6. Insurance Declaration 7. Application for Certificate of Origin 8. Letter to the Bank for Collection/Negotiation of Documents Principal Commercial Documents 1. Commercial Invoice 2. Packing List 3. Certificate of Inspection/Quality Control 4. Certificate of Insurance 5. Bill of Lading/Combined Transport Document 6. Certificate of Origin 7. Bill of Exchange 8. Shipment Advice
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REGULATORY DOCUMENTS Main and important regulatory documents 1. Shipping Bill / Bill of Export 2. Application for Remission of Excise (ARE I & II) 3. Exchange Control Declaration (SDF/GR/PP/SOFTEX/VOP) Forms 4. Bank Realisation Certificate 5. Proof of Landing Allied regulatory documents 1. Export Application/Dock Challan/Port Trust Copy of Shipping Bill 2. Receipt for Payment of Port Charges 3. Vehicle Chit 4. Freight Payment Certificate 5. Insurance Premium Payment Certificate
Table 14.2: Commercial and regulatory documents
14.3.1 Commercial invoice Commercial invoice is the document that is given to the seller from the buyer. It is called as the import invoice or export invoice. It is mainly used by the custom authorities of the importer country. Commercial invoice helps to evaluate goods for the purpose of taxation. The following are some criteria that are considered while issuing a commercial invoice. The commercial invoice must be: Issued by the seller in the credit, who is the beneficiary. It must include the price amount that should not exceed the price stated in the credit. Addressed to the applicant of the credit, which refers to the buyer. It must include the details of the goods, included in the credit. Signed by the beneficiary if it is required. Issued in the specified number of originals and copies and must include the price and unit prices, if it is required. Clear about the shipping terms. 14.3.2 Packing List Customs officials use packing list to check what is being exported or imported while importer uses it to know without opening the carton/packing
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that goods are of specified nature as requested by importer in exporter order. Cargo manifest or packing list provides all the information with respect to all the items in the box, crate, pallet, and container including their dimensions, type, and container weight so as to help the customs to known that what is inside the carton or packet. 14.3.3 Bill of lading The legal document that is issued by the shipping agency for the merchandises that are shipped from one destination to the other is called the bill of lading. The bill of lading is signed by the representatives of the carrying vessel. It contains the details of type, quantity and destination of the goods. Several times, the bill of lading is issued as a set of two, three or more. The number present on each bill of lading is to ensure security. Shipping company or th agent has to sign the bill of lading. It should also show the number of originals (signed). The bill of lading indicates whether the cost of carriage is paid or not. This will be of the following two types: Freight prepaid - This is paid for the shipper. Freight collect The buyer has to pay this amount at the port of discharge. To be acceptable by the buyer, the bill of lading should: Carry the correct date of shipment on the board. Have the notation of the shipping company if the goods are damaged. The main people that are involved in the bill of lading are mentioned below: Shipper He/she is person who sends the merchandises. Consignee - He/she is person who delivers the merchandises. Notify party - He/she is person who is informed by the shipping company on the arrival of goods. Carrier - This can be a person or company who is in contract with the shipper for transport of the merchandises. Bill of lading has to be in line with the specifications of the letter of credit. Even a small spelling mistake may lead to rejection of documents. The consignee, exact shipper, and the notifying party need to be known.
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Means of transportation and ports of loading and release need to be mentioned. The description/quality of the goods needs to be consistent with the other as shown on the documents. The measurements/quantity need to match with the measurements/ quantity that are on the other documents. The shipping marks and numbers need to match with the numbers that are shown on the other documents. The bill of lading has to state whether the goods are paid or if it needs to be paid during the release of goods. The bill of lading has to state the last date for the shipment, that is before the date specified in the credit. The bill of lading has to state actual name of the carrier.
14.3.4 Insurance certificate Also called as insurance policy, insurance certificate certifies that the goods that are transported are insured through an open policy . It is mandatory that the date of effectiveness of the insurance is either same or earlier than the date of issuance of transport documents. If the document is submitted under the letter of credit, the insured amount should be in the currency as mentioned in the credit. This is usually the amount of the bill with an additional 10 percent. For insurance policy to be complete, following information is needed: The name of the party in favour, which the document has been issued. The place from where the insurance has to commerce should be detailed. The insurance cases include the buyers warehouse and the port of destination. The details of the flight and the name of the vessel. The marks and numbers need to match with the numbers that are present on the other documents. The value of insurance need to be specified in the credit. The information related to the names and addresses of the claims should be included in this document. Consistency should be maintained in case of the the description of the goods with that of the invoice credit. Wherever it is necessary, the document is countersigned.
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The date of issue of the insurance certificate should not be later than the date of isuuance of transport documents unless the cover that is shown be effective before the date of transport documents.
Self Assessment Questions 2 3. The legal document, given by the shipping company for the merchandises shipped from one place to another is called as ________. 4. The ______________ document is required when you are exporting the goods to other countries. 5. Which of the following document certifies that the goods that are transported are insured under an open policy? a) Consular invoice b) Insurance certificate c) Commercial invoice d) Bill of lading Activity 1 Consider that you are a product manager in XYZ creations and your company is exporting leathers and laces to the ST Company in Thailand and importing shoes from the same company. Your management has asked you to maintain the documents related to the international trade of both the exports and imports. Name the documents that you would maintain for the same. Hint: Insurance certificate.
14.4 Financing Techniques

In the previous section, we have learnt about documentations that play an important role during transactions in the international market. Now let us learn about the financing techniques that enable us to know various ways of transactions other than direct bank financing. Planning plays an important role in the lifespan of investment so that financing is available at every stage. There are some well-known financing techniques that are explained in the upcoming sections.
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14.4.1 Bankers acceptance In financial terms, the bankers acceptance is the credit instrument that is developed by the non financial firm and guaranteed by a bank for payment. Usually, the acceptances are traded at discounts from face value in the secondary market, depending on the credit quality of the guaranteeing bank. The banker's acceptance has played an important role in financing foreign trade for many years. A banker's acceptance, is a promised future payment, or time draft, which is accepted and guaranteed by a bank and drawn on a deposit at the bank. After accepting the draft, the bank gives an unconditional promise to pay the holder of the draft a specified amount on a specified day. So, the bank substitutes its own credit for that of a borrower and in the process, creates an instrument that is freely traded. 14.4.2 Factoring The term factoring means the financial transaction in which the factoring organisation buys the exporters foreign accounts receivable at a discount. In this, the factor assumes all the credit and political risks that are present with the importer. From the perspective of the exporter, factoring is advantageous as it serves to help the firm realise cash immediately. Following are the three ways in which factoring differs from bank loan: Factoring mainly focuses on the value of the receivables but not on the worth of the organisation's credit. Factoring is the purchase of the financial asset, which refers to the receivable, but it is not a loan. Whilst bank involves just two parties for a loan, factoring involves three parties the seller, debtor and factor. 14.4.3 Forfaiting In international trade, the term forfaiting refers to the purchase of an exporters receivables, i.e. the amount importers owe the exporter. The amount is paid in cash by the forfaiter selling of an exporter's receivables for a specified transaction. Forfaiting is the financing technique that is used for financing the sale of capital goods. In Forfaiting, the buyer is known as the forfaiter who takes on all the risks involved with the receivables the importer now is obliged to pay the forfaiter. It involves the sale of notes signed by the importer in favour of the exporter. In this technique, exporter gets the payment for the
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goods. Forfaiter does not have a recourse on the promissory notes and the structure of the payment is extended for a period of three to seven years. Self Assessment Questions 3 6. The _________________is the credit instrument that is developed by the non financial firm. 7. The term factoring is the financial transaction in which the business sells its accounts receivable at a discount. (True/False) 8. In which of the following technique the buyer is known as the forfaiter? a) Bankers acceptance. b) Factoring. c) Forfaiting. d) Commercial invoice.
14.5 Export Promotion Schemes

In the previous section, we have learnt about financing techniques. Now let us understand the promotion schemes. Government, in order to promote the exports from the country, offers some export assistance and export promotion schemes so that exporters can benefit from them. They can improve their key weaknesses and stand up to compete in the international market by offering quality Indian products and services. Such export-promotion measures can be divided into direct and indirect assistance or programmes from the government agencies to enable Indian exporters to standardise the products and services as appropriate for the international quality and aesthetic appeal. Such measures may be targeted on any of the combination of the following: i. Market Access Initiatives (for studies, brochures etc.). ii. Marketing Development Assistance for participation in trade fairs etc. iii. Providing services to international market. iv. Marketing in difficult markets like certain African, Latin American and Commonwealth of Independent States (CIS) markets. v. Marketing difficult products like those from rural areas. vi. Special agricultural products and rural industrial products. vii. High-technology products
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India being a developing economy, export promotion schemes are needed to give a boost to our economy. The needs of the export promotion scheme are explained below. As the economy of the country is progressing with the increase in population, there is a need for more number of imports. We need to have surplus exports to pay our imports. It is not wise to depend on external assistances for financing essential imports, instead exportable surplus needs to be created. In any country, there are some capital goods, machinery and raw materials that cannot be produced for some time and it has to be imported from other countries. In order to pay for such imports, the country needs to have sufficient funds so that the country has to pay for its exports. The earning from the exports needs to be increased to generate purchasing power in order to import the essential goods. We need to explore the foreign markets in order to expand the capacities of the existing units and find a market for new units. To tap our export potentials completely, we need to focus on our strengths like, price stability, low wages and the industrial bases to increase its exports. The deficits of payments in Indian economy can be resolved using funds received through foreign assistance. We need to create the repaying capacity with the help of exports. Table 14.3 shows the three main categories that are associated with the export promotion and assistance measures.
Table 14.3: Export promotion and assistance schemes in India Export incentives and benefits a. Market focus scheme Product focus scheme b. Status holder scheme c. VKGUY scheme d. Services from India scheme e. Services export scheme Duty neutralization and remission a. Advance authorisation scheme b. Duty free import authorisation scheme c. Duty drawback scheme Capacity building and infrastructural support a. Export promotion capital goods scheme b. EOU/STPI/BTP EHTP scheme c. Textiles and apparel park scheme d. Agri export zones scheme Page No. 307
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f.
Special focus initiatives d. Imprest license for in agriculture and village deemed export industry, handlooms, handicrafts, gems and jewellery, leather and footwear, marine sector, electronics and IT hardware manufacturing industries, sports goods and toys, green products and technologies, incentives for exports from the North Eastern Region
e. SEZ and FTWZ scheme f. ASIDE scheme g. Market access initiative scheme h. Market development assistance scheme i. Board of trade j. Town of export excellence scheme k. Brand promotion and quality and test houses scheme
Self Assessment Questions 4 9. The ________________________ helps in identification of the product and market. 10. The imports of second hand goods that have the minimum residual life of six years are allowed free of licensee. (True/False) 11. Which of the following scheme aims at import of goods for free of cost? a) Export Promotion Capital Goods Scheme b) Software Technology Parks c) Electronic Hardware Technology Parks d) Duty exemption scheme
14.6 Export and Import Finance

In the previous section, we have studied about the export promotion schemes. In this section, we will learn about the export and import finance. The export credit in India is studied with response to its two stages. The two stages are the pre-shipment credit and the post-shipment credit. The preshipment credit is mainly used for production, processing and packaging. The post-shipment credit is mainly required to finance the foreign buyers. Depending on the period of loans, there are three types of credits short term, medium term and long term credit.
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14.6.1 Short term credit The short term credit is provided in the form of pre-shipment and postshipment finance. This can be provided by the commercial banks that are authorised dealers in the foreign exchange. Short term credits are covered by RBI and provide credits at lower rate of interest. In relation to this type of credit, there are two schemes that are explained as follows: The Pre-shipment Credit in Foreign Currency (PCFC) in which the exporters can take the credit both in rupees as well as, the foreign currency. We get the credit in Indian rupees at base rate+1% of interest and the foreign exchange at London interbank offered rate (LIBOR)+1% rate of interest. Concessional pre-shipment credit as per RBI rules can be for 6 months. The second scheme is the post-shipment credit that is available in Indian rupees. This post-shipment credit rate of interest is available in Indian currency which does not exceed 13% for a maximum of 180 days. Higher rate of interest are charged when post-shipment finance is availed for more than 6 months. 14.6.2 Long term credit Long term credit is provided by the EXIM bank and the commercial banks that are refinanced by the IDBI. The important aspect of export credit is the risk of transacting with the overseas buyers. The risks with the foreign buyers occur due to the insolvency of the buyers when there are fluctuations in exchange rates and some government actions that cause delay in the payment to exporters. These types of risks can be averted by the insured Export Credit and Guarantee Corporation (ECGC). This corporation offers two types of services that are given as below: The export credit insurance, which consists of the policies that are issued to the exporters to protect themselves against the losses that occur from granting credit terms to the foreign buyers. The direct guarantees are the guarantees to the banks that give protection in respect of exporters. 14.6.3 EXIM bank The EXIM bank is the export import bank that has been set up by the Government of India. This is set up to perform many functions to finance,
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promote and develop the trade. This was established on Jan 1, 1982. This has the power to borrow from the RBI as well as from abroad. This plays an important role in the export financing. This bank provides the financial assistance for promoting the Indian exports. This provides the financial assistance through the direct financial assistance, abroad investment finance, pre-shipment credit, buyers lines, export bills discounting and so on. This also extends the help through the non funded facility for the exporters in the form of guarantees. This aims at export of the manufactured goods, export of technology, export of software. EXIM bank provides pre shipment and post shipment credit in Indian rupees and foreign currency. Finance is extended for short term i.e. upto 6 months and also for medium/long term i.e. beyond 6 months for eligible products and projects. Medium/long term export credit is extended by way of supplier's credits (i.e. through the Indian exporter) with recourse to the exporter or buyer's credits i.e. directly to the overseas buyer with no recourse to the Indian exporter. Certain RBI guidelines apply for such medium/long term export credit. The financing programmes of the EXIM bank are the most comprehensive among the export credit agencies across the globe. Self Assessment Questions 5 12. The ________________ credit is mainly used for production, processing and packaging. 13. Name the credit that is provided by the EXIM bank and the commercial banks that are again financed by the IDBI? 14. EXIM bank is a private owned body. (True/False) Activity 2 Consider that you are a business head in the company and you have to deal with the finance related to the imports and exports of the company. Due to the transit period in the company, there is shortage of funds and your management has planned to go for credit terms. Name the credits that you would suggest for the same. Hint: Short term credit.
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14.7 Summary
Let us summarise the points covered in this unit about finance and international trade: International trade refers to the exchange of products, services and money at the national level. The international trade increases gross domestic product by increasing the economic opportunities. There are some risks with both the exporter and importer of the goods. The letter of credit is a letter that is given to the seller. The letter of credit helps in solving the risks that the importer and exporter may face in terms of payment or delivery of goods. Documentation plays an important role while making transactions at international markets. The bill of lading is a document that is given by the shipping agency for the goods that are shipped from one destination to other. Commercial invoice is the document that is given to the seller from the buyer. The insurance certificate is the insurance policy which allows the transport of goods under the open policy. The consular invoice plays an important role while transporting the goods to another country. Different financing techniques play an important role in the lifespan of the investment. We have seen the banker's acceptance, which is the time at which the draft is drawn on a bank. The factoring technique helps to realise the cash immediately. The forfaiting technique is used for financing the sale of capital goods. The export promotion schemes are the incentive programs developed to attract more firms towards exporting. There is a need for the export promotion schemes in the developing country like India. There are many export promotion schemes and Export Promotion Capital Goods (EPCG) is one of the export promotion schemes that aim at import of capital goods at a reduced rate. The three broad categories of credits include the short term, medium term and long term credit.
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14.8 Glossary
Beneficiary: In insurance, the beneficiary is the person or organisation that receives money from insurance company when the insured event occurs. Commodity: The physical substances such as food, grains and metals are interchangeable with other products of the same type. Export promotion: Program that promotes the domestic producer for exporting and importing goods. Foreign Direct Investment (FDI): This is the amount of money that is invested by foreign companies and other assets that helps the economies to grow more efficiently and become competitive participants. Gross Domestic Product (GDP): The final market value of all the goods and services are produced in the country in one financial year. Monopoly: Situation in which a single firm owns almost all the market of a given type of product or service.

1. 2. 3. 4. 5. Explain in brief about letter of credit. Write a short note on insurance certificate. Discuss factoring. Elaborate the need for the export promotion scheme in the country. Describe the functions of the EXIM bank.
14.10 Answers
Self Assessment Questions 1 1. True 2. a. Open account Self Assessment Questions 2 3. Bill of lading 4. Consular invoice 5. b. Insurance certificate
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Self Assessment Questions 3 6. bankers acceptance 7. True 8. c. Forfaiting Self Assessment Questions 4 9. export promotion scheme 10. False 11. d. Duty exemption scheme Self Assessment Questions 5 12. Pre-shipment 13. Long term 14. False Terminal Questions 1. The letter of credit is a letter that is given to the seller. In the letter, the bank promises that it will honour the drafts drawn on it if the seller confirms to the specific conditions that are set forth in the letter of credit. For more information, refer subsection 14.2.2 of this unit. 2. Insurance certificate is known as an insurance policy which certifies that the goods that are transported are insured under an open policy and are not actionable with the risks that are covered. We have discussed this in subsection 14.3.3 of this unit. You can refer the same for more details. 3. Term factoring is the financial transaction in which the business sells its accounts receivable at a discount. For more information on factoring, refer subsection 14.4.2 of this unit. 4. As the country economy is progressing, there is a need for more number of imports. We need to have much of the exports to pay our imports. You can refer section 14.5 of this unit for more details. 5. EXIM bank plays an important role in export financing. This bank provides the financial assistance for promoting the Indian exports. For more information, refer subsection 14.6.3 of this unit.
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14.11 Caselet
In order to promote paperless, transperent and cost effective export import operations; government of India with the help of UNCTAD has implemented the ICEGATE platform which is a one-stop-window for filing of export import documents so that the goods can be cleared for export and import. ICEGATE is an e-commerce initiative for filing of all export import documents so that the cargo can be cleared on real time basis and informed decisions vis-a-vis composition and direction of foreign trade can be taken. Thus, ICEGATE is an infrastructure project that fulfils the customs department's electronic communication/electronic data interchange and data communication requirements. ICEGATE system facilitates the smooth functioning of Central Board of Exicse and Customs through various facilities such as electronic filing of Bill of Entry (import goods declaration) and Shipping Bills (export goods declaration) and related electronic messages between customs and the trading partners using communication facilities, i.e. e-mail. The ICEGATE also ensures 24X7 helpdesk facilities on status of trade documents to trading partners, i.e. exporters and importers. For safe and secure transactions, it is mandatory that one should use only digital signatures on Bill of Entry and other documents/messages to be handled on the gateway. At present, ICEGATE system at Indian customs is working through a MPLS based Wide Area Network. It links all the buildings of the 582 departments of Indian customs all over the country. In addition to e-filing of export import documents, ICEGATE also provides a host of other services like e-payment, online registration for intellectual property rights/SPS barriers/TBT barriers etc. One can check the status of trade by using Document Tracking status platform at ICEGATE. Now, it is possible to make online verification of export promotion schemes like DCS/DEPB/DEEC/EPCG licences, Importer-Exporter code status. ICEGATE is also linked up with other system like ACES (excise and service tax), PAN (income tax) for availing input credit if any. Custom House Agents can also use it on behalf of exporter/importer and can access important information relating to export or import from other websites and databases. Due to all these reasons, Indian exporters and
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importers are fast moving towards paperless trade by filing shipping bill/bill of entry at ICEGATE. Q. No. 1: What are the major benefits of customs clearance platform called as ICEGATE? Q. No. 2: How does ICEGATE system ensure cost effective operations of customs? Q. No. 3: What are the advantages of ICEGATE linkages with other systems like ACES (excise and services tax), PAN (income tax) Quality assurance agency and DGFT? References: B.L. Mathur (2001), Towards economic development, Discovery publishing house. Aswathappa (2008), International business, Tata McGraw-Hill.
E-Reference: http://www.businesslink.gov.uk/bdotg/action/detail?itemId=1077787643& type=RESOURCES, retrieved on 3rd November, 2010. http://www.infodriveindia.com/Exim/Guides/Exportinance/Ch_4_Trade_Documents.aspx, retrieved on 4th November, 2010 http://www.investopedia.com/articles/03/112503.asp, retrieved on 5th November, 2010 http://ecedweb.unomaha.edu/ve/library/bfte.pdf, retrieved on 11th November, 2010. http://www.economywatch.com/international-trade/heckscher-ohlinmodel.html, retrieved on 15 Nov 2010 http://www.bangkoklogistics.com/international-business/Three-BarriersTo-International-Trade.html, retrieved on 18th November 2010 http://www.pierobon.org/export/outline.htm, retrieved on 20 April 2012
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Unit 15
Global Sourcing and Indian Industries Structure
Structure: 15.1 Introduction 15.2 What is Global Sourcing? 15.3 Reasons for Global Sourcing Lower salary and wages Regulatory costs in business Tax breaks and benefits Improved performance Faster turnaround time Uncertainty over political/business climate Proximity to key markets 15.4 Advantages of Global Sourcing Benefits of Core Competency Effective and efficient business operations Reduced overhead expenses Better control on operations Manpower staffing flexibility Sustainable business operations and reduced risks 15.5 Disadvantages of Global Sourcing Loss of managerial control Hidden costs in business operations: when company outsources business process Threat to security and confidentiality Quality assurance in business process Financial dependence on another company Ill-will and bad publicity 15.6 Global Sourcing Challenges to Indian Industries Recruiting competent and skilled workforce Training and development for manpower Controlling attrition and managing retention Ensuring satisfactory customer satisfaction/service levels Infrastructural and logistical challenges 15.7 Summary 15.8 Glossary
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15.9 Terminal Questions 15.10 Answers 15.11 Case-let
15.1 Introduction
In this unit, you will study about global sourcing and its impact on Indian industries. Global sourcing is a procurement strategy that is aimed at exploiting global efficiencies in production. This unit discusses the evolution of globalisation in India and its impact on Indian business. It also discusses the prevailing competitive environment in India with respect to international business, challenges and threats faced by Indian business. Some proven strategy models have also been discussed for better understanding of international business operations in India. Objectives: After studying this unit, you should be able to: understand the importance of global sourcing. understand why India is an attractive destination for global sourcing understand the advantages & disadvantages of global sourcing interpret the competitive environment in India. explain the global sourcing challenges to Indian industry.
15.2 What is Global Sourcing?

Globalisation of the world economy under the WTO has opened abundant opportunities of cost cutting, gaining competitive advantage and saving time for industries worldwide. Indian industries have experienced such developments as India is a member of the WTO since its inception in 1995. Global sourcing is described as the practice of sourcing cost effective and best goods and services across geopolitical boundaries in order to cater to global markets. Global sourcing strategy is aimed at exploiting global efficiencie in all areas of manufacturing, trading and services to enable offering clients and customer the best possible product or service. Usually, efficiencies that prompt firms for global sourcing are low cost skilled labor, low cost raw material, proximity to key markets, time zone differences and other economic factors such as tax exemption and low trade tariffs.
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Indian industries have successfully levered global sourcing strategies in their global trade operations and sourcing has been the driving force behind the development and expansion of Indian foreign trade in the recent past. Global sourcing strategy has made Indian industry more globalised as buyers from all over the world are bidding for Indian goods, particularly services, to enable executing their contracts on time, reduce prices and generate efficiency in the system through increased competition. Indian industries, in order to reap the benefits of sourcing opportunities, has opened global offices and subsidiaries to tap opportunities on all fronts, i.e., manufacturing, trading, skilled services and call centers. As we know, manufacturing costs vary from country to country due to factors such as currency conversion and cost of living. Due to different factor endowments of countries, the costs of labor and materials may differ, for example, labour cost is far lower in developing countries like India than in North America and Europe. For companies that have labour intensive work, this difference in costing results into significant savings in terms of salaries, wages, post retirement benefits, fringe benefits and other benefits. India is emerging as a global hub in gems and jewellery, oil refining, engineering equipments, textiles, sports goods, auto components, etc. In a globalised set up, trade and commerce of skilled services such as IT enabled services, software development and testing, purchasing, engineering and integrated chip designing, knowledge process outsourcing (KPO), offshoring and home shoring is growing much faster than trade in merchandise. India, with its demographic dividends has been benefitted from all such developments as the level of skill and knowledge held by Indian professional allows them to provide high quality services to their clients in developed countries. For example, India has been successful in software development, BPO services, KPO services and in the recent past in areas like Engineering Process Outsourcing, Analysis Process Outsourcing, content development and website designing. The main reasons for skills sourcing to India is represented pictorially as under:
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Figure 15.1
Global sourcing has both benefits and risks for the Indian industry. Global sourcing has helped Indian companies in the generation of additional revenue and profits, precious foreign exchange, scalable business operations and employment. There are spillover effects of outsourcing to India and its economy has grown additionally by emerging as lower cost suppliers of merchandise and services. Brand India is widely recognised in the silicon valley and the Indian governments bargaining power has increased due to the dependence of many countries for Indian services. Living standards of the people has improved, higher wages, improved working conditions and learning transferable skills has helped thousands of Indians. Risks from global sourcing such as cultural and language related issues, withdrawal of tax benefits, accent problems, high labour attrition, diversification of business operations across different countries, increased business travel and local management issues are present. In addition to this, there also comes the risks related to logistics and transportation.
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Activity 1 What are the reasons that India is a global power house in IT and ITes enabled services outsourcing? Hint: http://www.outsource2india.com/india/why-outsourcing-india-goodfor-business.asp
15.3 Reasons for Global Sourcing

Global sourcing is one of the most controversial subjects as the benefits of outsourcing is not properly understood by both companies and politicians. In the current phase of global economic recession, politicians condemn outsourcing as it sends both money and work out of the country thus affecting employment and peoples income level. Even then, the global sourcing industry is on a growth run as there are sound business reasons in global sourcing. These reasons are explained as under: 15.3.1 Lower salary and wages
The foremost reasons for global sourcing has been the financial incentive of
outsourced operations to low cost labour destinations such as India, Philippines, Poland and Romania. Due to the different stages of economic development, labour cost of workers in any developed countries is far higher than their counterparts. The following table illustrate labour cost differentials among countries.
Indexes of Hourly Compensation Costs in $ For Select Countries 2010
100 80 60 40 20 0 India Mexico Japan Labour Cost in $ per Hour
Figure 15.2: Source: Bureau of Labour Statistics; US Department of Labour
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15.3.2 Regulatory costs in business An underappreciated incentive in global sourcing to developing countries including India has seen significant difference in the regulatory cost of business. Attorneys in India charge a fraction of the cost compared to those in the US, hence, law firms in the US get their law related work done in India. Moreove, cost of employment in US is far higher as companies have to offer legally complying pay packages which includes social security, medical care, post retirement benefits, entertainment allowances, employee group insurance, unemployment insurance, etc. Such components may not exist in countries like India. Layoff expenditure in US are far higher than in India, thus, companies outsource their business operations to countries like India, China, Vietnam, Thailand, South Africa, Nigeria and Brazil. 15.3.3 Tax breaks and benefits Developing countries like India offer tax breaks for new entrants thus offering cost savings for these companies. For example, Hyundai was offered a tax break (VAT) of 5 years by the Tamilnadu government for setting up a plant. Nokia shifted its plant from Germany to Romania as it had low labour cost coupled with tax breaks offered by government. 15.3.4 Improved performance Developed countries usually outsource their business operations to developing countries like India which is at the bottom of their core operations, monotonous and require huge labor. Such work can be done by dedicated outsourced labour force in developing country at a fraction of the cost of developed countries. It is found that such bottom of the pyramid, monotonous and repetitive work has far better performance in developing countries due to specialisation and dedicated expertise for the work. 15.3.5 Faster turnaround time Companies as well as government are outsourcing their non core operations to low cost countries as it helps not only to focus on core activities but to also get the required job done much faster with reduced time and accuracy. In business, time is money as the saying goes, thus, firms outsource some of their business operations for faster and quicker turnaround time.
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Reasons for global sourcing
Figure 15.3
15.3.6 Uncertainty over political/business climate Another advantage of global sourcing is that companies want to evade their political and business risks by locating their business operations at various parts of the world. If political or economic problems occur in any region, the company will be able to continue its operations without disruption by fulfilling their needs from other global sourcing location. For example, auto companies worldwide have invested in India as well as in Thailand for supply of auto components as both are low cost countries having specialisation in the auto component industry. If there is a problem in India supplies can be taken from Thailand or vice versa. 15.3.7 Proximity to key markets In an era of globalization, firms have outsourced their business operations close to their key markets. For example, it is cheaper to manufacture goods in Thailand or China and then ship them to Japan than to ship them from US or Europe. Multination organisations have resorted to global sourcing to
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countries like India to fulfil their markets demand not only for South Asia but also for East Asia, Middle-East and Eastern Africa. Self Assessment Questions 1 1. Firms outsource as it enables them for faster turnaround time in their business operations. (True/ False) 2. Manufacturing costs vary from country to country. (True/ False) 3. Low wages and salary are the prime motivators for US companies to outsource to India. (True/ False) 4. Which of the following is not a reason for Indias outsourcing attractiveness? a) Cost Restructuring. b) Better Capacity Management. c) Focus on Core Business. d) Polite People.
15.4 Advantages of Global Sourcing

As business operations diversified in the global production chain due to globalization, companies have to evaluate their choices, decisions and strategy for outsourcing different components at a cost effective level from all around the world. Outsourcing offers several advantages as different countries are endowed with different natural, physical and demographic resources. Multinationals spread their production to low cost, developing countries. Business operations are shifted to many country depending on the comparative and competitive advantage. Global sourcing has actually helped multinational enterprises to grow and save money. There are other advantages of global sourcing that go beyond financial benefits. Detailed below are some advantages that prompt companies to sources globally for cost, reliability and efficiency reasons. 15.4.1 Benefits of core competency A large company offering products and services in many segments and industries need to constantly focus on delivering innovative products. Larger business organisation sometimes develop stagnancy due to their back office operations which may affect its core function or activities. Therefore, such companies usually outsource their non core activities to other companies.
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For example, for a pharma company it is important that its manpower focuses on research and innovation of new drugs, but if it expands its organisation to resolve problems such as order processing, managing inventory, warehousing, documentation, booking new orders and handling customer problems it will make the organisation redundant since most of its top management energy will go into non core issues. Outsourcing these non core activities can make firms lean, fast, cost effective and competitive in the market.
Figure 15.4
15.4.2 Effective and efficient business operations Back office operations for any firm in todays competitive environment are not only complicated in nature but also expensive in terms of both financial resources and time. Organisations can focus on core strength when such non allied activities are outsourced at consistent and reasonable cost. Outsourcing such operations can help firms tide over such problems areas. 15.4.3 Reduced overhead expenses Firms have to outsource some of their functions to cost effective destinations as overhead costs of performing a particular back office function may be extremely high in its own country due to different factor endowments. For example, medical transcription which is considered as a non core activity is outsourced to India by US firms. India is considered as most cost effective, cost competitive and is a strong market leader in medical transcription outsourcing because of its large resource of young,
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college educated and productive workforce. Indians are also good in the use of the English language. Globally, firms are looking at Indias best-inclass medical transcription training methodologies for outsourcing their work in medical transcription outsourcing. 15.4.4 Better control on operations Any business operations for which costs are running out of control is better outsourced. Sometimes, there are certain departments that may have evolved over time into uncontrolled and poorly managed areas. This becomes a prime motivator for outsourcing. Outsourcing such departments to another country/region helps the firm learn/imbibe better management skills, innovation and practices. 15.4.5 Manpower staffing flexibility Outsourcing seasonal/cyclical business operations also help firms save costs. There are seasonal or cyclical demands of goods and services requiring additional manpower resources from firms. Firms can outsource such operations to another region/country where labour expenses may be just a fraction of what it is in the domestic market. For example, taxation of many US states has been successfully outsourced to Indian firms. 15.4.6 Sustainable business operations and reduced risks Due to uncertain business scenarios and the changing demographic profile of countries, there have been trends and periods of high employee turnover which add uncertainty and inconsistency to a firms business operations. More so, it has been observed that sometimes a region of the world may go into turmoil, civil disorder, God or manmade catastropheies, etc. If a firms business operations are outsourced to different parts of the world, it can survive from such risks and can ensure sustainable business operations. For example, due to the Jasmine revolution many multinationals survived even after the shutdown of their businesses in the Gulf/Arab region. Firms who had outsourced their activities to multiple regions were able to fulfil their client/customer needs from another part of the world.
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Activity 2 What makes India so attractive for global outsourcing companies to outsource auto components from India? Hint: Read the case Indian Auto Component Industry: New Destination for Outsourcing at http://www.frost.com/prod/servlet/market-insighttop.pag?docid=8011194
15.5 Disadvantages of Global Outsourcing

Global sourcing also has certain disadvantages such a loss of managerial control, hidden costs, threat to security and confidentially, quality problems, financial dependence on another company and bad publicity campaign to sourced city/countries/region. For example, retrenched employees of a US firm usually talk about being banglored; meaning laid off from the job. One has to make a trade-off of between advantages and disadvantages before arriving at outsource of not to outsource decision. 15.5.1 Loss of managerial control One of main disadvantages of global outsourcing is that the company loses managerial control on the certain functions to the outsourced company. As the outsorcing company has only a contract and entire functional responsibilities are handed over to another company; it becomes dependent on the outsourced company for its operations. The main motive of the outsourced company is profits. Thus the same performance standards; mission and drives cannot be expected from an outsourced company. 15.5.2 Hidden costs in business operations: when company outsources business process The outsourced company has to sign a contract with the outsourcing company which covers the details of the services that will be provided by the outsourced company. Usually, the contract that best suits the requirements is framed by the outsourcing company with the help of their legal team to. Additional charges will have to be paid for anything which is not covered in the contract . Additionally, each time the company signs the contract, it will have to incur legal charges and fees to a lawyer to review the contacts that company gets into.
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15.5.3 Threat to security and confidentiality In an era of globalisation; information is well considered as the fourth factor of production, in addition to land, labour and capital. Information keeps a business running. If business operations such as payroll processing, medical records, credit cards records, accounting and financial information are provided to the outsourcing company, the security and confidentiality of the company may be at risk. While outsourcing any business process, it is important that the outsourcing company should ensure protection of data from falling into miscreant hands and the contract should have a penalty clause if such an incident occurs. 15.5.4 Quality assurance in business process Outsourcing companies usually neglect the quality assurance and control in business operations as they are motivated to increase their profits by reducing operating expenses. Sourcing contracts usually fix the price for any service rendered. If any additional services are needed in line with this service, the outsourced company will neglect it or demand extra changes for that. Additionally, a company will lose the ability to respond to emerging quality control changes in business operations
Figure 15.5
15.5.5 Financial dependence on another company When outsourced to other company; such company becomes dependent on the financial well-being of that company. If the outsourcing company becomes insolvent or defaults on financial as well as in business operations,
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the very existence; brand image and reputation of the outsourcing company comes under risk. 15.5.6 Ill-will and bad publicity When business operations are outsourced from one country to another, various factors are taken into consideration. The Chinese are usually distasted upon in Europe for offering low cost, inferior products. Similarly in the US, retrenched employees talk of being Banglored, as the company in the US would have outsourced its business operations to a Bangalore based company in India. Job losses lead to ill feelings. As China and India are the powerhouses in outsourcing (China in goods and India in services), both the countries have certain amount of bad publicity in developed countries especially among the people that have been laid off.
15.6 Global Sourcing Challenges to Indian Industries

Once it becomes clear for any company that it is strategically in its interest to outsource, strategic planning and review of the advantages and disadvantages of each scenario under which it will outsource its business operations to other country/region should be done. There can be many potential opportunities and challenges which can be converted into opportunities while outsourcing business operations to another country. The challenges while outsourcing to India are detailed as under the following: 15.6.1 Recruiting competent and skilled workforce India has the largest cost effective, professional talent pool of English speaking people in the world. The main reason for outsourcing of US/UK/ Australia/Canada companies to India has been the English speaking strengths of Indian people. While outsourcing their business operations to India, companies look into it that the service provider has considerable outreach activities to reach a potential talent pool. A more systematic selection process is required than that of the home country especially in case of voice-based process. It is estimated that a BPO company in India has to screen at least 20 candidates to be able to recruit one employee (the ratio is 20:1). The major challenge for Indian BPO/KPO companies is that this number is increasing. Recruitment market for providing services to clients is India is getting extremely competitive and companies in India are compelled to open offices in second tier cities to expand their business operations by recruiting cost effective talent pool.
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15.6.2 Training and development for manpower For creating a successful platform in services sector sourcing in global markets, India has to have trained workforce that is competent to respond to onetime floor challenges. This is especially true in case of IT/ITes sector where India has many opportunites in terms of ramp-up of people and processes. In addition to improving the soft skills, accent adaptation and cross cultural sensitivity, workforce also needs to be trained in maintaining a balance in social and profesional life. Health of employees is important. Yoga, physical exercise can be made part of routine life of such workforce in order to reap the desired benefits of Indias potential in global markets. 15.6.3 Controlling attrition and managing retention In Indias IT and ITes companies; attrition levels are in the range of 15%60% per year. The average attrition level for a voice-based call center in India is around 40%. There is huge challenge in workforce management in India. Most young employees leave the BPOs industry due to the monotonous work, and the physical toil of night-shift jobs. Companies in India need to realise this aspect and set realistic expectations for the employees. There should be support services by HR department for recreation and entertainment of the employees. 15.6.4 Ensuring satisfactory customer satisfaction/service levels Companies from developed countries that outsource their established processes to Indian services provider expect that the quality and performance standards should be of highest level. Customers must be satisfied from such offshoring of business operations with at least the same level of or even higher level of performance standards. 15.6.5 Infrastructural and logistical challenges India has infrastructural bottlenecks in all areas, i.e., roads, rail, air and maritime transport. Even virtual infrastructure like internet access, telecommunication, etc., which are vital for growth of services outsourcing is poor in India. Power and connectivity are the most important components for sustainable growth of services sector outsourcing from India. Data/voice connectivity, lower bandwidth, transportation, food, services, etc., are some of the other challenges confronting the growth of outsourcing from India.
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If these challenges are overcome, India can reap the desired benefits from growth and expansion of sourcing of services and can even emerge as market leader in the world. Self Assessment Questions 2 5. IT/ITes outsourcing has brought some ill will/bad publicity towards Indians. (True/False) 6. Outsourcing helps the firm with increased managerial control over all functions. (True/False) 7. Global sourcing does not pose any security/confidentiality threat to the country. (True/False) 8. Which one of the following is not a concern for India for increasing its stregth as outsourcing destination? a) Lack of skilled workforce. b) Tax breaks. c) Logistical challenge. d) Managing retention.
15.7 Summary
Let us now summarise the salient points you have learnt in this unit on global sourcing and its impact in India: Globalisation of world economy under WTO has opened abundant opportunities of cost cutting, gaining competitive advantage and saving time for industries worldwide. Manufacturing costs vary from country to country due to factors such as currency conversion and the cost of living in different countries. Principal reasons for global sourcing has been the financial incentive to outsource operations to low cost labour destinations such as India, Philippines, Poland and Romania. Outsourcing offers several advantages as different countries are endowed with different natural, physical and demographic resources. Firms have to outsource certain functions to cost effective destinations because of high overhead costs of executing a back-office function in its own country due to different factor endowments.
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India has the largest cost effective, available, professional talent pool of English speaking people in the world. Virtual infrastructure like internet access, telecommunication. etc., which are vital for growth of services outsourcing is poor in India. Outsourcing companies usually neglect the quality assurance and control in business operations as they are motivated to increase their profits by reducing operating expenses.
15.8 Glossary
Sourcing: It refers to a number of procurement practices, aimed at finding, evaluating and engaging suppliers of goods and services for better work delivery and cost effective services. Banglored: Losing a job to an Indian outsourcing firm based in Banglore city is called banglored in US. BPO: Business Process Outsourcing KPO: Knowledge Process Outsourcing Jasmine Revolution: This is the December-January mass uprising incident that overthrew the president Zine El Abidine Ben Ali. An intensive campaign of civil resistance along with a series of street demonstrations took place in Tunisia. Sub-contracting: The practice of assigning work under a contract to another party.

1. What is global sourcing? What makes India so attractive for global sourcing? 2. Elaborate the reasons due to which firm outsource to India. 3. What are the advantages of global sourcing? 4. What are disadvantages of global sourcing? 5. What has been the impact of global sourcing on Indian business?
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15.10 Answers
Self Assessment Questions 1 1. True. 2. True. 3. True. 4. Polite people. Self Assessment Questions 2 5. True. 6. False. 7. False. 8. Tax breaks. Terminal Questions 1. Global sourcing is described as the practice of sourcing cost effective and best goods and services across geopolitical boundaries in order to cater to global markets. Refer to section 15.2 2. Global sourcing industry is on growth run as there are sound business reasons in global sourcing. Refer to section 15.3 3. Global sourcing has helped the multinational enterprises to grow and save money. There are other advantages of global sourcing that go beyond financial benefits. Refer to section 15.4 4. Global sourcing also has certain disadvantages such loss of managerial control, hidden costs, threat to security and confidentially, quality problems, financial dependence on another company and bad publicity. Refer to section 15.5 5. Indian business is facing competition and has to improve in efficiency and quality due to market forces. This will ultimately help india in utilising opportunities and facing challenges. Refer to section 15.6.
15.11 Case-let
Challenges faced by McDonalds in India McDonalds is an MNC and is one of the largest fast food chains in the world. McDonalds began its operations in India in 1996. Initially, the McDonalds food outlets reported accumulated losses. To overcome this failure, McDonalds developed a business strategy in India which adapted
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to the local culture in India, its localisation and pricing strategy. McDonalds famous dish is the beef-based hamburger. In India, most of the people do not eat beef and pork and some prefer vegetarian. McDonalds customised its menu with more than 50 percent vegetarian products. It introduced an Indian version of burgers which are made from mutton and chicken. McDonalds also introduced its price strategy in India. It announced reduction in prices by 25 percent for its lunch and dinner menus. Today, McDonalds is a successful food chain and has more than 170 restaurants in India. Discussion question 1. What challenges did McDonalds face in India? Source: http://www.scribd.com/doc/6464143/McDonalds-4Ps-Ofmarketing References: Jayanta Bagchi. (2005). Liberalisation of Services Global and Indian Perspective. I.K.International Pvt Ltd. Boutilier, Robert. (1993). Targeting Families: Marketing To and Through the New Family. American Demographics Books. Miller, Berna. (1995). A Beginner's Guide to Demographics. Marketing Tools. Nirmalya Kumar, Pradipta K. Mohapatra & Suj Chandrasekhar. (2009). India's Global Powerhouses. Tata McGraw-Hill Publishing Company Limited. Abrol P. N., Bhalla V. K. (2005), International business environment and management, Anmol Publications PVT LTD. Bennet Roger (2006). International Business, Pearson Education Ltd Aswathappa. K. (2008). International Business. Tata McGraw Hill Education: New Delhi.
E-References: http://books.google.co.in/books?id=bgLXTW2oq2cC&pg=PA144&dq= labour+practices+in+indiaglobal+sourcing, retrieved on 10th April, 2012
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http://books.google.co.in/books?id=39lJz_L4MdUC&pg=PA133&dq= Challenges+for+Indian+BusinessesBrand+india, retrieved on 3rd November, 2010
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International Business Management

Revised Edition: Spring 2010

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MB 0053 International Business Management

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Introduction to International Business

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1.2 Introduction to International Business

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Figure 1.1: Factors affecting international business

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Bank Financial institutions Factor/forfeitors Other Intermediaries

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Figure 1.3: Ancient Silk Road and Spice Route

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1.3 Elements of International Business

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Figure 1.4: Drivers of international business

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Source of supply of raw materials Marketing and distribution

Cross country connections

Efforts made to transfer ideas, technologies, competencies and

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1.7 Terminal Questions

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International Trade Theories & their Application

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2.2 Why Do Nations Trade?

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