Chapter 2

Trading and investing in international business

Three ways of doing international business:

1) International tradeImporting and exporting goods and services

2) Foreign direct investment (FDI)Purchase of sufficient stock in a firm to obtain significant

management control

3) Foreign sourcingThe overseas procurement of raw materials, components,

and products

Domestic market or the global market?

• Foreign sales averaged 56.6% of the total sales of the largest 100 global companies (2008).

• Ratio of income from foreign sales to total income averaged 51.5% for these large multinationals.

• Without sales and profits generated from foreign operations, the competitiveness of many of these companies would be seriously damaged and some of them might be unable to remain business.

Leading exporters and importers (2008)

Merchandise exporters Merchandise importersvalue share value

shareGermany 1,112 9.2 US 1,919 15.5US 1.038 8.6 Germany 909 7.3China 969 8.0 China 792 6.4Japan 650 5.4 UK 619 5.0France 490 4.1 Japan 580 4.7Netherlands 462 3.8 France 535 4.3UK 448 3.7 Italy 437 3.5Italy 411 3.4 Netherlands 416 3.4

Leading exporters an importers (2008)

Service exporters Service importersvalue share value share

US 389 14.1 US 308 11.6

UK 228 8.3 Germany 219 8.3

Germany169 6.1 UK 172 6.5

Japan 123 4.4 Japan 144 5.4

France 115 4.2 France 109 4.1

Spain 106 3.8 China 100 3.8

Italy 98 3.5 Italy 98 3.7

China 91 3.3 Ireland 78 3.0

Leading exporters and importers

• Generally, the largest exporters and importers are the same countries. It means that once a country participates in the global trade, its imports and exports increase.

• Generally, services trade is one-third of the merchandise trade.

• Trade regionalizes in time. That is, members of the regional blocks trade more with eachother.

Major trading partners:

They are those countries where the firm has affiliates.

Why focus on major trading partners?

1) The business climate in the importing nation is relatively favorable.

2) Export and import regulations are not insurmountable.3) No strong cultural objections to buying that nation’s goods.4) Satisfactory transportation facilities have already

established.5) Import channel members (merchants, banks, custom

brokers, etc) are experienced in handling import shipments from the exporter’s area.

6) Foreign exchange to pay for the exports is available.7) The government of a trading partner may be applying

pressure on importers to buy from countries that are good customers for that nation’s exports.

Foreign Direct Investment (FDI)

• The outstanding stock of FDI – is the book value or the value of total outstanding stock.

The total FDI worldwide is $12.5 trillion (2006). The major investor countries are US ($2.4 billion), UK, and France.

The proportion of FDI accounted for by the US declined more than 47% between 1980-2006, from 36% to 19%.

The proportion of FDI accounted for by the EU increased from 36% to 52%.

The FDI by M-BRIC countries are increasing.Overseas Chinese investors have more than $1 trillion

assets abroad (in Malaysia, Thailand, Indonesia, Vietnam, Philippines, and Hong Kong). They are the major source of investment capital flowing into China.

Annual outflows of FDI

It is the amount invested each year into other nations.

1985-1995 1996 20002006(billion$)

World 203 391 1.201 1.216Developed countries 182 332 1.098 1.023Developing countries 22 58 99 174USA 43 84 143 217EU 96 182 819 572UK 26 34 250 79Germany 18 51 57 79

Annual inflows of FDI

It shows the yearly amount of FDI coming intı the country.

1985-1995 1996 2000 2006(billions$)

World 181 278 1.393 1.306Developed count. 128 220 1,121 857Developing count. 50 145 246 379US 44 85 314 175EU 66 109 684 530UK 17 24 130 140China(+Hong Kong)16 51 103 112

Does trade lead to FDI?

Historically, FDI has followed foreign trade.

• One reason is that trade is less costly and less risky than making a FDI.

• Also, management can expand the business in small increments rather than through the large amounts that are required by FDI.

Why enter foreign markets?

1) Increase profits and sales• Enter new markets – managers are always under

pressure to increase profits and sales, and when they face a mature, saturated market at home, they search for new markets in other countries (especially when the incomes and population in these markets are growing).– New market creation: Find potential new markets.– Preferential trading arrangement: An agreement by a small

group of nations to establish free trade among themselves while maintaining trade restriction with other nations.

– Faster growing markets: Some new markets are growing faster than the home market.

– Improved communications: Firms can communicate faster and cheaper with the customers.

Why enter foreign markets?

• Obtain greater profits – It can be achieved through increasing revenues and/or decreasing costs.-Greater revenue: If the firm’s competitors have not entered the market, the firm may ask higher prices for its goods.-Lower cost of goods sold: Lower taxes, lower interest rates, lower wages, subsidized investments, allocation of public land for the investments, export incentives, etc.-Higher overseas profits as an investment motive: More than 90% of global companies obtain greater profits overseas.

Why enter foreign markets?

• Test market – A global market will test-market in foreign location that is less important to the company than its home market and major overseas markets.

Management’s thinking is that any mistakes made in the test-market should not adversely affect the firm in any of its major markets.

Why enter foreign markets?

2) Protect markets, profits, and sales• Protect domestic market – A firm will go abroad

to protect its home market.-Follow customers overseas: Service companies (like accounting, advertising, marketing research, banking, law) will establish foreign operations in markets to prevent competitors from gaining access to those accounts. They know that once a competitor gains one of the subsidiary’s management, it can get access to all the accounts.

Why enter foreign markets?

• Attack in competitor’s home market –A firm may set up an operation in the home country of a major competitor with the idea of keeping the competitor so occupied defending that market that it will have less energy to compete in the firm’s home country.

Why enter foreign markets?• Using foreign production to lower costs – A company may go

abroad to protect its domestic market when it faces domestic competition from low-priced imports. It can enjoy low-cost labor, raw materials, and energy.- export processing zones: It is where, mostly foreign manufacturers, enjoy absence of taxation, import regulations. It is a government designated zone in which workers are permitted to import parts and materials without paying import duties, as long as these imported items are then exported once they have been processed and assembled. In-bond plants (maquiladoras), for example, are production facilities in Mexico that temporarily import raw materials, components, or parts duty-free to be manufactured, processed, or assembled with less expensive local labor, after which the finished or semi-finished product is exported.

Why enter foreign markets?• Protect foreign markets – Changing the method of going abroad

from exporting to overseas production may be necessary to protect foreign markets.- Lack of foreign exchange: There may be foreign exchange scarcity in the local market. In this case, if the advantages outweight the disadvantages, the firm may decide to produce locally to protect the market.- Local production by competitors: The firm may decide to produce locally, if the demand for the product justifies that investment, especially if the competitors are investing in that market.- Downstream markets: A number of OPEC countries have invested in refining and marketing outlets to guarantee a market for their crude oil at more favorable prices.- Protectionism: When the government sees that local industry is threatened by imports, it may impose import barriers to protect the local firms. The exporter then may be forced to invest in the market.

Why enter foreign markets?

• Guarantee supply of raw materials – Most of the raw materials are in the developing countries. Japan and Europe are totally depended on imported raw materials. Even the US depends on the imported aluminum, chromium, manganese, nickel, tin, and zinc. Iron, lead, tungsten, copper, potassium, and sulfur will soon be added to the list. To ensure continuous supply, firms have to invest in the developing countries with resources.

Why enter foreign markets?

• Acquire technology and management know-how – Many US firms invest in foreign markets to acquire technological and management know-how. Herbal medicine is a production line learned from the Chinese, for example.

Why enter foreign markets?

• Geographic diversification – Many companies have chosen geographic diversification as a means of maintaining stable sales and earnings when the domestic economy or their industry goes into a slump. Often, in other parts of the world economic growth makes a peak.

Why enter foreign markets?• Satisfy management’s desire for

expansion – Stockholders and financial analysts expect the firm to grow, so managers feel obliged to grow, even at times when growing makes little economic sense. When it becomes difficult to grow in the domestic market, the firm invests in other countries.

HOW TO ENTER FOREIGN MARKETS?

1) Exporting

2) Turnkey projects

3) Foreign manufacturing

Exporting – selling some of the firm’s products in

overseas markets

Indirect expoting – exporting via home

based exporters

1) Manufacturers’ export agents: they sell for the manufacturer2) Export commission agents: they buy for their overseas customers3) Export merchants: they purchase and sell on their own account4) International firms: they buy and sell goods overseas, like mining, petroleum companies.

Direct exporting – exports undertaken by the firm producing goods and

services.

If business expands in export markets, firm follows these steps:

Salesman (in the firm)↓

Export department (in the firm)↓

Sales company (maybe with channels of distribution)

Turnkey projects can be export of technology,

management expertise, and in some cases capital equipment.

In turnkey projects,the contractor builds the plant,

supply the technology, provides suppliers of raw materials and other production inputs, train operating personnel, run the

factory for some time and return the factory to the owner.

FOREIGN MANUFACTURING

1) Wholly owned subsisidary2) Joint venture3) Licensing4) Franchising5) Contract manufacturing

1) Wholly owned subsidiarya. Start by building a new plantb. Acquire a going concern – mostly firms buy an already existing firm. This way it will have one less competitor and an established firm with customers, suppliers, permissions taken.c.Purchase a distribution firm

2) Joint venturea. It can be between a company owned by an international firm and local owners,b.Two international companies come together for the purpose of doing business in a third market,c.A joint venture between an international company and a government firmd.A cooperation between two or more firms for the duration of a project, like a damn, airport, etc.

Advantages of joint ventures:

By-pass nationalistic feelingsAcquire expertise, tax, and other benefitsReduce investment risks

Disadvantages of joint ventures:

Firms have to share profits

Lack of control

3) Licensing is a contractual arrangement in which one firm grants access to its patents, trade secrets, or technology for a fee.

4) Franchising is a form of licensing in which one firm contracts with another to operate a certain type of business under an established name according to specific rules.

5) Contract manufacturing is an arrangement in which one firm contracts with another to produce products to its specifications but assumes responsibility for marketing.

Strategic alliances can be established with customers, suppliers, competitors.

The purposes of strategic alliances are;to achieve faster market entry and start-up,to gain access to new products,to share costs, resources, and risks.