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International Business


By Charles W.L. Hill


Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 1


What Is Globalization?
Globalization - the shift toward a more
integrated and interdependent world
The world is moving away from selfcontained national economies toward an
interdependent, integrated global
economic system


What Is The
Globalization of Markets?
Historically distinct and separate national
markets are merging
It no longer makes sense to talk about the
German market or the American market
Instead, there is the global market
falling trade barriers make it easier to sell globally
consumers tastes and preferences are converging on
some global norm
firms promote the trend by offering the same basic
products worldwide

What Is The
Globalization of Markets?
Firms of all sizes benefit and contribute to
the globalization of markets
97% of all U.S. exporters have less than 500
98% of all small and mid-sized German
companies participate in international markets


What Is The
Globalization of Production?
Firms source goods and services from
locations around the globe to capitalize on
national differences in the cost and quality
of factors of production like land, labor,
energy, and capital
Companies can
lower their overall cost structure
improve the quality or functionality of their
product offering


Why Do We Need
Global Institutions?
Global institutions
help manage, regulate, and police the global
promote the establishment of multinational
treaties to govern the global business system


Why Do We Need
Global Institutions?
Examples include
the General Agreement on Tariffs and Trade
the World Trade Organization (WTO)
the International Monetary Fund (IMF)
the World Bank
the United Nations (UN)
the G20


What Do Global
Institutions Do?
The World Trade Organization (like its
predecessor GATT)
polices the world trading system
makes sure that nation-states adhere to the
rules laid down in trade treaties
promotes lower barriers to trade and
154 members in 2011


What Do Global
Institutions Do?
The International Monetary Fund (1944)
maintains order in the international monetary
lender of last resort for countries in crisis
Argentina, Indonesia, Mexico, Russia, South
Korea, Thailand, Turkey, Ireland, and Greece

The World Bank (1944)

promotes economic development via low
interest loans for infrastructure projects

What Do Global
Institutions Do?
The United Nations (1945)
maintains international peace and security
develops friendly relations among nations
cooperates in solving international problems
and in promoting respect for human rights
is a center for harmonizing the actions of

The G20
forum through which major nations tried to
launch a coordinated policy response to the
2008-2009 global financial crisis

What Is Driving
Declining barriers to the free flow of goods,
services, and capital
average tariffs are now at just 4%
more favorable environment for FDI
global stock of FDI was $15.5 trillion in 2009
facilitates global production

Technological change
microprocessors and telecommunications
the Internet and World Wide Web
transportation technology

What Does Globalization

Mean For Firms?
Lower barriers to trade and investment
mean firms can
view the world, rather than a single country,
as their market
base production in the optimal location for that

But, firms may also find their home

markets under attack by foreign firms


Declining Trade And

Investment Barriers
Average Tariff Rates on Manufactured Products as Percent of Value


What Does Globalization

Mean For Firms?
Technological change means
lower transportation costs
help create global markets and allow firms to
disperse production to economical, geographically
separate locations
low cost information processing and communication
firms can create and manage globally dispersed
low cost global communications networks
help create an electronic global marketplace
global communication networks and global media
create a worldwide culture and a global consumer
product market

The Changing Demographics

Of The Global Economy
Four trends are important:
1. The changing world output and world
trade picture
2. The changing foreign direct investment
3. The changing nature of the multinational
4. The changing world order

How Has World Output And

World Trade Changed?
In 1960, the U.S. accounted for over 40%
of world economic activity, but by 2009,
the U.S. accounted for just 24%
a similar trend occurred in other developed

In contrast, the share of world output

accounted for by developing nations is
expected to account for more than 60% of
world economic activity by 2020

How Has World Output And

World Trade Changed?
The Changing Demographics of World GDP and Trade


How Has Foreign Direct

Investment Changed Over Time?
In the 1960s, U.S. firms accounted for
about two-thirds of worldwide FDI flows
Today, the United States accounts for less
than one-fifth of worldwide FDI flows
Other developed countries have followed a
similar pattern

In contrast, the share of FDI accounted for

by developing countries has risen
Developing countries, especially China, have
also become popular destinations for FDI

How Has Foreign Direct

Investment Changed Over Time?
Percentage Share of Total FDI Stock 1980-2007


How Has Foreign Direct

Investment Changed Over Time?
FDI Inflows 1988-2008


What Is A
Multinational Enterprise?
Multinational enterprise (MNE) - any
business that has productive activities in
two or more countries
Since the 1960s
the number of non-U.S. multinationals has
the number of mini-multinationals has risen


The Changing World Order

Many former Communist nations in Europe and
Asia are now committed to democratic politics
and free market economies
creates new opportunities for international businesses
but, there are signs of growing unrest and totalitarian
tendencies in some countries

China and Latin America are also moving toward

greater free market reforms
between 1983 and 2010, FDI in China increased from
less than $2 billion to $100 billion annually
but, China also has many new strong companies that
could threaten Western firms


How Will The Global Economy

Of The 21st Century Look?
The world is moving toward a more global
economic system
But globalization is not inevitable
there are signs of a retreat from liberal economic
ideology in Russia

Globalization brings risks

the financial crisis that swept through South East Asia
in the late 1990s
the recent financial crisis that started in the U.S. in
2007-2008, and moved around the world


Is An Interdependent Global
Economy A Good Thing?
Supporters believe that increased trade and
cross-border investment mean
lower prices for goods and services
greater economic growth
higher consumer income, and more jobs

Critics worry that globalization will cause

job losses
environmental degradation
the cultural imperialism of global media and MNEs

Anti-globalization protesters now regularly show

up at most major meetings of global institutions


How Does Globalization

Affect Jobs And Income?
Critics argue that falling barriers to trade
are destroying manufacturing jobs in
advanced countries
Supporters contend that the benefits of
this trend outweigh the costs
countries will specialize in what they do most
efficiently and trade for other goodsand all
countries will benefit


How Does Globalization Affect Labor

Policies And The Environment?
Critics argue that firms avoid the cost of
adhering to labor and environmental regulations
by moving production to countries where such
regulations do not exist, or are not enforced
Supporters claim that tougher environmental
and labor standards are associated with
economic progress
as countries get richer from free trade, they
implement tougher environmental and labor


How Does Globalization

Affect National Sovereignty?
Is todays global economy shifting economic power away
from national governments toward supranational
organizations like the WTO, the EU, and the UN?
Critics argue that unelected bureaucrats have the power
to impose policies on the democratically elected
governments of nation-states
Supporters claim that the power of these organizations is
limited to what nation-states agree to grant
the power of the organizations lies in their ability to
get countries to agree to follow certain actions


How Is Globalization
Affecting The Worlds Poor?
Is the gap between rich nations and poor nations
getting wider?
Critics believe that if globalization was beneficial
there should not be a divergence between rich
and poor nations
Supporters claim that the best way for the poor
nations to improve their situation is to
reduce barriers to trade and investment
implement economic policies based on free market
receive debt forgiveness for debts incurred under
totalitarian regimes


How Does The Global

Marketplace Affect Managers?
Managing an international business differs from
managing a domestic business because
countries are different
the range of problems confronted in an international
business is wider and the problems more complex
than those in a domestic business
firms have to find ways to work within the limits
imposed by government intervention in the
international trade and investment system
international transactions involve converting money
into different currencies

International Business

By Charles W.L. Hill


Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 2

National Differences
in Political Economy

What Is A Political Economy?

Political economy of a nation - how the
political, economic, and legal systems of a
country are interdependent
they interact and influence each other
they affect the level of economic well-being in
the nation


What Is A Political System?

Political system - the system of
government in a nation
Assessed according to
the degree to which the country emphasizes
collectivism as opposed to individualism
the degree to which the country is democratic
or totalitarian


What Is Collectivism?
Collectivism stresses the primacy of
collective goals over individual goals
can be traced to the Greek philosopher, Plato
(427-347 BC)

Today, collectivism is equated with

socialists (Karl Marx 1818-1883)
advocate state ownership of the basic means
of production, distribution, and exchange
manage to benefit society as a whole, rather
than individual capitalists

How Does Modern-Day

Socialism Look?
In the early 20th century, socialism split into
1. Communism socialism can only be achieved
through violent revolution and totalitarian
in retreat worldwide by mid-1990s

2. Social democrats socialism is achieved

through democratic means
retreating as many countries move toward free
market economies
state-owned enterprises have been privatized


What Is Individualism?
Individualism refers to philosophy that an
individual should have freedom in his own
economic and political pursuits
can be traced to Greek philosopher, Aristotle (384322 BC)
individual diversity and private ownership are
individual economic and political freedoms are the
ground rules on which a society should be based
implies democratic political systems and free market


What Is Democracy?
Democracy - a political system in which
government is by the people, exercised either
directly or through elected representatives
usually associated with individualism
pure democracy is based on the belief that citizens
should be directly involved in decision making
most modern democratic states practice
representative democracy where citizens periodically
elect individuals to represent them


What Is Totalitarianism?
Totalitarianism - form of government in
which one person or political party
exercises absolute control over all
spheres of human life and prohibits
opposing political parties


What Is Totalitarianism?
Four major forms of totalitarianism exist today
1. Communist totalitarianism found in states where
the communist party monopolizes power
2. Theocratic totalitarianism - found in states where
political power is monopolized by a party, group, or
individual that governs according to religious
3. Tribal totalitarianism - found in states where a
political party that represents the interests of a
particular tribe monopolizes power
4. Right-wing totalitarianism - permits some individual
economic freedom, but restricts individual political


What Is The Link Between Political

Ideology and Economic Systems?
Political ideology and economic systems
are connected
countries that stress individual goals are
likely to have market based economies
in countries where state-ownership is
common, collective goals are dominant


What Is An Economic System?

There are three types of economic
1. Market economies - all productive
activities are privately owned and
production is determined by the
interaction of supply and demand
government encourages free and fair
competition between private producers


What Is An Economic System?

2. Command economies - government plans the
goods and services that a country produces,
the quantity that is produced, and the prices as
which they are sold
all businesses are state-owned, and
governments allocate resources for the
good of society
because there is little incentive to control
costs and be efficient, command economies
tend to stagnate


What Is An Economic System?

3. Mixed economies - certain sectors of the
economy are left to private ownership
and free market mechanisms while other
sectors have significant state ownership
and government planning
governments tend to own firms that are
considered important to national security


What Is A Legal System?

Legal system - the rules that regulate behavior
along with the processes by which the laws are
enforced and through which redress for
grievances is obtained
the system in a country is influenced by the
prevailing political system

Legal systems are important for business

because they
define how business transactions are executed
identify the rights and obligations of parties involved
in business transactions


What Are The

Different Legal Systems?
There are three types of legal systems
1. Common law - based on tradition, precedent,
and custom
2. Civic law - based on detailed set of laws
organized into codes
3. Theocratic law - law is based on religious


How Are Contracts Enforced

In Different Legal Systems?
Contract - document that specifies the conditions
under which an exchange is to occur and details
the rights and obligations of the parties involved
Contract law is the body of law that governs
contract enforcement
under a common law system, contracts tend to be
very detailed with all contingencies spelled out
under a civil law system, contracts tend to be much
shorter and less specific because many issues are
already covered in the civil code


Which Countrys Laws Should

Apply In A Contract Dispute?
The United Nations Convention on Contracts for
the International Sale of Goods (CIGS)
establishes a uniform set of rules governing certain
aspects of the making and performance of everyday
commercial contracts between buyers and sellers
who have their places of business in different nations

Ratified by the U.S. and about 70 countries

but, many larger trading nations including Japan and
the U.K. have not agreed to the provisions of CIGS
and opt for arbitration instead


How Are Property Rights

And Corruption Related?
Property rights - the legal rights over the
use to which a resource is put and over
the use made of any income that may be
derived from that resource


How Are Property Rights

And Corruption Related?
Property rights can be violated through
1. Private action theft, piracy, blackmail
2. Public action - legally - ex. excessive
taxation or illegally - ex. bribes or
high levels of corruption reduce foreign direct
investment, the level of international trade, and
the economic growth rate in a country


How Are Property Rights

And Corruption Related?
The Foreign Corrupt Practices Act makes it
illegal for U.S. companies to bribe foreign
government officials to obtain or maintain
business over which that foreign official has
facilitating or expediting payments to secure or
expedite routine government action are permitted


Which Countries Are

Most Corrupt?
Rankings of Corruption by Country 2010


How Can Intellectual

Property Be Protected?
Intellectual property - property that is the product of
intellectual activity
Can be protected using
1. Patents exclusive rights for a defined period to the
manufacture, use, or sale of that invention
2. Copyrights the exclusive legal rights of authors,
composers, playwrights, artists, and publishers to
publish and disperse their work as they see fit
3. Trademarks design and names by which merchants
or manufacturers designate and differentiate their


How Can Intellectual

Property Be Protected?
Protection of intellectual property rights differs
from country to country
World Intellectual Property Organization
Paris Convention for the Protection of Industrial

To avoid piracy, firms can

stay away from countries where intellectual property
laws are lax
file lawsuits
lobby governments for international property rights
agreements and enforcement


What Is Product Safety

And Liability?
Product safety laws set certain standards to
which a product must adhere
Product liability involves holding a firm and its
officers responsible when a product causes
injury, death, or damage
liability laws tend to be less extensive in less
developed nations


Why Is Product Safety And

Product Liability Important?
Does the high cost of liability insurance in the
U.S. make American companies less
Is it ethical to follow host country standards
when product safety laws are stricter in a
firms home country than in a foreign country?
Is it ethical to follow host country standards
when liability laws are more lax in the host


How Can Managers Determine A

Markets Overall Attractiveness?
The overall attractiveness of a country as a
potential market and/or investment site for an
international business depends on balancing the
benefits, costs, and risks associated with doing
business in that country
Other things being equal, more attractive countries
have democratic political institutions, market based
economies, and strong legal systems that protect
property rights and limit corruption


International Business
By Charles W.L. Hill

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 4

in Culture

How Do Cultural Differences

Affect International Business?
Understanding and adapting to the local cultural
is important international companies
cross-cultural literacy - an understanding of how
cultural differences across and within nations can
affect the way in which business is practiced
cross-cultural literacy is important for business

A relationship may exist between culture and the

costs of doing business in a country or region
MNEs can be agents of cultural change


What Is Culture?
Culture - a system of values and norms that are
shared among a group of people and that when
taken together constitute a design for living
values are abstract ideas about what a group believes
to be good, right, and desirable
norms are the social rules and guidelines that
prescribe appropriate behavior in particular situations

Society - a group of people who share a

common set of values and norms

What Are Values And Norms?

Values provide the context within which a
societys norms are established and
justified and form the bedrock of a culture
Norms include
folkways - the routine conventions of
everyday life
mores - norms that are seen as central to the
functioning of a society and to its social life


How Are Culture, Society,

And The Nation-State Related?
The relationship between a society and a
nation state is not strictly one-to-one
Nation-states are political creations
can contain one or more cultures

A culture can embrace several nations


What Determines Culture?

The values and norms of a culture evolve
over time
Determinants include
political and economic philosophies
social structure


What Determines Culture?

Determinants of Culture


What Is A Social Structure?

Social structure - a societys basic social
the degree to which the basic unit of social
organization is the individual, as opposed to
the group
the degree to which a society is stratified into
classes or castes


How Are Individuals

And Groups Different?
A group is an association of two or more
people who have a shared sense of
identity and who interact with each other in
structured ways on the basis of a common
set of expectations about each others
individuals are involved in families, work
groups, social groups, recreational groups,

Societies place different values on groups


How Are Individuals

And Groups Different?
In Western societies, there is a focus on the
individual achievement is common
dynamism of the U.S. economy
high level of entrepreneurship

But, creates a lack of company loyalty and

failure to gain company specific knowledge
competition between individuals in a company instead
of than team building
less ability to develop a strong network of contacts
within a firm


How Are Individuals

And Groups Different?
In many Asian societies, the group is the
primary unit of social organization
discourages job switching between firms
encourages lifetime employment systems
leads to cooperation in solving business

But, might also suppress individual

creativity and initiative


What Is Social Stratification?

All societies are stratified on a
hierarchical basis into social categories,
or social strata
individuals are born into a particular stratum

Must consider
1. mobility between strata
2. the significance placed on social strata in
business contexts


What Is Social Stratification?

1. Social mobility - the extent to which individuals
can move out of the strata into which they are
caste system - closed system of stratification in
which social position is determined by the family
into which a person is born
change is usually not possible during an
individual's lifetime
class system - form of open social stratification
position a person has by birth can be changed
through achievement or luck


What Is Social Stratification?

2. The significance attached to social strata
in business contacts
class consciousness - a condition where people
tend to perceive themselves in terms of their
class background, and this shapes their
relationships with others
an antagonistic relationship between
management and labor raises the cost of
production in countries with significant class


How Do Religious And

Ethical Systems Differ?
Religion - a system of shared beliefs and
rituals that are concerned with the realm of the
Four religions dominate society

Confucianism is also important in influencing
behavior and culture in many parts of Asia

How Do Religious And

Ethical Systems Differ?
World Religions


How Do Religious And

Ethical Systems Differ?
Ethical systems - a set of moral
principles, or values, that are used to
guide and shape behavior
Religion and ethics are often closely
ex. Christian or Islamic ethics


What Is Christianity?
the worlds largest religion
found throughout Europe, the Americas, and
other countries settled by Europeans
the Protestant work ethic (Max Weber, 1804)
hard work, wealth creation, and frugality is the
driving force of capitalism


What Is Islam?
the worlds second largest religion dating to AD 610
there is only one true omnipotent God
an all-embracing way of life that governs one's being
associated in the Western media with militants,
terrorists, and violent upheavals
but, in fact teaches peace, justice, and tolerance
fundamentalists have gained political power and
blame the West for many social problems
people do not own property, but only act as stewards
for God
supportive of business, but the way business is
practiced is prescribed

What Is Hinduism?
practiced primarily on the Indian sub-continent
focuses on the importance of achieving
spiritual growth and development, which may
require material and physical self-denial
Hindus are valued by their spiritual rather than
material achievements
promotion and adding new responsibilities
may not be important, or may be infeasible
due to the employee's caste

What Is Buddhism?
has about 350 millions followers
stresses spiritual growth and the afterlife,
rather than achievement while in this world
does not emphasize wealth creation
entrepreneurial behavior is not stressed
does not support the caste system, individuals
do have some mobility and can work with
individuals from different classes

What Is Confucianism?
ideology practiced mainly in China
teaches the importance of attaining personal
salvation through right action
high morals, ethical conduct, and loyalty to
others are stressed
three key teachings of Confucianism - loyalty,
reciprocal obligations, and honesty - may all
lead to a lowering of the cost of doing
business in Confucian societies

What Is The Role

Of Language In Culture?
Language - the spoken and unspoken
(nonverbal communication such as facial
expressions, personal space, and hand
gestures ) means of communication
countries with more than one language often
have more than one culture
Canada, Belgium, Spain


What Is The Role

Of Language In Culture?
Language is one of the defining characteristics
of culture
Chinese is the mother tongue of the largest number of
English is the most widely spoken language in the
English is also becoming the language of international
but, knowledge of the local language is still beneficial,
and in some cases, critical for business success
failing to understand the nonverbal cues of another
culture can lead to communication failure


What Is The Role

Of Education In Culture?
Formal education is the medium through which
individuals learn many of the language,
conceptual, and mathematical skills that are
indispensable in a modern society
important in determining a nations competitive
Japans postwar success can be linked to its
excellent education system
general education levels can be a good index for the
kinds of products that might sell in a country
ex. impact of literacy rates


How Does Culture

Impact The Workplace?
Management processes and practices
must be adapted to culturally-determined
work-related values
Geert Hofstede studied culture using
data collected from 1967 to 1973 for
100,000 employees of IBM
Hofstede identified four dimensions that
summarized different cultures


How Does Culture

Impact The Workplace?
Hofstedes dimensions of culture:
1. Power distance - how a society deals with the
fact that people are unequal in physical and
intellectual capabilities
2. Uncertainty avoidance - the relationship
between the individual and his fellows
3. Individualism versus collectivism - the extent to
which different cultures socialize their
members into accepting ambiguous situations
and tolerating ambiguity
4. Masculinity versus femininity -the relationship
between gender and work roles

How Does Culture

Impact The Workplace?
Work-Related Values for 20 Countries


How Does Culture

Impact The Workplace?
Hofstede later expanded added a fifth
dimension called Confucian dynamism or
long-term orientation
captures attitudes toward time, persistence,
ordering by status, protection of face, respect
for tradition, and reciprocation of gifts and
Japan, Hong Kong, and Thailand scored high on
this dimension
the U.S. and Canada scored low


Was Hofstede Right?

Hofstedes work has been criticized for several
made the assumption there is a one-to-one
relationship between culture and the nation-state
study may have been culturally bound
used IBM as sole source of information
culture is not static it evolves

But, it is a starting point for understanding how

cultures differ, and the implications of those
differences for managers

Does Culture Change?

Culture evolves over time
changes in value systems can be slow and
painful for a society

Social turmoil - an inevitable outcome of

cultural change
as countries become economically stronger,
cultural change is particularly common
economic progress encourages a shift from
collectivism to individualism

globalization also brings cultural change


What Do Cultural Differences

Mean For Managers?
1. It is important to develop cross-cultural literacy
companies that are ill informed about the practices
of another culture are unlikely to succeed in that

To avoid being ill-informed

consider hiring local citizens
transfer executives to foreign locations on a regular

Managers must also guard against

a belief in the superiority of one's own culture

What Do Cultural Differences

Mean For Managers?
2. There is a connection between culture
and national competitive advantage
suggests which countries are likely to
produce the most viable competitors
has implications for the choice of countries
in which to locate production facilities and do


International Business

By Charles W.L. Hill


Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 5
Ethics in
International Business

What Is Ethics?
Ethics - accepted principles of right or wrong that
the conduct of a person
the members of a profession
the actions of an organization

Business ethics - accepted principles of right or

wrong governing the conduct of business people
Ethical strategy - a strategy, or course of action,
that does not violate these accepted principles


Which Ethical Issues Are Most

Relevant To International Firms?
The most common ethical issues in
business involve

employment practices
human rights
environmental regulations
the moral obligation of multinational


How Are Ethics Relevant

To Employment Practices?
Suppose work conditions in a host nation
are clearly inferior to those in the
multinationals home nation
Which standards should apply?
home country standards
host country standards
something in between


How Are Ethics Relevant

To Employment Practices?
Firms should
establish minimal acceptable standards that
safeguard the basic rights and dignity of
audit foreign subsidiaries and subcontractors
regularly to ensure they are meeting the
take corrective action as necessary


How Are Ethics Relevant

To Human Rights?
Basic human rights are taken for granted
in developed countries
freedom of association
freedom of speech
freedom of assembly
freedom of movement

Question: What are the responsibilities of

firms in countries where basic human
rights are not respected?

How Are Ethics Relevant

To Human Rights?
Question: Is it ethical for companies to do
business with countries with repressive

Question: Does multinational investment actually

help bring change to these countries and
ultimately improve the rights of citizens?


How Are Ethics Relevant

To Environmental Regulations?
Some parts of the environment are a public good that no
one owns, but anyone can despoil
What happens when environmental regulations in host
nations are far inferior to those in the home nation?
Is it permissible for multinationals to pollute in
developing countries simply because there are no
regulations against it?
legal versus ethical behavior
The tragedy of the commons occurs when a resource
held in common by all, but owned by no one, is overused
by individuals, resulting in its degradation


How Are Ethics Relevant

To Corruption?
The U.S. Foreign Corrupt Practices Act outlawed
the practice of paying bribes to foreign
government officials in order to gain business
amended to allow for facilitating payments
The Convention on Combating Bribery of
Foreign Public Officials in International Business
Transactions was adopted by the Organization
for Economic Cooperation and Development
obliges member states to make the bribery of
foreign public officials a criminal offense


How Are Ethics Relevant

To Corruption?
But, is it permissible for multinationals to
pay government officials facilitating
payments if doing so creates local income
and jobs?
is it ok to do a little evil in order to do a greater
does grease money actually improve
efficiency and help growth?


How Are Ethics Relevant

To Moral Obligations?
Social responsibility refers to the idea that
managers should consider the social
consequences of economic actions when
making business decisions
there should be a presumption in favor of
decisions that have both good economic and
good social consequences
it is the right way for a business to behave


How Are Ethics Relevant

To Moral Obligations?
Advocates argue that businesses need to
recognize their noblesse oblige honorable and benevolent behavior that is
the responsibility of successful companies
give something back to the societies that have
made their success possible

But, are multinationals morally required to

use their power to enhance local welfare?


What Are Ethical Dilemmas?

Ethical dilemmas - situations in which none of
the available alternatives seems ethically
real-world decisions are complex, difficult to frame,
and involve consequences that are difficult to quantify
the ethical obligations of an MNE toward employment
conditions, human rights, corruption, environmental
pollution, and the use of power are not always clear
the right course of action is not always clear


Why Do Managers
Behave Unethically?
Several factors contribute to unethical behavior
1. Personal ethics - the generally accepted
principles of right and wrong governing the
conduct of individuals
expatriates may face pressure to violate their
personal ethics because they are away from their
ordinary social context and supporting culture
managers fail to question whether a decision or
action is ethical, and instead rely on economic
analysis when making decisions


Why Do Managers
Behave Unethically?
2. Decision-making processes - the values and
norms that are shared among employees of an
organization culture that does not
emphasize business culture encourages
unethical behavior
3. Organizational culture - organizational culture
can legitimize unethical behavior or reinforce
the need for ethical behavior
4. Unrealistic performance expectations encourage managers to cut corners or act in
an unethical manner

Why Do Managers
Behave Unethically?
5. Leadership - helps establish the culture of an
organization, and set the examples that others
when leaders act unethically, subordinates may act
unethically, too

6. Societal culture firms headquartered in

cultures where individualism and uncertainty
avoidance are strong are more likely to stress
ethical behavior than firms headquartered in
cultures where masculinity and power distance
rank high

Why Do Managers
Behave Unethically?
Determinants of Ethical Behavior


What Are The Philosophical

Approaches To Ethics?
There are several different approaches to
business ethics
Straw men approaches deny the value of
business ethics or apply the concept in an
unsatisfactory way
Others approaches are favored by moral
philosophers and are the basis for current
models of ethical behavior

What Are The Straw Men

Approaches To Business Ethics?
There are four common straw men approaches
1. Friedman doctrine - the only social responsibility
of business is to increase profits, so long as the
company stays within the rules of law
2. Cultural relativism - ethics are culturally
determined and firms should adopt the ethics of
the cultures in which they operate
when in Rome, do as the Romans do


What Are The Straw Men

Approaches To Business Ethics?
3. Righteous moralist - a multinationals home
country standards of ethics should be followed
in foreign countries
4. Nave immoralist - if a manager of a
multinational sees that firms from other nations
are not following ethical norms in a host nation,
that manager should not either
All approaches offer inappropriate guidelines
for ethical decision making


What Are Utilitarian And

Kantian Approaches To Ethics?
Utilitarian ethics - (David Hume, Jeremy
Bentham, John Stuart Mills) - the moral worth of
actions or practices is determined by their
actions are desirable if they lead to the best possible
balance of good consequences over bad
but, it is difficult to measure the benefits, costs, and
risks of an action
the approach fails to consider justice


What Are Utilitarian And

Kantian Approaches To Ethics?
Kantian ethics - (Immanuel Kant) - people
should be treated as ends and never
purely as means to the ends of others
people have dignity and need to be respected
people are not machines


What Are Rights Theories?

Rights theories - human beings have
fundamental rights and privileges which
transcend national boundaries and cultures
establish a minimum level of morally acceptable
the Universal Declaration of Human Rights - basic
principles that should always be adhered to
irrespective of the culture in which one is doing

Moral theorists argue that fundamental human

rights form the basis for the moral compass that
managers should navigate by when making
decisions which have an ethical component

What Are Justice Theories?

Justice theories focus on the attainment of a just
distribution of economic goods and services
a just distribution is one that is considered fair and

John Rawls argued that all economic goods and

services should be distributed equally except
when an unequal distribution would work to
everyones advantage
impartiality is guaranteed by the veil of ignorance everyone is imagined to be ignorant of all his or her
particular characteristics


How Can Managers

Make Ethical Decisions?
1. Hire and promote people with a well
grounded sense of personal ethics
refrain from promoting individuals who have
acted unethically
try to hire only people with strong ethics
prospective employees should find out as
much as they can about the ethical climate in
an organization prior to taking a position


How Can Managers

Make Ethical Decisions?
2. Build an organizational culture that places a
high value on ethical behavior
articulate values that place a strong
emphasis on ethical behavior
emphasize the importance of a code of
ethics - formal statement of the ethical
priorities a business adheres to
implement a system of incentives and
rewards that recognize people who engage
in ethical behavior and sanction those who
do not


How Can Managers

Make Ethical Decisions?
3. Make sure that leaders within the
business articulate the rhetoric of ethical
behavior and act in a manner that is
consistent with that rhetoric
give life and meaning to words
make sure that leaders emphasize the
importance of ethics verbally and through
their actions


How Can Managers

Make Ethical Decisions?
4. Put decision making processes in place that
require people to consider the ethical
dimensions of business decisions
Ask whether
decisions fall within the accepted values of
standards that typically apply in the
organizational environment
decisions can be communicated to all
stakeholders affected by it
if colleagues would approve of decisions


How Can Managers

Make Ethical Decisions?
Managers can also use a five step process to
think through ethical problems:
Step1: Identify which stakeholders (the individuals
or groups who have an interest, stake, or
claim in the actions and overall
performance of a company) a decision
would affect and in what ways
internal stakeholders are people who work for or who
own the business such as employees, the board of
directors, and stockholders
external stakeholders are the individuals or groups who
have some claim on a firm such as customers,
suppliers, and unions


How Can Managers

Make Ethical Decisions?
Step 2: Determine whether a proposed decision
would violate the fundamental rights of any
Step 3: Establish moral intent - place moral
concerns ahead of other concerns in
cases where either the fundamental rights
of stakeholders or key moral principles
have been violated


How Can Managers

Make Ethical Decisions?
Step 4: Engage in ethical behavior
Step 5: Audit decisions and review them to
make sure that they are consistent
with ethical principles
this step is often overlooked even
though it is critical to finding out
whether a decision process is working


What Is An Ethics Officer?

Many firms now have ethics officers to
all employees are trained in ethics
ethics is considered in the decision-making
the companys code of conduct is followed


How Can Managers

Make Ethical Decisions?
5. Develop moral courage
enables managers to walk away from a decision
that is profitable, but unethical
gives an employee the strength to say no to a
superior who instructs her to pursue actions that are
gives employees the integrity to go public to the
media and blow the whistle on persistent unethical
behavior in a company


How Can Managers

Make Ethical Decisions?
In the end, there are clearly things that an
international business should do, and
there are things that an international
business should not do
But, it is important to remember that not all
ethical dilemmas have a clean and
obvious solution
in these situations, firms must rely on the
decision making ability of its managers

International Business

By Charles W.L. Hill


Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 6

Trade Theory

Why Is Free Trade Beneficial?

Free trade - a situation where a
government does not attempt to influence
through quotas or duties what its citizens
can buy from another country or what they
can produce and sell to another country
Trade theory shows why it is beneficial for
a country to engage in international trade
even for products it is able to produce for


Why Is Free Trade Beneficial?

International trade allows a country
to specialize in the manufacture and export of
products and services that it can produce
import products and services that can be
produced more efficiently in other countries
limits on imports may be beneficial to
producers, but not beneficial for consumers


Why Do Certain
Patterns Of Trade Exist?
Some patterns of trade are fairly easy to
it is obvious why Saudi Arabia exports oil,
Ghana exports cocoa, and Brazil exports

But, why does Switzerland export

chemicals, pharmaceuticals, watches, and
Why does Japan export automobiles,
consumer electronics, and machine tools?

What Role Does

Government Have In Trade?
The mercantilist philosophy makes a crude case
for government involvement in promoting
exports and limiting imports
Smith, Ricardo, and Heckscher-Ohlin promote
unrestricted free trade
New trade theory and Porters theory of national
competitive advantage justify limited and
selective government intervention to support the
development of certain export-oriented

What Is Mercantilism?
Mercantilism (mid-16th century) suggests
that it is in a countrys best interest to
maintain a trade surplus -to export more
than it imports
advocates government intervention to achieve
a surplus in the balance of trade

Mercantilism views trade as a zero-sum

game - one in which a gain by one country
results in a loss by another


What Is Smiths Theory

Of Absolute Advantage?
Adam Smith (1776) argued that a country
has an absolute advantage in the
production of a product when it is more
efficient than any other country in
producing it
countries should specialize in the production
of goods for which they have an absolute
advantage and then trade these goods for
goods produced by other countries

How Does The Theory

Of Absolute Advantage Work?
Assume that two countries, Ghana and South
Korea, both have 200 units of resources that
could either be used to produce rice or cocoa
In Ghana, it takes 10 units of resources to
produce one ton of cocoa and 20 units of
resources to produce one ton of rice
Ghana could produce 20 tons of cocoa and no rice,
10 tons of rice and no cocoa, or some combination of
rice and cocoa between the two extremes


How Does The Theory

Of Absolute Advantage Work?
In South Korea it takes 40 units of
resources to produce one ton of cocoa
and 10 resources to produce one ton of
South Korea could produce 5 tons of cocoa
and no rice, 20 tons of rice and no cocoa, or
some combination in between


How Does The Theory

Of Absolute Advantage Work?
Without trade
Ghana would produce 10 tons of cocoa and 5
tons of rice
South Korea would produce 10 tons of rice
and 2.5 tons of cocoa

With specialization and trade

Ghana would produce 20 tons of cocoa
South Korea would produce 20 tons of rice
Ghana could trade 6 tons of cocoa to South
Korea for 6 tons of rice


How Does The Theory

Of Absolute Advantage Work?
After trade
Ghana would have 14 tons of cocoa left, and
6 tons of rice
South Korea would have 14 tons of rice left
and 6 tons of cocoa

If each country specializes in the

production of the good in which it has an
absolute advantage and trades for the
other, both countries gain
trade is a positive sum game


How Does The Theory

Of Absolute Advantage Work?
Absolute Advantage and the Gains from Trade


What Is Ricardos Theory

Of Comparative Advantage?
David Ricardo asked what happens when one
country has an absolute advantage in the
production of all goods
The theory of comparative advantage (1817) countries should specialize in the production of
those goods they produce most efficiently and
buy goods that they produce less efficiently from
other countries
even if this means buying goods from other
countries that they could produce more
efficiently at home

How Does The Theory Of

Comparative Advantage Work?
Assume Ghana is more efficient in the
production of both cocoa and rice
In Ghana, it takes 10 resources to produce
one ton of cocoa, and 13 1/3 resources to
produce one ton of rice
So, Ghana could produce 20 tons of cocoa
and no rice, 15 tons of rice and no cocoa,
or some combination of the two


How Does The Theory Of

Comparative Advantage Work?
In South Korea, it takes 40 resources to
produce one ton of cocoa and 20
resources to produce one ton of rice
So, South Korea could produce 5 tons of
cocoa and no rice, 10 tons of rice and no
cocoa, or some combination of the two


How Does The Theory Of

Comparative Advantage Work?
With trade
Ghana could export 4 tons of cocoa to South
Korea in exchange for 4 tons of rice
Ghana will still have 11 tons of cocoa, and 4
additional tons of rice
South Korea still has 6 tons of rice and 4 tons
of cocoa
if each country specializes in the production of
the good in which it has a comparative
advantage and trades for the other, both
countries gain

How Does The Theory Of

Comparative Advantage Work?
Comparative advantage theory provides a
strong rationale for encouraging free trade
total output is higher
both countries benefit

Trade is a positive sum game


How Does The Theory Of

Comparative Advantage Work?
Comparative Advantage and the Gains from Trade


Is Unrestricted Free Trade

Always Beneficial?
Unrestricted free trade is beneficial, but the gains may
not be as great as the simple model of comparative
advantage would suggest

immobile resources
diminishing returns
dynamic effects and economic growth
the Samuelson critique

But, opening a country to trade could increase

a country's stock of resources as increased supplies become
available from abroad
the efficiency of resource utilization and so free up resources for
other uses
economic growth


Could A Rich Country Be

Worse Off With Free Trade?
Paul Samuelson - the dynamic gains from trade
may not always be beneficial
free trade may ultimately result in lower
wages in the rich country
The ability to offshore services jobs that were
traditionally not internationally mobile may have
the effect of a mass inward migration into the
United States, where wages would then fall
but, protectionist measures could create a
more harmful situation than free trade


What Is The
Heckscher-Ohlin Theory?
Eli Heckscher (1919) and Bertil Ohlin
(1933) - comparative advantage arises
from differences in national factor
the extent to which a country is endowed with
resources like land, labor, and capital

The more abundant a factor, the lower its



What Is The
Heckscher-Ohlin Theory?
The pattern of trade is determined by
factor endowments
Heckscher and Ohlin predict that countries
export goods that make intensive use of
locally abundant factors
import goods that make intensive use of
factors that are locally scarce


Does The Heckscher-Ohlin

Theory Hold?
Wassily Leontief (1953) theorized that since the
U.S. was relatively abundant in capital compared
to other nations, the U.S. would be an exporter
of capital intensive goods and an importer of
labor-intensive goods.
However, he found that U.S. exports were
less capital intensive than U.S. imports
Since this result was at variance with the
predictions of trade theory, it became known as
the Leontief Paradox


What Is The
Product Life Cycle Theory?
The product life-cycle theory - as products
mature both the location of sales and the
optimal production location will change
affecting the flow and direction of trade
proposed by Ray Vernon in the mid-1960s
At this time most of the worlds new products were
developed by U.S. firms and sold first in the U.S.


What Is The
Product Life Cycle Theory?
According to the product life-cycle theory
the size and wealth of the U.S. market gave U.S.
firms a strong incentive to develop new products
initially, the product would be produced and sold in
the U.S.
as demand grew in other developed countries, U.S.
firms would begin to export
demand for the new product would grow in other
advanced countries over time making it worthwhile for
foreign producers to begin producing for their home

What Is The
Product Life Cycle Theory?
U.S. firms might set up production facilities
in advanced countries with growing
demand, limiting exports from the U.S.
As the market in the U.S. and other
advanced nations matured, the product
would become more standardized, and
price would be the main competitive


What Is The
Product Life Cycle Theory?
Producers based in advanced countries where
labor costs were lower than the United States
might now be able to export to the United States
If cost pressures were intense, developing
countries would acquire a production advantage
over advanced countries
Production became concentrated in lower-cost
foreign locations, and the U.S. became an
importer of the product


What Is The
Product Life Cycle Theory?
The Product Life Cycle Theory


Does The Product Life

Cycle Theory Hold?
The product life cycle theory accurately explains
what has happened for products like
photocopiers and a number of other high
technology products developed in the United
States in the 1960s and 1970s
mature industries leave the U.S. for low cost
assembly locations


Does The Product Life

Cycle Theory Hold?
But, the globalization and integration of the
world economy has made this theory less
valid today
the theory is ethnocentric
production today is dispersed globally
products today are introduced in multiple
markets simultaneously


What Is New Trade Theory?

New trade theory suggests that the ability of
firms to gain economies of scale (unit cost
reductions associated with a large scale of
output) can have important implications for
international trade
Countries may specialize in the production and
export of particular products because in certain
industries, the world market can only support a
limited number of firms
new trade theory emerged in the 1980s
Paul Krugman won the Nobel prize for his
work in 2008

What Is New Trade Theory?

1. Through its impact on economies of scale, trade
can increase the variety of goods available to
consumers and decrease the average cost of
those goods
without trade, nations might not be able to produce
those products where economies of scale are
with trade, markets are large enough to support the
production necessary to achieve economies of scale
so, trade is mutually beneficial because it allows for
the specialization of production, the realization of
scale economies, and the production of a greater
variety of products at lower prices


What Is New Trade Theory?

2. In those industries when output required to
attain economies of scale represents a
significant proportion of total world demand,
the global market may only be able to support
a small number of enterprises
first mover advantages - the economic and
strategic advantages that accrue to early
entrants into an industry
economies of scale
first movers can gain a scale based cost
advantage that later entrants find difficult to

What Are The Implications Of

New Trade Theory For Nations?
Nations may benefit from trade even when they
do not differ in resource endowments or
a country may dominate in the export of a good
simply because it was lucky enough to have one or
more firms among the first to produce that good

Governments should consider strategic trade

policies that nurture and protect firms and
industries where first mover advantages and
economies of scale are important

What Is Porters Diamond Of

Competitive Advantage?
Michael Porter (1990) tried to explain why a
nation achieves international success in a
particular industry
identified four attributes that promote or
impede the creation of competitive
1. Factor endowments - a nations position in
factors of production necessary to compete in
a given industry
can lead to competitive advantage
can be either basic (natural resources, climate,
location) or advanced (skilled labor, infrastructure,
technological know-how)

What Is Porters Diamond Of

Competitive Advantage?
2. Demand conditions - the nature of home
demand for the industrys product or service
influences the development of capabilities
sophisticated and demanding customers pressure
firms to be competitive

3. Relating and supporting industries - the

presence or absence of supplier industries and
related industries that are internationally
can spill over and contribute to other industries
successful industries tend to be grouped in clusters
in countries


What Is Porters Diamond Of

Competitive Advantage?
4. Firm strategy, structure, and rivalry - the
conditions governing how companies are
created, organized, and managed, and the
nature of domestic rivalry
different management ideologies affect the
development of national competitive advantage
vigorous domestic rivalry creates pressures to
innovate, to improve quality, to reduce costs, and to
invest in upgrading advanced features


What Is Porters Diamond Of

Competitive Advantage?
Determinants of National Competitive Advantage: Porters Diamond


Does Porters Theory Hold?

Government policy can
affect demand through product standards
influence rivalry through regulation and antitrust laws
impact the availability of highly educated workers and
advanced transportation infrastructure.

The four attributes, government policy, and

chance work as a reinforcing system,
complementing each other and in combination
creating the conditions appropriate for
competitive advantage
So far, Porters theory has not been sufficiently
tested to know how well it holds up

What Are The Implications Of

Trade Theory For Managers?

Location implications - a firm should disperse its

various productive activities to those countries where
they can be performed most efficiently
firms that do not may be at a competitive
2. First-mover implications - a first-mover advantage can
help a firm dominate global trade in that product
3. Policy implications - firms should work to encourage
governmental policies that support free trade
want policies that have a favorable impact on each
component of the diamond


What Is The
Balance Of Payments?
A countrys balance of payments accounts
keep track of the payments to and receipts
from other countries for a particular time period
double entry bookkeeping
sum of the current account balance, the
capital account and the financial account
should be zero


What Is The
Balance Of Payments?


There are three main accounts

The current account records transactions of goods,
services, and income, receipts and payments
current account deficit - a country imports more
than it exports
current account surplus a country exports more
than it imports
2. The capital account records one time changes in the
stock of assets
3. The financial account records transactions that involve
the purchase or sale of assets
net change in U.S. assets owned abroad
foreign owned assets in the U.S.

What Is The
Balance Of Payments?
United States Balance of Payments Accounts, 2010


Is A Current
Account Deficit Bad?
Question: Does current account deficit in the
United States matter?
A current account deficit implies a net debtor
so, a persistent deficit could limit future
economic growth
But, even though capital is flowing out of the
U.S. as payments to foreigners, much of it flows
back in as investments in assets
Yet, suppose foreigners stop buying U.S. assets
and sell their dollars for another currency
a dollar crisis could occur

International Business

By Charles W.L. Hill


Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 8

Foreign Direct

What Is FDI?
Foreign direct investment (FDI) occurs
when a firm invests directly in new
facilities to produce and/or market in a
foreign country
the firm becomes a multinational enterprise

FDI can be in the form of

greenfield investments - the establishment of
a wholly new operation in a foreign country
acquisitions or mergers with existing firms in
the foreign country


What Is FDI?
The flow of FDI - the amount of FDI
undertaken over a given time period
Outflows of FDI are the flows of FDI out of a
Inflows of FDI are the flows of FDI into a

The stock of FDI - the total accumulated

value of foreign-owned assets at a given

What Are The Patterns Of FDI?

Both the flow and stock of FDI have
increased over the last 30 years
Most FDI is still targeted towards developed
United States, Japan, and the EU
but, other destinations are emerging
South, East, and South East Asia
especially China
Latin America

What Are The Patterns Of FDI?

FDI Outflows 1982-2010 ($ billions)


What Are The Patterns Of FDI?

FDI Inflows by Region 1995-2010 ($ billion)


What Are The Patterns Of FDI?

The growth of FDI is a result of
1. a fear of protectionism
want to circumvent trade barriers
2. political and economic changes
deregulation, privatization, fewer restrictions on
3. new bilateral investment treaties
designed to facilitate investment
4. the globalization of the world economy
many companies now view the world as their
need to be closer to their customers


What Are The Patterns Of FDI?

Gross fixed capital formation - the total
amount of capital invested in factories,
stores, office buildings, and the like
the greater the capital investment in an
economy, the more favorable its future
prospects are likely to be

So, FDI is an important source of capital

investment and a determinant of the future
growth rate of an economy

What Are The Patterns Of FDI?

Inward FDI as a % of Gross Fixed Capital Formation 1992-2008


What Is The Source Of FDI?

Since World War II, the U.S. has been the
largest source country for FDI
the United Kingdom, the Netherlands, France,
Germany, and Japan are other important
source countries
together, these countries account for 60% of
all FDI outflows from 1998-2010


What Is The Source Of FDI?

Cumulative FDI Outflows 1998-2010 ($ billions)


Why Do Firms Choose Acquisition

Versus Greenfield Investments?
Most cross-border investment is in the
form of mergers and acquisitions rather
than greenfield investments
between 40-80% of all FDI inflows per annum
from 1998 to 2009 were in the form of
mergers and acquisitions
but in developing countries two-thirds of
FDI is greenfield investment
fewer target companies

Why Do Firms Choose Acquisition

Versus Greenfield Investments?
Firms prefer to acquire existing assets
mergers and acquisitions are quicker to
execute than greenfield investments
it is easier and perhaps less risky for a firm to
acquire desired assets than build them from
the ground up
firms believe that they can increase the
efficiency of an acquired unit by transferring
capital, technology, or management skills

Why Choose FDI?

Question: Why does FDI occur instead of
exporting or licensing?
1. Exporting - producing goods at home
and then shipping them to the receiving
country for sale
exports can be limited by transportation
costs and trade barriers
FDI may be a response to actual or
threatened trade barriers such as import
tariffs or quotas

Why Choose FDI?

2. Licensing - granting a foreign entity the right to
produce and sell the firms product in return for
a royalty fee on every unit that the foreign
entity sells

Internalization theory (aka market imperfections

theory) - compared to FDI licensing is less attractive
firm could give away valuable technological knowhow to a potential foreign competitor
does not give a firm the control over manufacturing,
marketing, and strategy in the foreign country
the firms competitive advantage may be based on
its management, marketing, and manufacturing


What Is The Pattern Of FDI?

Question: Why do firms in the same industry
undertake FDI at about the same time and the
same locations?
Knickerbocker - FDI flows are a reflection of
strategic rivalry between firms in the global
multipoint competition -when two or more enterprises
encounter each other in different regional markets,
national markets, or industries

Vernon - firms undertake FDI at particular stages

in the life cycle of a product

What Is The Pattern Of FDI?

Question: But, why is it profitable for firms to
undertake FDI rather than continuing to export
from home base, or licensing a foreign firm?
Dunnings eclectic paradigm - it is important to
location-specific advantages - that arise from using
resource endowments or assets that are tied to a
particular location and that a firm finds valuable to
combine with its own unique assets
externalities - knowledge spillovers that occur when
companies in the same industry locate in the same


What Are The Theoretical

Approaches To FDI?
The radical view - the MNE is an instrument of
imperialist domination and a tool for exploiting
host countries to the exclusive benefit of their
capitalist-imperialist home countries
in retreat almost everywhere

The free market view - international production

should be distributed among countries according
to the theory of comparative advantage
embraced by advanced and developing nations
including the United States and Britain, but no country
has adopted it in its purest form


What Are The Theoretical

Approaches To FDI?
Pragmatic nationalism - FDI has both benefits
(inflows of capital, technology, skills and jobs)
and costs (repatriation of profits to the home
country and a negative balance of payments
FDI should be allowed only if the benefits outweigh
the costs

Recently, there has been a strong shift toward

the free market stance creating
a surge in FDI worldwide
an increase in the volume of FDI in countries with
newly liberalized regimes


How Does FDI Benefit

The Host Country?
There are four main benefits of inward
FDI for a host country
1. Resource transfer effects - FDI brings
capital, technology, and management
2. Employment effects - FDI can bring jobs


How Does FDI Benefit

The Host Country?
3. Balance of payments effects - FDI can help a
country to achieve a current account surplus
4. Effects on competition and economic growth greenfield investments increase the level of
competition in a market, driving down prices
and improving the welfare of consumers
can lead to increased productivity growth, product
and process innovation, and greater economic


What Are The Costs Of

FDI To The Host Country?
Inward FDI has three main costs:
1. Adverse effects of FDI on competition
within the host nation
subsidiaries of foreign MNEs may have
greater economic power than indigenous
competitors because they may be part of a
larger international organization


What Are The Costs Of

FDI To The Host Country?
2. Adverse effects on the balance of payments
when a foreign subsidiary imports a substantial
number of its inputs from abroad, there is a debit on
the current account of the host countrys balance of

3. Perceived loss of national sovereignty and

decisions that affect the host country will be made
by a foreign parent that has no real commitment to
the host country, and over which the host countrys
government has no real control

How Does FDI Benefit

The Home Country?
The benefits of FDI for the home country
1. The effect on the capital account of the home
countrys balance of payments from the inward
flow of foreign earnings
2. The employment effects that arise from
outward FDI
3. The gains from learning valuable skills from
foreign markets that can subsequently be
transferred back to the home country

What Are The Costs Of

FDI To The Home Country?
1. The home countrys balance of payments
can suffer
from the initial capital outflow required to
finance the FDI
if the purpose of the FDI is to serve the home
market from a low cost labor location
if the FDI is a substitute for direct exports


What Are The Costs Of

FDI To The Home Country?
2. Employment may also be negatively affected if
the FDI is a substitute for domestic production
But, international trade theory suggests that
home country concerns about the negative
economic effects of offshore production (FDI
undertaken to serve the home market) may not
be valid
may stimulate economic growth and employment in
the home country by freeing resources to specialize
in activities where the home country has a
comparative advantage


How Does Government

Influence FDI?
Governments can encourage outward FDI
government-backed insurance programs to
cover major types of foreign investment risk

Governments can restrict outward FDI

limit capital outflows, manipulate tax rules, or
outright prohibit FDI


How Does Government

Influence FDI?
Governments can encourage inward FDI
offer incentives to foreign firms to invest in
their countries
gain from the resource-transfer and employment
effects of FDI, and capture FDI away from other
potential host countries

Governments can restrict inward FDI

use ownership restraints and performance


How Do International
Institutions Influence FDI?
Until the 1990s, there was no consistent
involvement by multinational institutions in
the governing of FDI
Today, the World Trade Organization is
changing this by trying to establish a
universal set of rules designed to promote
the liberalization of FDI


What Does FDI

Mean For Managers?
Managers need to consider what trade
theory implies about FDI, and the link
between government policy and FDI
The direction of FDI can be explained
through the location-specific advantages
argument associated with John Dunning
however, it does not explain why FDI is
preferable to exporting or licensing, must
consider internalization theory

What Does FDI

Mean For Managers?
A Decision Framework


What Does FDI

Mean For Managers?
A host governments attitude toward FDI is
important in decisions about where to
locate foreign production facilities and
where to make a foreign direct investment
firms have the most bargaining power when
the host government values what the firm has
to offer, when the firm has multiple
comparable alternatives, and when the firm
has a long time to complete negotiations

International Business
By Charles W.L. Hill

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 9

Regional Economic

What Is Regional
Economic Integration?
Regional economic integration - agreements
between countries in a geographic region to
reduce tariff and non-tariff barriers to the free
flow of goods, services, and factors of
production between each other
Question: Do regional trade agreements
promote free trade?
In theory, yes, but the world may be moving toward a
situation in which a number of regional trade blocks
compete against each other


What Are The Levels Of

Regional Economic Integration?
1. A free trade area eliminates all barriers to
the trade of goods and services among
member countries
European Free Trade Association (EFTA) Norway, Iceland, Liechtenstein, and
North American Free Trade Agreement
(NAFTA) - U.S., Canada, and Mexico


What Are The Levels Of

Regional Economic Integration?
2. A customs union eliminates trade barriers
between member countries and adopts a
common external trade policy
Andean Community (Bolivia, Columbia, Ecuador,
and Peru)

3. A common market has no barriers to trade

between member countries, a common
external trade policy, and the free movement of
the factors of production
MERCOSUR (Brazil, Argentina, Paraguay, and


What Are The Levels Of

Regional Economic Integration?
4. An economic union has the free flow of
products and factors of production between
members, a common external trade policy, a
common currency, a harmonized tax rate, and
a common monetary and fiscal policy
European Union (EU)

5. A political union involves a central political

apparatus that coordinates the economic,
social, and foreign policy of member states
the EU is headed toward at least partial political
union, and the U.S. is an example of even closer
political union


What Are The Levels Of

Regional Economic Integration?
Levels of Economic Integration


Why Should Countries

Integrate Their Economies?
All countries gain from free trade and investment
regional economic integration is an attempt to exploit
the gains from free trade and investment

Linking countries together, making them more

dependent on each other
creates incentives for political cooperation and
reduces the likelihood of violent conflict
gives countries greater political clout when dealing
with other nations


What Limits Efforts

At Integration?
Economic integration can be difficult because
while a nation as a whole may benefit from a regional
free trade agreement, certain groups may lose
it implies a loss of national sovereignty

Regional economic integration is only beneficial

if the amount of trade it creates exceeds the
amount it diverts
trade creation occurs when low cost producers within
the free trade area replace high cost domestic
trade diversion occurs when higher cost suppliers
within the free trade area replace lower cost external

What Is The Status Of Regional

Economic Integration In Europe?
Europe has two trade blocs
1. The European Union (EU) with 27
2. The European Free Trade Area (EFTA)
with 4 members
The EU is seen as the worlds next
economic and political superpower


What Is The Status Of Regional

Economic Integration In Europe?
Member States of The European Union in 2011


What Is The European Union?

The devastation of two world wars on Western
Europe prompted the formation of the EU
Members wanted lasting peace and to hold their own
on the worlds political and economic stage

Forerunner was the European Coal and Steel

Community (1951)
The European Economic Community (1957) was
formed at the Treaty of Rome with the goal of
becoming a common market


What Is The European Union?

The Single European Act (1987)
committed the EC countries to work toward
establishment of a single market by December 31,
was born out of frustration among EC members that
the community was not living up to its promise
provided the impetus for the restructuring of
substantial sections of European industry allowing for
faster economic growth than would otherwise have
been the case


What Is The Political Structure

Of The European Union?
The main institutions in the EU include:
1. The European Council - the ultimate controlling
authority within the EU
2. The European Commission - responsible for proposing
EU legislation, implementing it, and monitoring
compliance with EU laws by member states
3. The European Parliament - debates legislation
proposed by the commission and forwarded to it by the
4. The Court of Justice - the supreme appeals court for EU


What Is The Euro?

The Maastricht Treaty committed the EU
to adopt a single currency
created the second largest currency zone in
the world after that of the U.S. dollar
used by 17 of the 27 member states
Britain, Denmark and Sweden opted out

since its establishment January 1, 1999,

the euro has had a volatile trading history
with the U.S. dollar

Is The Euro A Good Thing?

Benefits of the euro
savings from having to handle one currency, rather
than many
it is easier to compare prices across Europe, so firms
are forced to be more competitive
gives a strong boost to the development of highly
liquid pan-European capital market
increases the range of investment options open both
to individuals and institutions

Costs of the euro

loss of control over national monetary policy
EU is not an optimal currency area


Should The EU
Continue To Expand?
Many countries have applied for EU
Ten countries joined in 2004 expanding
the EU to 25 states
In 2007, Bulgaria and Romania joined
bringing membership to 27 countries
Turkey has been denied full membership
because of concerns over human rights

What Is The Status Of Economic

Integration In The Americas?
There is a move toward greater regional
economic integration in the Americas
The biggest effort is the North American
Free Trade Area (NAFTA)
Other efforts include the Andean
Community and MERCOSUR
A hemisphere-wide Free Trade of the
Americas is under discussion

What Is The Status Of Economic

Integration In The Americas?
Economic Integration in the Americas


What Is The North American

Free Trade Agreement?
The North American Free Trade Area includes the
United States, Canada, and Mexico
abolished tariffs on 99% of the goods traded between
removed barriers on the cross-border flow of services
protects intellectual property rights
removes most restrictions on FDI between members
allows each country to apply its own environmental
establishes two commissions to impose fines and
remove trade privileges when environmental
standards or legislation involving health and safety,
minimum wages, or child labor are ignored


Is The North American

Free Trade Area Beneficial?
Supporters of NAFTA claimed that
Mexico would benefit
from increased jobs as low cost production moves
south and will see more rapid economic growth as a

the U.S. and Canada would benefit from

access to a large and increasingly prosperous market
the lower prices for consumers from goods produced
in Mexico
low cost labor and the ability to be more competitive
on world markets
increased imports by Mexico


Is The North American

Free Trade Area Beneficial?
Critics of NAFTA claimed that
jobs would be lost and wage levels would
decline in the U.S. and Canada
pollution would increase due to Mexico's more
lax standards
Mexico would lose its sovereignty


Who Was Right?

Research indicates that NAFTAs early
impact was subtle, and both advocates
and detractors may have been guilty of
NAFTA is credited with helping create
increased political stability in Mexico
Other Latin American countries would like
to join NAFTA

What Is
The Andean Community?
The Andean Pact
formed in 1969 using the EU model
had more or less failed by the mid-1980s
was re-launched in 1990, and now operates
as a customs union
renamed the Andean Community in 1997
signed an agreement in 2003 with
MERCOSUR to restart negotiations towards
the creation of a free trade area

originated in 1988 as a free trade pact between Brazil
and Argentina
was expanded in 1990 to include Paraguay and
Uruguay and in 2005 with the addition of Venezuela
may be diverting trade rather than creating trade, and
local firms are investing in industries that are not
competitive on a worldwide basis
initially made progress on reducing trade barriers
between member states, but more recently efforts
have stalled

What Is The Central American

Trade Agreement And CARICOM?
There are two other trade pacts in the Americas
the Central American Trade Agreement (CAFTA,
2005) - to lower trade barriers between the U.S. and
CARICOM (1973) - to establish a customs union

Neither pact has achieved its goals yet

In 2006, six CARICOM members formed the
Caribbean Single Market and Economy (CSME)
- to lower trade barriers and harmonize macroeconomic and monetary policy between

What Is Free Trade

Of The Americas?
Talks began in April 1998 to establish a Free Trade of
The Americas (FTAA) by 2005
The FTAA was not established and now support from the
U.S. and Brazil is mixed
the U.S. wants stricter enforcement if intellectual
property rights
Brazil and Argentina want the U.S. to eliminate
agricultural subsidies and tariffs
If the FTAA is established, it will have major implications
for cross-border trade and investment flows within the
would create a free trade area of 850 million people
who accounted for nearly $18 trillion in GDP in 2008


What Is The Status Of

Economic Integration In Asia?
Various efforts at integration have been
attempted in Asia, but most exist in name
Association of Southeast Asian Nations
Asia-Pacific Economic Cooperation (APEC)


What Is The Association Of

Southeast Asian Nations?
The Association of Southeast Asian Nations
(ASEAN, 1967)
currently includes Brunei, Indonesia, Malaysia, the
Philippines, Singapore, Thailand, Vietnam, Myanmar,
Laos, and Cambodia
wants to foster freer trade between member countries
and to achieve some cooperation in their industrial

An ASEAN Free Trade Area (AFTA) between

the six original members of ASEAN came into
effect in 2003
ASEAN and AFTA are moving towards establishing a
free trade zone

What Is The Association Of

Southeast Asian Nations?
ASEAN Countries


What Is The Asia-Pacific

Economic Cooperation?
The Asia-Pacific Economic Cooperation
has 21 members including the United States,
Japan, and China
wants to increase multilateral cooperation
member states account for 55% of worlds
GNP, and 49% of world trade


What Is The Asia-Pacific

Economic Cooperation?
APEC Members


What Is The Status Of

Economic Integration In Africa?
Many countries are members of more than
one of the nine blocs in the region
but, since many countries support the use of
trade barriers to protect their economies from
foreign competition, meaningful progress is

The East African Community (EAC) was

re-launched in 2001, however so far, the
effort appears futile

What Does Economic

Integration Mean For Managers?
Regional economic integration
opens new markets
allows firms to realize cost economies by centralizing
production in those locations where the mix of factor
costs and skills is optimal

within each grouping, the business environment
becomes competitive
there is a risk of being shut out of the single market by
the creation of a trade fortress


International Business
By Charles W.L. Hill

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 10

The Foreign
Exchange Market

Why Is The Foreign

Exchange Market Important?
The foreign exchange market
1. is used to convert the currency of one country
into the currency of another
2. provides some insurance against foreign
exchange risk - the adverse consequences of
unpredictable changes in exchange rates

The exchange rate is the rate at which

one currency is converted into another
events in the foreign exchange market affect
firm sales, profits, and strategy

When Do Firms Use The

Foreign Exchange Market?
International companies use the foreign
exchange market when
the payments they receive for exports, the income
they receive from foreign investments, or the income
they receive from licensing agreements with foreign
firms are in foreign currencies
they must pay a foreign company for its products or
services in its countrys currency
they have spare cash that they wish to invest for short
terms in money markets
they are involved in currency speculation - the shortterm movement of funds from one currency to another
in the hopes of profiting from shifts in exchange rates


How Can Firms Hedge Against

Foreign Exchange Risk?
The foreign exchange market provides
insurance to protect against foreign
exchange risk
the possibility that unpredicted changes in
future exchange rates will have adverse
consequences for the firm

A firm that insures itself against foreign

exchange risk is hedging


What Is The Difference Between

Spot Rates And Forward Rates?
The spot exchange rate is the rate at which a
foreign exchange dealer converts one currency
into another currency on a particular day
spot rates change continually depending on the
supply and demand for that currency and other

Spot exchange rates can be quoted as the

amount of foreign currency one U.S. dollar can
buy, or as the value of a dollar for one unit of
foreign currency

What Is The Difference Between

Spot Rates And Forward Rates?
Value of the U.S. Dollar Against Other Currencies 2/12/11


What Is The Difference Between

Spot Rates And Forward Rates?
To insure or hedge against a possible
adverse foreign exchange rate movement,
firms engage in forward exchanges
two parties agree to exchange currency and
execute the deal at some specific date in the

A forward exchange rate is the rate used

for these transactions
rates for currency exchange are typically
quoted for 30, 90, or 180 days into the future

What Is A Currency Swap?

A currency swap is the simultaneous purchase
and sale of a given amount of foreign exchange
for two different value dates
Swaps are transacted
between international businesses and their banks
between banks
between governments when it is desirable to move
out of one currency into another for a limited period
without incurring foreign exchange rate risk


What Is The Nature Of The

Foreign Exchange Market?
The foreign exchange market is a global network
of banks, brokers, and foreign exchange dealers
connected by electronic communications
the average total value of global foreign exchange
trading in March, 1986 was just $200 billion, in April,
2010 it hit $4 trillion per day
the most important trading centers are London, New
York, Zurich, Tokyo, and Singapore
the market is always open somewhere in the worldit
never sleeps


Do Exchange Rates Differ

Between Markets?
High-speed computer linkages between
trading centers mean there is no
significant difference between exchange
rates in the differing trading centers
If exchange rates quoted in different
markets were not essentially the same,
there would be an opportunity for arbitrage
the process of buying a currency low
and selling it high

Do Exchange Rates Differ

Between Markets?
Most transactions involve dollars on one
sideit is a vehicle currency
85% of all foreign exchange transactions
involve the U.S. dollar
other vehicle currencies are the euro, the
Japanese yen, and the British pound
Chinas renminbi is still only used for about
0.3% of foreign exchange transactions


How Are Exchange Rates

Exchange rates are determined by the
demand and supply for different
Three factors impact future exchange
rate movements
1. A countrys price inflation
2. A countrys interest rate
3. Market psychology


How Do Prices
Influence Exchange Rates?
The law of one price states that in
competitive markets free of transportation
costs and barriers to trade, identical
products sold in different countries must
sell for the same price when their price is
expressed in terms of the same currency
otherwise there is an opportunity for arbitrage
until prices equalize between the two markets


How Do Prices
Influence Exchange Rates?
Purchasing power parity theory (PPP)
argues that given relatively efficient
markets (a market with no impediments to
the free flow of goods and services) the
price of a basket of goods should be
roughly equivalent in each country
predicts that changes in relative prices will
result in a change in exchange rates


How Do Prices
Influence Exchange Rates?
A positive relationship exists between the
inflation rate and the level of money supply
when the growth in the money supply is greater than
the growth in output, inflation will occur

PPP theory suggests that changes in relative

prices between countries will lead to exchange
rate changes, at least in the short run
a country with high inflation should see its currency
depreciate relative to others


How Do Prices
Influence Exchange Rates?
Question: How well does PPP work?
Empirical testing of PPP theory suggests that
it is most accurate in the long run, and for countries
with high inflation and underdeveloped capital
it is less useful for predicting short term exchange
rate movements between the currencies of advanced
industrialized nations that have relatively small
differentials in inflation rates


How Do Interest Rates

Influence Exchange Rates?
The International Fisher Effect states that for any
two countries the spot exchange rate should
change in an equal amount but in the opposite
direction to the difference in nominal interest
rates between two countries
In other words:
[(S1 - S2) / S2 ] x 100 = i $ - i

where i$ and i are the respective nominal

interest rates in two countries (in this case the
U.S. and Japan), S1 is the spot exchange rate at
the beginning of the period and S2 is the spot
exchange rate at the end of the period

How Does Investor Psychology

Influence Exchange Rates?
The bandwagon effect occurs when
expectations on the part of traders turn into selffulfilling prophecies - traders can join the
bandwagon and move exchange rates based on
group expectations
investor psychology and bandwagon effects
greatly influence short term exchange rate
government intervention can prevent the
bandwagon from starting, but is not always

Should Companies Use Exchange

Rate Forecasting Services?
There are two schools of thought
1. The efficient market school - forward exchange
rates do the best possible job of forecasting
future spot exchange rates, and, therefore,
investing in forecasting services would be a
waste of money
2. The inefficient market school - companies can
improve the foreign exchange markets
estimate of future exchange rates by investing
in forecasting services


Should Companies Use Exchange

Rate Forecasting Services?
1. An efficient market is one in which prices
reflect all available information
if the foreign exchange market is efficient,
then forward exchange rates should be
unbiased predictors of future spot rates

Most empirical tests confirm the efficient

market hypothesis suggesting that
companies should not waste their money
on forecasting services

Should Companies Use Exchange

Rate Forecasting Services?
2. An inefficient market is one in which
prices do not reflect all available
in an inefficient market, forward exchange
rates will not be the best possible predictors
of future spot exchange rates and it may be
worthwhile for international businesses to
invest in forecasting services

However, the track record of forecasting

services is not good

How Are Exchange

Rates Predicted?
Two schools of thought on forecasting:
1. Fundamental analysis draws upon economic
factors like interest rates, monetary policy,
inflation rates, or balance of payments
information to predict exchange rates
2. Technical analysis charts trends with the
assumption that past trends and waves are
reasonable predictors of future trends and


Are All Currencies

Freely Convertible?
A currency is freely convertible when a government of a
country allows both residents and non-residents to
purchase unlimited amounts of foreign currency with the
domestic currency
A currency is externally convertible when non-residents
can convert their holdings of domestic currency into a
foreign currency, but when the ability of residents to
convert currency is limited in some way
A currency is nonconvertible when both residents and
non-residents are prohibited from converting their
holdings of domestic currency into a foreign currency


Are All Currencies

Freely Convertible?
Most countries today practice free convertibility
but many countries impose restrictions on the
amount of money that can be converted
Countries limit convertibility to preserve foreign
exchange reserves and prevent capital flight
when residents and nonresidents rush to
convert their holdings of domestic currency
into a foreign currency
most likely to occur in times of hyperinflation
or economic crisis


Are All Currencies

Freely Convertible?
When a currency is nonconvertible, firms may
turn to countertrade
barter-like agreements where goods and
services are traded for other goods and
was more common in the past when more
currencies were nonconvertible, but today
involves less than 10% of world trade


What Do Exchange Rates

Mean For Managers?
Managers need to consider three types
of foreign exchange risk
1. Transaction exposure - the extent to
which the income from individual
transactions is affected by fluctuations in
foreign exchange values
includes obligations for the purchase or sale
of goods and services at previously agreed
prices and the borrowing or lending of funds
in foreign currencies

What Do Exchange Rates

Mean For Managers?
2. Translation exposure - the impact of
currency exchange rate changes on the
reported financial statements of a
concerned with the present measurement of
past events
gains or losses are paper losses

they are unrealized


What Do Exchange Rates

Mean For Managers?
3. Economic exposure - the extent to which
a firms future international earning
power is affected by changes in
exchange rates
concerned with the long-term effect of
changes in exchange rates on future prices,
sales, and costs


How Can Managers

Minimize Exchange Rate Risk?
To minimize transaction and translation
exposure, managers should
1. Buy forward
2. Use swaps
3. Lead and lag payables and receivables
lead and lag strategies can be difficult to


How Can Managers

Minimize Exchange Rate Risk?
Lead strategy - attempt to collect foreign
currency receivables early when a foreign
currency is expected to depreciate and pay
foreign currency payables before they are due
when a currency is expected to appreciate
Lag strategy - delay collection of foreign
currency receivables if that currency is
expected to appreciate and delay payables if
the currency is expected to depreciate


How Can Managers

Minimize Exchange Rate Risk?
To reduce economic exposure, managers
1. Distribute productive assets to various
locations so the firms long-term financial wellbeing is not severely affected by changes in
exchange rates
2. Ensure assets are not too concentrated in
countries where likely rises in currency values
will lead to increases in the foreign prices of the
goods and services the firm produces

How Can Managers

Minimize Exchange Rate Risk?
In general, managers should
1. Have central control of exposure to protect resources
efficiently and ensure that each subunit adopts the
correct mix of tactics and strategies
2. Distinguish between transaction and translation
exposure on the one hand, and economic exposure on
the other hand
3. Attempt to forecast future exchange rates
4. Establish good reporting systems so the central finance
function can regularly monitor the firms exposure
5. Produce monthly foreign exchange exposure reports

International Business
By Charles W.L. Hill

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 11

The International
Monetary System

What Is The International

Monetary System?
The international monetary system refers to the
institutional arrangements that countries adopt
to govern exchange rates
A floating exchange rate system exists when a
country allows the foreign exchange market to
determine the relative value of a currency
the U.S. dollar, the EU euro, the Japanese yen, and
the British pound all float freely against each other
their values are determined by market forces and
fluctuate day to day


What Is The International

Monetary System?
A pegged exchange rate system exists when a
country fixes the value of its currency relative to
a reference currency
many Gulf states peg their currencies to the U.S.

A dirty float exists when a country tries to hold

the value of its currency within some range of a
reference currency such as the U.S. dollar
China pegs the yuan to a basket of other currencies


What Is The International

Monetary System?
A fixed exchange rate system exists when
countries fix their currencies against each
other at some mutually agreed on
exchange rate
European Monetary System (EMS) prior to


What Was The Gold Standard?

The gold standard refers to a system in
which countries peg currencies to gold and
guarantee their convertibility
the gold standard dates back to ancient times
when gold coins were a medium of exchange,
unit of account, and store of value
payment for imports was made in gold or silver


What Was The Gold Standard?

later, payment was made in paper currency
which was linked to gold at a fixed rate
in the 1880s, most nations followed the gold
$1 = 23.22 grains of fine (pure) gold

the gold par value refers to the amount of a

currency needed to purchase one ounce of


Why Did The

Gold Standard Make Sense?
The great strength of the gold standard
was that it contained a powerful
mechanism for achieving balance-of-trade
equilibrium by all countries
when the income a countrys residents earn
from its exports is equal to the money its
residents pay for imports

It is this feature that continues to prompt

calls to return to a gold standard

Why Did The

Gold Standard Make Sense?
The gold standard worked well from the
1870s until 1914
but, many governments financed their World
War I expenditures by printing money and so,
created inflation

People lost confidence in the system

demanded gold for their currency putting
pressure on countries' gold reserves, and
forcing them to suspend gold convertibility

By 1939, the gold standard was dead


What Was The

Bretton Woods System?
In 1944, representatives from 44 countries met
at Bretton Woods, New Hampshire, to design a
new international monetary system that would
facilitate postwar economic growth
Under the new agreement
a fixed exchange rate system was established
all currencies were fixed to gold, but only the U.S.
dollar was directly convertible to gold
devaluations could not to be used for competitive
a country could not devalue its currency by more than
10% without IMF approval


What Institutions Were

Established At Bretton Woods?
The Bretton Woods agreement also
established two multinational institutions
1. The International Monetary Fund (IMF) to
maintain order in the international monetary
system through a combination of discipline and
2. The World Bank to promote general economic
also called the International Bank for Reconstruction
and Development (IBRD)


What Institutions Were

Established At Bretton Woods?
1. The International Monetary Fund (IMF)
fixed exchange rates stopped competitive
devaluations and brought stability to the world trade
fixed exchange rates imposed monetary discipline
on countries, limiting price inflation
in cases of fundamental disequilibrium,
devaluations were permitted
the IMF lent foreign currencies to members during
short periods of balance-of-payments deficit, when
a rapid tightening of monetary or fiscal policy would
hurt domestic employment

What Institutions Were

Established At Bretton Woods?
2. The World Bank
Countries can borrow from the World Bank in two
1. Under the IBRD scheme, money is raised through
bond sales in the international capital market
borrowers pay a market rate of interest - the
bank's cost of funds plus a margin for expenses.
2. Through the International Development Agency, an
arm of the bank created in 1960
IDA loans go only to the poorest countries


Why Did The Fixed Exchange

Rate System Collapse?
Bretton Woods worked well until the late 1960s
It collapsed when huge increases in welfare programs
and the Vietnam War were financed by increasing the
money supply and causing significant inflation
other countries increased the value of their currencies
relative to the U.S. dollar in response to speculation
the dollar would be devalued
However, because the system relied on an economically
well managed U.S., when the U.S. began to print money,
run high trade deficits, and experience high inflation, the
system was strained to the breaking point
the U.S. dollar came under speculative attack


What Was The

Jamaica Agreement?
A new exchange rate system was established in
1976 at a meeting in Jamaica
The rules that were agreed on then are still in
place today
Under the Jamaican agreement
floating rates were declared acceptable
gold was abandoned as a reserve asset
total annual IMF quotas - the amount member
countries contribute to the IMF - were increased to
$41 billion today they are about $300 billion

What Has Happened To

Exchange Rates Since 1973?
Since 1973, exchange rates have been
more volatile and less predictable than
they were between 1945 and 1973
because of
the 1971 and 1979 oil crises
the loss of confidence in the dollar after U.S.
inflation in 1977-78
the rise in the dollar between 1980 and 1985
the partial collapse of the EMS in 1992
the 1997 Asian currency crisis
the decline in the dollar from 2001 to 2009

What Has Happened To

Exchange Rates Since 1973?
Major Currencies Dollar Index, 1973-2010


Which Is Better Fixed

Rates Or Floating Rates?
Floating exchange rates provide
1. Monetary policy autonomy
removing the obligation to maintain exchange rate
parity restores monetary control to a government

2. Automatic trade balance adjustments

under Bretton Woods, if a country developed a
permanent deficit in its balance of trade that could
not be corrected by domestic policy, the IMF would
have to agree to a currency devaluation


Which Is Better Fixed Rates

Or Floating Rates?
But, a fixed exchange rate system
1. Provides monetary discipline
ensures that governments do not expand
their money supplies at inflationary rates

2. Minimizes speculation
causes uncertainty

3. Reduces uncertainty
promotes growth of international trade and

Who Is Right?
There is no real agreement as to which
system is better
We know that a Bretton Woods-style fixed
exchange rate regime will not work
But a different kind of fixed exchange rate
system might be more enduring
could encourage stability that would facilitate
more rapid growth in international trade and


What Type of Exchange Rate

System Is In Practice Today?
Various exchange rate regimes are followed
14% of IMF members follow a free float policy
26% of IMF members follow a managed float system
22% of IMF members have no legal tender of their
ex. Euro Zone countries
the remaining countries use less flexible systems
such as pegged arrangements, or adjustable pegs


What Type of Exchange Rate

System Is In Practice Today?
Exchange Rate Policies of IMF Members


What Is A Pegged Rate

A country following a pegged exchange
rate system pegs the value of its currency
to that of another major currency
popular among the worlds smaller nations
imposes monetary discipline and leads to low
adopting a pegged exchange rate regime can
moderate inflationary pressures in a country


What Is A Currency Board?

Countries using a currency board commit
to converting their domestic currency on
demand into another currency at a fixed
exchange rate
the currency board holds reserves of foreign
currency equal at the fixed exchange rate to
at least 100% of the domestic currency issued
the currency board can issue additional
domestic notes and coins only when there are
foreign exchange reserves to back them

What Is The Role

Of The IMF Today?
Today, the IMF focuses on lending
money to countries in financial crisis
There are three main types of financial
1. Currency crisis
2. Banking crisis
3. Foreign debt crisis


What Is The Role

Of The IMF Today?
A currency crisis
occurs when a speculative attack on the
exchange value of a currency results in a
sharp depreciation in the value of the
currency, or forces authorities to expend large
volumes of international currency reserves
and sharply increase interest rates in order to
defend prevailing exchange rates
Brazil 2002


What Is The Role

Of The IMF Today?
A banking crisis refers to a situation in which a
loss of confidence in the banking system leads
to a run on the banks, as individuals and
companies withdraw their deposits
A foreign debt crisis is a situation in which a
country cannot service its foreign debt
obligations, whether private sector or
government debt
Greece and Ireland 2010


What Was The Mexican

Currency Crisis Of 1995?
The Mexican currency crisis of 1995 was a
result of
high Mexican debts
a pegged exchange rate that did not allow for
a natural adjustment of prices

To keep Mexico from defaulting on its

debt, the IMF created a $50 billion aid
required tight monetary policy and cuts in
public spending

What Was The

Asian Currency Crisis?
The 1997 Southeast Asian financial crisis was
caused by events that took place in the
previous decade including
1. An investment boom - fueled by huge increases in
2. Excess capacity - investments were based on
projections of future demand conditions
3. High debt - investments were supported by dollarbased debts
4. Expanding imports caused current account

What Was The

Asian Currency Crisis?
By mid-1997, several key Thai financial
institutions were on the verge of default
speculation against the baht

Thailand abandoned the baht peg and allowed

the currency to float
The IMF provided a $17 billion bailout loan
required higher taxes, public spending cuts,
privatization of state-owned businesses, and higher
interest rates

What Was The

Asian Currency Crisis?
Speculation caused other Asian currencies
including the Malaysian Ringgit, the Indonesian
Rupaih and the Singapore Dollar to fall
These devaluations were mainly driven by
excess investment and high borrowings, much of it in
dollar denominated debt
a deteriorating balance of payments position


What Was The

Asian Currency Crisis?
The IMF provided a $37 billion aid package for
required public spending cuts, closure of troubled
banks, a balanced budget, and an end to crony

The IMF provided a $55 billion aid package to

South Korea
required a more open banking system and economy,
and restraint by chaebol


How Has The IMF Done?

By 2010, the IMF was committing loans to 68
countries in economic and currency crisis
All IMF loan packages require tight
macroeconomic and monetary policy
However, critics worry
the one-size-fits-all approach to macroeconomic
policy is inappropriate for many countries
the IMF is exacerbating moral hazard - when people
behave recklessly because they know they will be
saved if things go wrong
the IMF has become too powerful for an institution
without any real mechanism for accountability

How Has The IMF Done?

But, as with many debates about international
economics, it is not clear who is right
However, in recent years, the IMF has started to
change its policies and be more flexible
urged countries to adopt fiscal stimulus and monetary
easing policies in response to the 2008-2009 global
financial crisis


What Does The Monetary

System Mean For Managers?
Managers need to understand how the
international monetary system affects
1. Currency management - the current system is
a managed float - government intervention can
influence exchange rates
speculation can also create volatile movements in
exchange rates


What Does The Monetary

System Mean For Managers?
2. Business strategy - exchange rate movements
can have a major impact on the competitive
position of businesses
need strategic flexibility

3. Corporate-government relations - businesses

can influence government policy towards the
international monetary system
companies should promote a system that facilitates
international growth and development


International Business
By Charles W.L. Hill

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 15

Entry Strategy and

Strategic Alliances

What Are The Basic Decisions Firms

Make When Expanding Globally?


Firms expanding internationally must decide

Which markets to enter
When to enter them and on what scale
Which entry mode to use
licensing or franchising to a company in the host
establishing a joint venture with a local company
establishing a new wholly owned subsidiary
acquiring an established enterprise

What Influences
The Choice Of Entry Mode?
Several factors affect the choice of entry mode
transport costs
trade barriers
political risks
economic risks
firm strategy

The optimal mode varies by situation what

makes sense for one company might not make
sense for another

Which Foreign Markets

Should Firms Enter?
The choice of foreign markets will depend
on their long run profit potential
Favorable markets
are politically stable
have free market systems
have relatively low inflation rates
have low private sector debt


Which Foreign Markets

Should Firms Enter?
Less desirable markets
are politically unstable
have mixed or command economies
have excessive levels of borrowing

Markets are also more attractive when the

product in question is not widely available
and satisfies an unmet need


When Should A Firm

Enter A Foreign Market?
Once attractive markets are identified,
the firm must consider the timing of entry
1. Entry is early when the firm enters a
foreign market before other foreign firms
2. Entry is late when the firm enters the
market after firms have already
established themselves in the market


Why Enter A
Foreign Market Early?
First mover advantages include
the ability to pre-empt rivals by establishing
a strong brand name
the ability to build up sales volume and ride
down the experience curve ahead of rivals
and gain a cost advantage over later
the ability to create switching costs that tie
customers into products or services making
it difficult for later entrants to win business

Why Enter A
Foreign Market Late?
First mover disadvantages include
pioneering costs - arise when the foreign
business system is so different from that in
the home market that the firm must devote
considerable time, effort and expense to
learning the rules of the game
the costs of business failure if the firm,
due to its ignorance of the foreign
environment, makes some major mistakes
the costs of promoting and establishing a
product offering, including the cost of
educating customers

On What Scale Should A Firm

Enter Foreign Markets?
After choosing which market to enter and the
timing of entry, firms need to decide on the scale
of market entry
firms that enter a market on a significant scale make a
strategic commitment to the market
the decision has a long term impact and is difficult
to reverse
small-scale entry has the advantage of allowing a firm
to learn about a foreign market while simultaneously
limiting the firms exposure to that market


Is There A Right Way To

Enter Foreign Markets?
No, there are no right decisions when
deciding which markets to enter, and the
timing and scale of entry - just decisions
that are associated with different levels of
risk and reward


How Can Firms

Enter Foreign Markets?
These are six different ways to enter a foreign
1. Exporting a common first step for many
manufacturing firms
later, firms may switch to another mode

2. Turnkey projects - the contractor handles every

detail of the project for a foreign client, including
the training of operating personnel
at completion of the contract, the foreign client is
handed the "key" to a plant that is ready for full

How Can Firms

Enter Foreign Markets?
3. Licensing - a licensor grants the rights to
intangible property to the licensee for a
specified time period, and in return, receives a
royalty fee from the licensee
patents, inventions, formulas, processes, designs,
copyrights, trademarks

4. Franchising - a specialized form of licensing in

which the franchisor not only sells intangible
property to the franchisee, but also insists that
the franchisee agree to abide by strict rules as
to how it does business
used primarily by service firms


How Can Firms

Enter Foreign Markets?
5. Joint ventures with a host country firm - a
firm that is jointly owned by two or more
otherwise independent firms
most joint ventures are 50:50 partnerships

6. Wholly owned subsidiary - the firm owns

100 percent of the stock
set up a new operation
acquire an established firm


Why Choose Exporting?

Exporting is attractive because
it avoids the costs of establishing local manufacturing
it helps the firm achieve experience curve and
location economies

Exporting is unattractive because

there may be lower-cost manufacturing locations
high transport costs and tariffs can make it
agents in a foreign country may not act in exporters
best interest


Why Choose A
Turnkey Arrangement?
Turnkey projects are attractive because
they are a way of earning economic returns from the
know-how required to assemble and run a
technologically complex process
they can be less risky than conventional FDI

Turnkey projects are unattractive because

the firm has no long-term interest in the foreign
the firm may create a competitor
if the firm's process technology is a source of
competitive advantage, then selling this technology
through a turnkey project is also selling competitive
advantage to potential and/or actual competitors

Why Choose Licensing?

Licensing is attractive because
the firm avoids development costs and risks
associated with opening a foreign market
the firm avoids barriers to investment
the firm can capitalize on market opportunities without
developing those applications itself

Licensing is unattractive because

the firm doesnt have the tight control required for
realizing experience curve and location economies
the firms ability to coordinate strategic moves across
countries is limited
proprietary (or intangible) assets could be lost
to reduce this risk, use cross-licensing agreements

Why Choose Franchising?

Franchising is attractive because
it avoids the costs and risks of opening up a foreign
firms can quickly build a global presence

Franchising is unattractive because

it inhibits the firm's ability to take profits out of one
country to support competitive attacks in another
the geographic distance of the firm from its
franchisees can make it difficult to detect poor quality


Why Choose Joint Ventures?

Joint ventures are attractive because
firms benefit from a local partner's knowledge
of the local market, culture, language, political
systems, and business systems
the costs and risks of opening a foreign
market are shared
they satisfy political considerations for market


Why Choose Joint Ventures?

Joint ventures are unattractive because
the firm risks giving control of its technology to
its partner
the firm may not have the tight control to
realize experience curve or location
shared ownership can lead to conflicts and
battles for control if goals and objectives differ
or change over time


Why Choose A
Wholly Owned Subsidiary?
Wholly owned subsidiaries are attractive
they reduce the risk of losing control over core
they give a firm the tight control in different countries
necessary for global strategic coordination
they may be required in order to realize location and
experience curve economies

Wholly owned subsidiaries are unattractive

the firm bears the full cost and risk of setting up
overseas operations


Which Entry Mode Is Best?

Advantages and Disadvantages of Entry Modes


How Do Core Competencies

Influence Entry Mode?
The optimal entry mode depends on the nature
of a firms core competencies
When competitive advantage is based on
proprietary technological know-how
avoid licensing and joint ventures unless the
technological advantage is only transitory, or can be
established as the dominant design

When competitive advantage is based on

management know-how
the risk of losing control over the management skills
is not high, and the benefits from getting greater use
of brand names is significant


How Do Pressures For Cost

Reductions Influence Entry Mode?
When pressure for cost reductions is high,
firms are more likely to pursue some
combination of exporting and wholly
owned subsidiaries
allows the firm to achieve location and scale
economies and retain some control over
product manufacturing and distribution
firms pursuing global standardization or
transnational strategies prefer wholly owned

Which Is Better
Greenfield or Acquisition?
The choice depends on the situation
confronting the firm
1. A greenfield strategy - build a subsidiary
from the ground up
a greenfield venture may be better when the
firm needs to transfer organizationally
embedded competencies, skills, routines,
and culture


Which Is Better
Greenfield or Acquisition?
2. An acquisition strategy acquire an
existing company
acquisition may be better when there are
well-established competitors or global
competitors interested in expanding

The volume of cross-border acquisitions

has been rising for the last two decades


Why Choose Acquisition?

Acquisitions are attractive because
they are quick to execute
they enable firms to preempt their competitors
they may be less risky than greenfield ventures
Acquisitions can fail when
the acquiring firm overpays for the acquired firm
the cultures of the acquiring and acquired firm clash
anticipated synergies are slow and difficult to achieve
there is inadequate pre-acquisition screening
To avoid these problems, firms should
carefully screen the firm to be acquired
move rapidly to implement an integration plan

Why Choose Greenfield?

The main advantage of a greenfield
venture is that it gives the firm a greater
ability to build the kind of subsidiary
company that it wants
But, greenfield ventures are slower to
Greenfield ventures are also risky


What Are Strategic Alliances?

Strategic alliances refer to cooperative
agreements between potential or actual
range from formal joint ventures to short-term
contractual agreements
the number of strategic alliances has
exploded in recent decades


Why Choose
Strategic Alliances?
Strategic alliances are attractive because they
facilitate entry into a foreign market
allow firms to share the fixed costs and risks of
developing new products or processes
bring together complementary skills and assets that
neither partner could easily develop on its own
help a firm establish technological standards for the
industry that will benefit the firm

But, the firm needs to be careful not to give

away more than it receives

What Makes
Strategic Alliances Successful?
The success of an alliance is a function
1. Partner selection
A good partner
helps the firm achieve its strategic goals and
has the capabilities the firm lacks and that it
shares the firms vision for the purpose of
the alliance
will not exploit the alliance for its own ends

What Makes
Strategic Alliances Successful?
2. Alliance structure
The alliance should
make it difficult to transfer technology not
meant to be transferred
have contractual safeguards to guard
against the risk of opportunism by a partner
allow for skills and technology swaps with
equitable gains
minimize the risk of opportunism by an
alliance partner

What Makes
Strategic Alliances Successful?
3. The manner in which the alliance is
interpersonal relationships between
cultural sensitivity is important
learning from alliance partners
knowledge must then be diffused through
the organization


International Business
By Charles W.L. Hill

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 16

Exporting, Importing,
and Countertrade

Why Export?
Exporting is a way to increase market size
and profits
lower trade barriers under the WTO and
regional economic agreements such as the
EU and NAFTA make it easier than ever

Large firms often proactively seek new

export opportunities, but many smaller
firms export reactively
often intimidated by the complexities of

Why Export?
Exporting firms need to
identify market opportunities
deal with foreign exchange risk
navigate import and export financing
understand the challenges of doing business
in a foreign market


What Are The

Pitfalls Of Exporting?
Common pitfalls include
poor market analysis
poor understanding of competitive conditions
a lack of customization for local markets
a poor distribution program
poorly executed promotional campaigns
problems securing financing
a general underestimation of the differences and
expertise required for foreign market penetration
an underestimation of the amount of paperwork and
formalities involved


How Can Firms Improve

Export Performance?
Many firms are unaware of export opportunities
Firms need to collect information
Firms can get direct assistance from some
countries and/or use an export management
both Germany and Japan have developed extensive
institutional structures for promoting exports
Japanese exporters can use knowledge and contacts
of sogo shosha - great trading houses
U.S. firms have far fewer resources available

Where Can U.S. Firms Get

Export Information?
The U.S. Department of Commerce
the most comprehensive source of export information
for U.S. firms

The International Trade Administration and the

United States and Foreign Commercial Service
best prospects lists for firms

The Department of Commerce

organizes various trade events to help firms make
foreign contacts and explore export opportunities

The Small Business Administration

Local and state governments

What Are Export

Management Companies?
Export management companies (EMCs) are
export specialists that act as the export
marketing department or international
department for client firms
Two types of assignments are common:
1. EMCs start export operations with the
understanding that the firm will take over after
they are established
not all EMCs are equalsome do a better job than

What Are Export

Management Companies?
2. EMCs start services with the
understanding that the EMC will have
continuing responsibility for selling the
firms products
but, firms that use EMCs may not develop
their own export capabilities


How Can Firms Reduce

The Risks Of Exporting?
To reduce the risks of exporting, firms should
hire an EMC or export consultant to identify
opportunities and navigate paperwork and regulations
focus on one, or a few markets at first
enter a foreign market on a small scale in order to
reduce the costs of any subsequent failures
recognize the time and managerial commitment
develop a good relationship with local distributors and
hire locals to help establish a presence in the market
be proactive
consider local production

How Can Firms Overcome The Lack

Of Trust in Export Financing?
Because trade implies parties from different
countries exchanging goods and payment the
issue of trust is important
exporters prefer to receive payment prior to shipping
goods, but importers prefer to receive goods prior to
making payments

To get around this difference of preference,

many international transactions are facilitated by
a third party - normally a reputable bank
adds an element of trust to the relationship


How Can Firms Overcome The Lack

Of Trust in Export Financing?
The Use Of A Third Party


What Is A Letter Of Credit?

A letter of credit is issued by a bank at the
request of an importer
states the bank will pay a specified sum of
money to a beneficiary, normally the exporter,
on presentation of particular, specified
main advantage is that both parties are likely
to trust a reputable bank even if they do not
trust each other


What Is A Draft?
A draft
an order written by an exporter instructing an
importer, or an importer's agent, to pay a
specified amount of money at a specified time
the instrument normally used in
international commerce for payment
also called a bill of exchange


What Is A Draft?
A sight draft is payable on presentation to
the drawee
A time draft allows for a delay in payment
normally 30, 60, 90, or 120 days
once a time draft has been accepted it
becomes a negotiable instrument that can be
sold at a discount from its face value


What Is A Bill Of Lading?

The bill of lading is issued to the exporter by
the common carrier transporting the
It serves three purposes
1. It is a receipt - merchandise described on document
has been received by carrier
2. It is a contract - carrier is obligated to provide
transportation service in return for a certain charge
3. It is a document of title - can be used to obtain
payment or a written promise before the
merchandise is released to the importer


How Does An International

Trade Transaction Work?
A Typical International Trade Transaction


Where Can U.S. Firms

Get Export Assistance?
1. Financing aid is available from the
Export-Import Bank (Eximbank)
an independent agency of the U.S.
provides financing aid to facilitate exports,
imports, and the exchange of
commodities between the U.S. and other
achieves its goals though loan and loan
guarantee programs


Where Can U.S. Firms

Get Export Assistance?
2. Export credit insurance is available from
the Foreign Credit Insurance Association
provides coverage against commercial risks
and political risks
protects exporters against the risk that the
importer will default on payment


What Is Countertrade?
Countertrade - a range of barter-like agreements
that facilitate the trade of goods and services for
other goods and services when they cannot be
traded for money
emerged as a means purchasing imports during
the1960s when the USSR and the Communist states
of Eastern Europe had nonconvertible currencies
grew in popularity in the 1980s among many
developing nations that lacked the foreign exchange
reserves required to purchase necessary imports
notable increase after the 1997 Asian financial crisis


What Are The Forms

Of Countertrade?
There are five distinct versions of
1. Barter - a direct exchange of goods
and/or services between two parties
without a cash transaction
the most restrictive countertrade
used primarily for one-time-only deals in
transactions with trading partners who are
not creditworthy or trustworthy

What Are The Forms

Of Countertrade?
2. Counterpurchase - a reciprocal buying
occurs when a firm agrees to purchase a certain
amount of materials back from a country to which a
sale is made

3. Offset - similar to counterpurchase - one party

agrees to purchase goods and services with a
specified percentage of the proceeds from the
original sale
difference is that this party can fulfill the obligation
with any firm in the country to which the sale is being


What Are The Forms

Of Countertrade?
4. A buyback occurs when a firm builds a
plant in a country or supplies technology,
equipment, training, or other services to
the country
agrees to take a certain percentage of the
plants output as a partial payment for the


What Are The Forms

Of Countertrade?
5. Switch trading - the use of a specialized thirdparty trading house in a countertrade
when a firm enters a counterpurchase or offset
agreement with a country, it often ends up with
counterpurchase credits which can be used to
purchase goods from that country
switch trading occurs when a third-party trading
house buys the firms counterpurchase credits and
sells them to another firm that can better use them


What Are The

Pros Of Countertrade?
Countertrade is attractive because
it gives a firm a way to finance an export deal
when other means are not available
it give a firm a competitive edge over a firm
that is unwilling to enter a countertrade

Countertrade arrangements may be

required by the government of a country to
which a firm is exporting goods or services

What Are The

Cons Of Countertrade?
Countertrade is unattractive because
it may involve the exchange of unusable or poorquality goods that the firm cannot dispose of profitably
it requires the firm to establish an in-house trading
department to handle countertrade deals

Countertrade is most attractive to large, diverse

multinational enterprises that can use their
worldwide network of contacts to dispose of
goods acquired in countertrade deals
sogo shosha


International Business
By Charles W.L. Hill

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 17

Global Production,
Outsourcing, and

What Are The Main

Production Issues For Firms?
International firms must answer five interrelated
1. Where should production activities be located?
2. What should be the long-term strategic role of foreign
production sites?
3. Should the firm own foreign production activities or
outsource those activities to independent vendors?
4. How should a globally dispersed supply chain be
managed, and what is the role of Internet-based
information technology in the management of global
5. Should the firm manage global logistics itself, or should
it outsource the management to enterprises that
specialize in this activity?

How Are Strategy, Production,

And Logistics Related?
Production - activities involved in
creating a product
Logistics - procurement and physical
transmission of material through the
supply chain, from suppliers to


How Are Strategy, Production,

And Logistics Related?
Questions: How can production and logistics
1. Lower the costs of value creation?
disperse production to the most efficient locations
manage the global supply chain efficiently to better
match supply and demand

2. Add value by better serving customer needs?

eliminate defective products from the supply chain
and the manufacturing process


How Can Quality Be

Most firms use the Six Sigma program - a
direct descendant of total quality
management (TQM)
aims to reduce defects, boost productivity,
eliminate waste, and cut costs throughout the
in the EU, firms must meet ISO 9000
standards before gaining access to the EU

Improved quality reduces costs


How Can Quality Be

The Relationship Between Quality and Costs


Where Should
Production Be Located?
Firms should locate production so that
production and logistics can be locally
production and logistics can respond quickly
to shifts in customer demand

Firms should consider

1. Country factors
2. Technological factors
3. Product factors


Why Are
Country Factors Important?
Manufacturing should be located where
economic, political, and cultural conditions are
most conducive to the performance of that
create a global web of activities
global concentrations of activities at certain locations


Why Are
Country Factors Important?
Firms should consider
the availability of skilled labor and supporting
formal and informal trade barriers
expectations about future exchange rate changes
transportation costs
regulations affecting FDI


Why Are Technological

Factors Important?
Firms should consider
1. The level of fixed costs
if fixed costs are high, produce in a single
location or a few locations
when fixed costs are low, multiple
production plants may be possible
allows firms to respond to local demands


Why Are Technological

Factors Important?
2. The minimum efficient scale
the level of output at which most plant-level
scale economies are exhausted
when minimum efficient scale is high, choose
centralized production in a single location or a
limited number of locations
when minimum efficient scale is low, respond to
local market demands and hedge against
currency risk by operating in multiple locations


Why Are Technological

Factors Important?
3. The flexibility of the technology
flexible manufacturing technology or lean
reduces set up times for complex equipment
increases the utilization of individual machines
improves quality control

allows firms to produce a wide variety of end

products at a relatively low unit cost
mass customization
flexible machine cells


What Should a Firm Do?

Production should be concentrated in a few
locations when
fixed costs are substantial
the minimum efficient scale of production is high
flexible manufacturing technologies are available

Production in multiple locations makes sense

both fixed costs and the minimum efficient scale of
production are relatively low
appropriate flexible manufacturing technologies are
not available


Why Are Product Factors

Important To Location Decisions?
Two product factors impact location decisions
1. The product's value-to-weight ratio
if the value-to-weight ratio is high, produce the
product in a single location and export to other parts
of the world
if the value-to-weight ratio is low, there is greater
pressure to manufacture the product in multiple
locations across the world

2. Whether the product serves universal needs

when products serve universal needs, the need for
local responsiveness falls, and concentrating
manufacturing in a central location makes sense


How Are Location, Strategy,

And Production Related?
Location, Strategy, and Production


What Are The Hidden Costs of

Foreign Production Locations?
There may be hidden costs associated
with foreign production
Before making the decision to locate
production in a foreign location firms must
consider the potential for
high employee turnover
poor workmanship
poor product quality
low productivity

What Is The Strategic Role

Of Foreign Factories?
The strategic role of foreign factories and the
strategic advantage of a particular location can
change over time
factories established to take advantage of low cost
labor can evolve into facilities with advanced design

Improvement in a facility comes from

1. Pressure to lower costs or respond to local markets
2. An increase in the availability of advanced factors of


What Is The Strategic Role

Of Foreign Factories?
Many companies now see foreign factories
as globally dispersed centers of
supports the development of a transnational
global learning - valuable knowledge can be
found in foreign subsidiaries
implies that firms are less likely to switch
production to new locations simply because some
underlying variable like wage rates has changed

Should A Firm
Outsource Production?
Question: Should a firm make or buy the
component parts to go into its final
Make-or-buy decisions are important to
firms' manufacturing strategies
service firms also face make-or-buy decisions
decisions involving international markets are
more complex than those involving domestic

Why Make?
Vertical integration - making component parts
1. Lowers costs
if a firm is more efficient at that production activity
than any other enterprise, manufacturing in-house
makes sense

2. Facilitates investments in highly specialized

internal production makes sense when substantial
investments in specialized assets are required


Why Make?
3. Protects proprietary technology
in-house production makes sense when
component parts contain proprietary

4. Facilitates the scheduling of adjacent

planning, coordination, and scheduling of
adjacent processes can be easier with inhouse production

Why Buy?
Buying component parts from
independent suppliers
1. Gives the firm greater flexibility
important when changes in exchange rates
and trade barriers alter the attractiveness of
various supply sources over time


Why Buy?
2. Helps drive down the firm's cost structure
avoids challenges of coordination and control of
additional subunits
avoids the lack of incentive associated with internal
avoids the difficulties with setting appropriate
transfer prices

3. Helps the firm capture orders from international

can help firms gain orders from suppliers countries


Do Strategic Alliances With

Suppliers Make Sense?
Firms can capture the benefits of vertical
integration without the associated
organizational problems by forming longterm strategic alliances with key suppliers
however, these commitments may actually
limit strategic flexibility
risk giving away key technological know-how
to a supplier


How Do Firms Manage

The Global Supply Chain?
Logistics encompasses the activities necessary
to get materials to a manufacturing facility,
through the manufacturing process, and out
through a distribution system to the end user
The goal is to
manage a global supply chain at the lowest possible
cost and in a way that best serves customer needs
establish a competitive advantage through superior
customer service


What Is The Role Of

Just-In-Time Inventory?
Just-in-time (JIT) systems economize on
inventory holding costs by having materials
arrive at a manufacturing plant just in time to
enter the production process
JIT systems
generate major cost savings from reduced
warehousing and inventory holding costs
can help the firm spot defective parts and take them
out of the manufacturing process

But, a JIT system leaves the firm with no buffer

stock of inventory to meet unexpected demand
or supply changes

What Is The Role Of Information

Technology And The Internet?
Web-based information systems play a crucial
role in materials management
allow firms to optimize production scheduling
according to when components are expected to arrive

Electronic Data Interchange (EDI)

facilitates the tracking of inputs
allows the firm to optimize its production schedule
lets the firm and its suppliers communicate in real
eliminates the flow of paperwork between the firm and
its suppliers

International Business
By Charles W.L. Hill

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 18

Global Marketing
and R&D

What Is The Marketing Mix?

The marketing mix (the choices the firm
offers to its targeted market) is
comprised of

Product attributes
Distribution strategy
Communication strategy
Pricing strategy


Should The Marketing Mix Be

Changed For Each Market?
Question: Are markets and brands
becoming global?
Theodore Levitt argued that world markets
were becoming increasingly similar making it
unnecessary to localize the marketing mix

Question: Is Levitt right? Probably not!

Levitts theory has become a lightening rod in
the debate about globalization


Should The Marketing Mix Be

Changed For Each Market?
The current consensus is that while the
world is moving towards global markets,
global standardization is not possible
because of
cultural differences among nations
economic differences among nations
trade barriers
differences in product and technical standards


What Is Market Segmentation?

Market segmentation - identifying distinct
groups of consumers whose purchasing
behavior differs from others in important
Markets can be segmented by
socio-cultural factors
psychological factors

What Is Market Segmentation?

Two key market segmentation issues
1. The differences between countries in the
structure of market segments
may have to develop a unique marketing
mix to appeal to a certain segment in a
given country
2. The existence of segments that transcend
national borders
when segments transcend national
borders, a global strategy is possible

How Do Product Attributes

Influence Marketing Strategy?
A product is like a bundle of attributes
Products sell well when their attributes
match consumer needs
if consumer needs were the same
everywhere, a firm could sell the same
product worldwide

But, consumer needs depend on

1. Culture
tradition, social structure, language, religion,

How Do Product Attributes

Influence Marketing Strategy?
2. Level of economic development
consumers in highly developed countries
tend to demand a lot of extra performance
consumers in less developed nations tend to
prefer more basic products

3. Product and technical standards

national differences can force firms to
customize the marketing mix

How Does Distribution

Influence Marketing Strategy?
Distribution strategy - the means the firm
chooses for delivering the product to the
How a product is delivered depends on the
firms market entry strategy
firms that produce locally can sell directly to the
consumer, to the retailer, or to the wholesaler
firms that produce outside the country have the same
options plus the option of selling to an import agent


How Does Distribution

Influence Marketing Strategy?
A Typical Distribution Strategy


How Do Distribution
Systems Differ?
There are four main differences in distribution
1. Retail concentration concentrated or
concentrated retail system, a few retailers supply
most of the market
common in developed countries
fragmented retail system there are many retailers,
no one of which has a major share of the market
common in developing countries


How Do Distribution
Systems Differ?
2. Channel length - the number of
intermediaries between the producer and
the consumer
short channel - when the producer sells
directly to the consumer
common with concentrated systems

long channel - when the producer sells

through an import agent, a wholesaler, and
a retailer
common with fragmented retail systems


How Do Distribution
Systems Differ?
3. Channel exclusivity how difficult it is for
outsiders to access
Japan's system is a very exclusive system

4. Channel quality - the expertise, competencies,

and skills of established retailers in a nation,
and their ability to sell and support the
products of international businesses
good in most developed countries, but variable in
emerging markets and less developed countries
firms may have to devote considerable resources to
upgrading channel quality


Which Distribution Strategy

Should A Firm Choose?
The optimal strategy depends on the relative
costs and benefits of each alternative
When price is important, a shorter channel is
each intermediary in a channel adds its own markup
to the product

When the retail sector is very fragmented, a long

channel can be beneficial
economizes on selling costs
can offer access to exclusive channels

Why Is Communication
Strategy Important?
Communicating product attributes to prospective
customers is a critical element in the marketing
How a firm communicates with customers
depends partly on the choice of channel
Communication channels available to a firm
direct selling
sales promotion
direct marketing


What Are The Barriers to

International Communication?
The effectiveness of a firm's international
communication can be jeopardized by
1. Cultural barriers - it can be difficult to
communicate messages across cultures
a message that means one thing in one
country may mean something quite different
in another
firms need to develop cross-cultural literacy,
and use local input when developing
marketing messages

What Are The Barriers to

International Communication?
2. Source and country of origin effects
source effects occur when the receiver of
the message evaluates the message on the
basis of status or image of the sender
can counter negative source effects by
deemphasizing their foreign origins
country of origin effects - the extent to which
the place of manufacturing influences
product evaluations


What Are The Barriers to

International Communication?
3. Noise levels - the amount of other
messages competing for a potential
consumers attention
in highly developed countries, noise is very
in developing countries, noise levels tend to
be lower


How Do Firms Communicate

With Customers?
Firms have to choose between two types
of communication strategies
1. A push strategy emphasizes personnel
2. A pull strategy emphasizes mass media


Which Is Better
Push Versus Pull?
The choice between strategies depends on
1. Product type and consumer sophistication
a pull strategy works well for firms in consumer
goods selling to a large market segment
a push strategy works well for industrial products

2. Channel length
a pull strategy works better with longer distribution

3. Media availability
a pull strategy relies on access to advertising media
a push strategy may be better when media is not
easily available

What Is The Optimal Mix?

In general, a push strategy is better
for industrial products and/or complex new products
when distribution channels are short
when few print or electronic media are available

A pull strategy is better

for consumer goods products
when distribution channels are long
when sufficient print and electronic media are
available to carry the marketing message


Should A Firm Use

Standardized Advertising?
Standardized advertising makes sense
it has significant economic advantages
creative talent is scarce and one large effort
to develop a campaign will be more
successful than numerous smaller efforts
brand names are global


Should A Firm Use

Standardized Advertising?
Standardized advertising does not make sense
cultural differences among nations are significant
advertising regulations limit standardized advertising

Some firms standardize parts of a campaign to

capture the benefits of global standardization,
but customize others to respond to local cultural
and legal environments


What Pricing Strategy

Should Firms Use?


Firms need to consider

Price discrimination
Strategic pricing
Regulations that affect pricing decisions


What Is Price Discrimination?

Price discrimination - occurs when firms
charge consumers in different countries
different prices for the same product
For price discrimination to work
must be able to keep national markets
countries must have different price elasticity
of demand


What Is Price Discrimination?

Price elasticity of demand a measure
of the responsiveness of demand for a
product to changes in price
demand is elastic when a small change in price
produces a large change in demand
demand is inelastic when a large change in price
produces only a small change in demand

Typically, price elasticity is greater in

countries with lower income levels and
larger numbers of competitors


What Is Price Discrimination?

Elastic and Inelastic Demand Curves


What Is Strategic Pricing?

Strategic pricing has three aspects
1. Predatory pricing - use profit gained in
one market to support aggressive pricing
designed to drive competitors out in
another market
after competitors have left, the firm will raise
prices and earn higher profits


What Is Strategic Pricing?

2. Multi-point pricing - a firms pricing strategy in
one market may have an impact on a rivals
pricing strategy in another market
managers should centrally monitor pricing decisions

3. Experience curve pricing - price low worldwide

in an attempt to build global sales volume as
rapidly as possible, even if this means taking
large losses initially
firms that are further along the experience curve
have a cost advantage relative to firms further up
the curve


How Do Regulations
Influence Pricing?
A firms ability to set prices may be limited by
1. Antidumping regulations
dumping occurs when a firm sells a product for a
price that is less than the cost of producing it
antidumping rules set a floor under export prices
and limit a firms ability to pursue strategic

2. Competition policy
most industrialized nations have regulations
designed to promote competition and restrict
monopoly practices
can limit the prices that a firm can charge


How Should Firms Configure

The Marketing Mix?
Standardization versus customization is
not an all or nothing concept
most firms standardize some things and
customize others

Firms should consider the costs and

benefits of standardizing and customizing
each element of the marketing mix


Why Is New Product

Development Important?
Product innovation should be a strategic priority
today, competition is as much about
technological innovation as anything else
The pace of technological change is faster than
ever and product life cycles are often very short
new innovations can make existing products
obsolete, but at the same time, open the door
to a host of new opportunities
Firms need close links between R&D, marketing,
and manufacturing

Where Should
R&D Be Located?
New product ideas come from the interactions of
scientific research, demand conditions, and
competitive conditions
The rate of new product development is greater
in countries where
more money is spent on basic and applied research
and development
demand is strong
consumers are affluent
competition is intense

How Can R&D, Marketing, And

Production Be Integrated?
Since new product development has a high
failure rate, new product development efforts
should involve close coordination between R&D,
marketing, and production
Integration will ensure that
customer needs drive product development
new products are designed for ease of manufacture
development costs are kept in check
time to market is minimized


Why Are Cross-Functional

Teams Important?
Cross-functional integration is facilitated by
cross-functional product development teams
Effective cross functional teams should
be led by a heavyweight project manager with status
in the organization
include members from all the critical functional areas
have members located together
establish clear goals
develop an effective conflict resolution process


How Can Firms Build

Global R&D Capabilities?
To adequately commercialize new technologies,
firms need to integrate R&D and marketing
To successfully commercialize new
technologies, firms may need to develop
different versions for different countries
so, a firm may need R&D centers in North America,
Asia, and Europe that are closely linked by formal and
informal integrating mechanisms with marketing
operations in each country in their regions, and with
the various manufacturing facilities


International Business
By Charles W.L. Hill

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 19

Global Human
Resource Management

What Is Human
Resource Management?
Human resource management (HRM) - the
activities an organization carries out to utilize its
human resources effectively
These activities include
determining human resource strategy
performance evaluation
management development
labor relations

Firms need to ensure there is a fit between their

human resources practices and strategy

What Is The Strategic Role Of

HRM In International Firms?
HRM can help the firm reduce the costs of
value creation and add value by better
serving customer needs
more complex in an international business
differences between countries in labor
markets, culture, legal systems, economic
systems, etc.


What Is The Strategic Role Of

HRM In International Firms?
HRM must also determine when to use
expatriate managers
citizens of one country working abroad
who should be sent on foreign
how they should be compensated
how they should be trained
how they should be reoriented when they
return home

What Is The Strategic Role Of

HRM In International Firms?
The Role of Human Resources in Shaping Organizational Architecture


What Is A Staffing Policy?

Staffing policy is concerned with the
selection of employees who have the
skills required to perform a particular job
can be a tool for developing an promoting the
firms corporate culture
the organizations norms and value system
a strong corporate culture can help the firm
implement its strategy


What Is A Staffing Policy?

Three main approaches to staffing policy
1. The ethnocentric approach - fill key
management positions with parent-country
2. The polycentric approach recruit host country
nationals to manage subsidiaries in their own
country, and parent country nationals for
positions at headquarters
3. The geocentric approach seek the best people,
regardless of nationality for key jobs


Why Choose An Ethnocentric

Staffing Policy?
Firms that pursue an ethnocentric policy believe that
there is a lack of qualified individuals in the host
country to fill senior management positions
it is the best way to maintain a unified corporate
value can be created by transferring core
competencies to a foreign operation via parent
country nationals
it makes sense with an international strategy
it limits advancement opportunities for host country
it can lead to "cultural myopia"

Why Choose A Polycentric

Staffing Policy?
The polycentric approach
makes sense for firms pursuing a localization strategy
can minimize cultural myopia
may be less expensive to implement than an
ethnocentric policy

host country nationals have limited opportunities to
gain experience outside their own country and so
cannot progress beyond senior positions in their own
a gap can form between host country managers and
parent country managers


Why Choose A Geocentric

Staffing Policy?
The geocentric approach
is consistent with building a strong unifying culture
and informal management network
makes sense for firms pursuing a global or
transnational strategy
enables the firm to make the best use of its human
builds a cadre of international executives who feel at
home working in a number of different cultures

can be limited by immigration laws
is costly to implement


Which Staffing Policy

Is Best?
Comparison of Staffing Approaches


What Is Expatriate Failure?

Firms using an ethnocentric or geocentric
staffing strategy will have expatriate managers
Expatriate failure is the premature return of an
expatriate manager to the home country
each expatriate failure can cost between $40,000 and
$1 million
between 16 and 40% of all American expatriates in
developed countries fail and almost 70% of
Americans assigned to developing countries fail


What Is The Rate Of

Expatriate Failure?
Expatriate Failure Rates


Why Do Expatriate
Managers Fail?
The main reasons for U.S. expatriate
failure are
the inability of an expatriate's spouse to adapt
the managers inability to adjust
other family-related reasons
the managers personal or emotional maturity
the managers inability to cope with larger
overseas responsibilities


Why Do Expatriate
Managers Fail?
The reason for European expatriate failure is
the inability of the managers spouse to adjust

The main reasons for Japanese expatriate

failure are
the inability to cope with larger overseas responsibility
difficulties with the new environment
personal or emotional problems
a lack of technical competence
the inability of spouse to adjust


How Can Firms Reduce

Expatriate Failure?
Firms can reduce expatriate failure through improved
selection procedures
Four dimensions that predict expatriate success are
1. Self-orientation - the expatriate's self-esteem, selfconfidence, and mental well-being
2. Others-orientation - the ability to interact effectively with
host-country nationals
3. Perceptual ability - the ability to understand why people
of other countries behave the way they do
4. Cultural toughness the ability to adjust to the posting


Why Is A
Global Mindset Important?
A global mindset may be the fundamental
attribute of a global manager
cognitive complexity
cosmopolitan outlook

A global mindset is often acquired early in life

a family that is bicultural
living in foreign countries
learning foreign languages as a regular part of family

What Is Training And

Management Development?
After selecting a manager for a position, training
and development programs should be
Training focuses upon preparing the manager
for a specific job
Management development is concerned with
developing the skills of the manager over time
gives the manager a skill set and reinforces
organizational culture

Historically, most firms focus more on training

than on management development


Why Is Training Important For

Expatriate Managers?
Training can reduce expatriate failure
Cultural training - fosters an appreciation for the host
country's culture
Language training - an exclusive reliance on English
diminishes an expatriate's ability to interact with host
country nationals
Practical training - helps the expatriate and her family
ease themselves into day-to-day life in the host country
But, studies show only about 30% of managers sent on
one- to five-year expatriate assignments received
training before their departure


What Happens When

Expatriates Return Home?
Training and development should include
preparing and developing expatriate
managers for reentry into their home
country organization
need good programs for
re-integrating expatriates back into work life within
their home country organization
utilizing the knowledge they acquired while abroad


Why Is Management Development

Important To Firm Strategy?
Management development programs increase
the overall skill levels of managers through
ongoing management education
rotations of managers through jobs within the firm to
give them varied experiences

Management development can be a strategic

tool to build a strong unifying culture and
informal management network
support both transnational and global strategy


How Should
Expatriates Be Evaluated?
Evaluating expatriates can be especially
typically, both host nation managers and home office
managers evaluate the performance of expatriate

But, both types of managers are subject to

unintentional bias
home country managers tend to rely on hard data
when evaluating expatriates
host country managers can be biased towards their
own frame of reference

How Can Performance

Appraisal Bias Be Reduced?
To reduce bias in performance appraisal
more weight should be given to an on-site
manager's appraisal than to an off-site
manager's appraisal
a former expatriate who has served in the
same location should be involved in the
home office managers should be consulted
before an on-site manager completes a formal
termination evaluation

What Are The Key Issues In

Compensating Expatriates?
Two key issues on compensation
1. How to adjust compensation to reflect
differences in economic circumstances
and compensation practices
2. How to pay expatriate managers


How Should National Differences

In Compensation Be Treated?
Currently, there are substantial differences
in executive compensation across
Research shows
a top U.S. executive made an average of
$525,923 in the 2005-2006 period, compared
to $278,697 in Japan, and $158,146 in


How Should National Differences

In Compensation Be Treated?
Question: Should pay be equalized across
Many firms have recently moved toward a
compensation structure that is based on
global standards
especially important in firms with a geocentric
staffing policy

But, most firms still set pay according to

the prevailing standards in each country

How Should
Expatriates Be Paid?
Most firms use the balance sheet
equalizes purchasing power across countries
so employees have the same living standard
in their foreign posting as at home
and adds a financial incentive to take the


How Should
Expatriates Be Paid?
A compensation package has five components
1. Base salary - normally in the same range as the
base salary for a similar position in the home
can be paid either in the home currency or in the
local currency

2. Foreign service premium - extra pay the

expatriate receives for working outside his
country of origin
generally offered as an incentive to accept foreign

How Should
Expatriates Be Paid?
3. Various allowances - hardship, housing, costof-living, education
4. Tax differentials - may have to pay income tax
to both the home country and the host-country
governments no reciprocal tax treaty exists
company usually covers extra tax assessments

5. Benefits many firms provide the same level

of medical and pension benefits abroad that
employees receive at home


Why Are International Labor

Relations Important?
Question: Can organized labor limit the
choices available to an international
Labor unions can limit a firm's ability to
pursue a transnational or global strategy
HRM needs to foster harmony and minimize
conflict between management and organized


What Are The Concerns Of

Organized Labor?
Organized labor is concerned that
1. Multinationals can counter union bargaining power
by threatening to move production to another
2. Multinationals will farm out only low-skilled jobs to
foreign plants making it easier to switch production
3. Multinationals will import employment practices and
contractual agreements from their home countries
and reduce the influence of unions


How Does Organized Labor

Respond To MNC Power?
Organized labor has responded to the
increased bargaining power of multinational
corporations by
1. Trying to set-up their own international organizations
2. Lobbying for national legislation to restrict
3. Trying to achieve regulation of multinationals through
international organizations such as the United

So far, these efforts have had only limited


How Are MNCs Responding

To Organized Labor?
Many firms are centralizing labor relations to
enhance the bargaining power of the
multinational vis--vis organized labor
in the past, labor relations were usually decentralized
to individual subsidiaries

The way in which work is organized within a

plant can be a major source of competitive
advantage so it is important for management to
have a good relationship with labor


International Business
By Charles W.L. Hill

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 20
Accounting and Finance
in the International

What Is
Financial Management?
Financial management involves
1. Investment decisions what to finance
2. Financing decisions how to finance those
3. Money management decisions how to
manage the firms financial resources most


What Is Accounting?
Accounting is the language of business
it is the way firms communicate their financial

Accounting is more complex for international

firms because of differences in accounting
standards from country to country
differences make it difficult for investors, creditors,
and governments to evaluate firms

It is difficult to compare financial reports from

country to country because of national
differences in accounting and auditing standards

What Determines National

Accounting Standards?
Several variables influence the
development of a countrys accounting
system including
the relationship between business and the
providers of capital
political and economic ties with other
the level of inflation
the level of a countrys economic
the prevailing culture in a country

How Do Providers Of Capital

Influence Accounting?
A countrys accounting system reflects the
relative importance of each constituency
as a provider of capital
accounting systems in the U.S. and Great
Britain are oriented toward individual investors
Switzerland and Germany focus on providing
information to banks


How Do Political And Economic

Ties Influence Accounting?
Similarities in accounting systems across
countries can reflect political or economic
the U.S. accounting system influences the
systems in the Philippines
in the European Union, countries are moving
toward common standards
the British system of accounting is used by
many former colonies

How Do Levels of Development

Influence Accounting?
Developed nations tend to have more
sophisticated accounting systems than
developing countries
larger, more complex firms create accounting
providers of capital require detailed reports

Many developing nations have accounting

systems that were inherited from former colonial
lack of trained accountants

What Are Accounting And

Auditing Standards?
Accounting standards are rules for
preparing financial statements
they define useful accounting information

Auditing standards specify the rules for

performing an audit
the technical process by which an
independent person gathers evidence for
determining if financial accounts conform to
required accounting standards and if they are
also reliable

Why Are International

Accounting Standards Important?
The growth of transnational financing and
transnational investment has created a need for
transnational financial reporting
many companies obtain capital from foreign providers
who are demanding greater consistency

Standardization of accounting practices across

national borders is probably in the best interests
of the world economy
will facilitate the development of global capital


Why Are International

Accounting Standards Important?
The International Accounting Standards Board
(IASB) is a major proponent of standardization of
accounting standards
most IASB standards are consistent with standards
already in place in the U.S.
by 2011, 100 nations have adopted IASB standards
or permitted their use in reporting financial results
the EU has mandated harmonization of accounting
principles for members
there soon could be only two major accounting bodies
with substantial influence on global reporting
FASB in the U.S. and IASB elsewhere


How Does Accounting

Influence Control Systems?
The control process in most firms is
usually conducted annually and involves
three steps
1. Subunit goals are jointly determined by the
head office and subunit management
2. The head office monitors subunit
performance throughout the year
3. The head office intervenes if the subsidiary
fails to achieve its goal, and takes corrective
actions if necessary

How Do Exchange Rates

Influence Control?
Budgets and performance data are
usually expressed in the corporate
normally the home currency
facilitates comparisons between
but, can create distortions in financial


How Do Exchange Rates

Influence Control?
The Lessard-Lorange Model
firms can deal with the problems of exchange
rates and control in three ways
1. The initial rate
the spot exchange rate when the budget is adopted
2. The projected rate
the spot exchange rate forecast for the end of the
budget picture
3. The ending rate
the spot exchange rate when the budget and
performance are being compared

What Is The
Lessard-Lorange Model?
Possible Combinations of Exchange Rates in the Control Process


Why Separate Subsidiary and

Managerial Performance?
Subsidiaries operate in different
environments which influence profitability
the evaluation of a subsidiary should be kept
separate from the evaluation of its manager

A managers evaluation should

consider the countrys environment for
take place after making allowances for those
items over which managers have no control

What Is
Financial Management?
Good financial management can create a
competitive advantage
reduces the costs of creating value and adds
value by improving customer service

Decisions are more complex in

international business
different currencies, tax regimes, regulations
on capital flows, economic and political risk,

How Do Managers Make

Investment Decisions?
Financial managers must quantify the benefits,
costs, and risks associated with an investment in
a foreign country
To do this, managers use capital budgeting
involves estimating the cash flows associated with the
project over time, and then discounting them to
determine their net present value

If the net present value of the discounted cash

flows is greater than zero, the firm should go
ahead with the project

Why Is Capital Budgeting More

Difficult For International Firms?
Capital budgeting is more complicated in
international business
because a distinction must be made between
cash flows to the project and cash flows to the
parent company
because of political and economic risk
because the connection between cash flows
to the parent and the source of financing must
be recognized

What Is The Difference Between

Project And Parent Cash Flows?
Cash flows to the project and cash flows to the
parent company can be quite different
Parent companies are interested in the cash
flows they will receive, not the cash flows the
project generates
received cash flows are the basis for dividends, other
investments, repayment of debt, and so on

Cash flows to the parent may be lower because

of host country limits on the repatriation of
profits, host country local reinvestment
requirements, etc.

How Does Political Risk

Influence Investment Decisions?
Political risk - the likelihood that political forces
will cause drastic changes in a countrys
business environment that hurt the profit and
other goals of a business
higher in countries with social unrest or disorder, or
where the nature of the society increases the chance
for social unrest

Political change can result in the expropriation of

a firms assets, or complete economic collapse
that renders a firms assets worthless

How Does Economic Risk

Influence Investment Decisions?
Economic risk - the likelihood that
economic mismanagement will cause
drastic changes in a countrys business
environment that hurt the profit and other
goals of a business
The biggest economic risk is inflation
reflected in falling currency values and lower
project cash flows


How Can Firms Adjust For

Political And Economic Risk?
Firms analyzing foreign investment
opportunities can adjust for risk
1. By raising the discount rate in countries
where political and economic risk is high
2. By lowering future cash flow estimates to
account for adverse political or economic
changes that could occur in the future


How Do Firms Make

Financing Decisions?
Firms must consider two factors
1. How the foreign investment will be
the cost of capital is usually lowest in the
global capital market
but, some governments require local debt or
equity financing
firms that anticipate a depreciation of the
local currency, may prefer local debt

How Do Firms Make

Financing Decisions?
2. How the financial structure (debt vs.
equity) of the foreign affiliate should be
need to decide whether to adopt local capital
structure norms or maintain the structure
used in the home country

Most experts suggest that firms adopt

the structure that minimizes the cost of
capital, whatever that may be

What Is Global
Money Management?
Money management decisions attempt to
manage global cash resources efficiently
Firms need to
1. Minimize cash balances - need cash balances
on hand for notes payable and unexpected
cash reserves are usually invested in money market
accounts that offer low rates of interest
when firms invest in money market accounts they
have unlimited liquidity, but low interest rates
when they invest in long-term instruments they have
higher interest rates, but low liquidity


What Is Global
Money Management?
2. Reduce transaction costs - the cost of
every time a firm changes cash from one currency
to another, they face transaction costs

Most banks also charge a transfer fee for

moving cash from one location to another
Multilateral netting can reduce the number of
transactions between subsidiaries and the
number of transaction costs


How Can Firms Limit

Their Tax Liability?
Every country has its own tax policies
most countries feel they have the right to tax
the foreign-earned income of companies
based in the country

Double taxation occurs when the income

of a foreign subsidiary is taxed by the
host-country government and by the
home-country government


How Can Firms Limit

Their Tax Liability?
Taxes can be minimized through
1. Tax credits - allow the firm to reduce the taxes paid to
the home government by the amount of taxes paid to
the foreign government
2. Tax treaties - agreement specifying what items of
income will be taxed by the authorities of the country
where the income is earned
3. Deferral principle - specifies that parent companies
are not taxed on foreign source income until they
actually receive a dividend
4. Tax havens - countries with a very low, or no, income
tax firms can avoid income taxes by establishing a
wholly-owned, non-operating subsidiary in the

How Do Firms Move

Money Across Borders?
Firms can transfer liquid funds across
border via

Dividend remittances
Royalty payments and fees
Transfer prices
Fronting loans


What Are
Dividend Remittances?
Paying dividends is the most common method of
transferring funds from subsidiaries to the parent
The relative attractiveness of paying dividends
varies according to
tax regulations high tax rates make this less
foreign exchange risk dividends might speed up in
risky countries
the age of the subsidiary older subsidiaries remit a
higher proportion of their earning in dividends
the extent of local equity participation local owners
demands for dividends come into play

What Are
Royalty Payments And Fees?
Royalties - the remuneration paid to the owners
of technology, patents, or trade names for the
use of that technology or the right to
manufacture and/or sell products under those
patents or trade names
can be levied as a fixed amount per unit or as a
percentage of gross revenues
most parent companies charge subsidiaries royalties
for the technology, patents or trade names transferred
to them


What Are
Royalty Payments And Fees?
A fee is compensation for professional
services or expertise supplied to a foreign
subsidiary by the parent company or
another subsidiary
royalties and fees are often tax-deductible


What Are Transfer Prices?

Transfer prices - the price at which goods and
services are transferred between entities within
the firm
Transfer prices can be manipulated to
1. Reduce tax liabilities by shifting earnings from hightax countries to low-tax countries
2. Move funds out of a country where a significant
currency devaluation is expected
3. Move funds from a subsidiary to the parent when
dividends are restricted by the host government
4. Reduce import duties when ad valorem tariffs are in


What Makes
Transfer Prices Unattractive?
But, using transfer pricing can be
problematic because
1. Governments think they are being cheated
out of legitimate income
2. Governments believe firms are breaking the
spirit of the law when transfer prices are used
to circumvent restrictions of capital flows
3. It complicates management incentives and
performance evaluation

What Are Fronting Loans?

Fronting loans are loans between a parent
and its subsidiary channeled through a
financial intermediary, usually a large
international bank
Firms use fronting loans
to circumvent host-country restrictions on the
remittance of funds from a foreign subsidiary
to the parent company
to gain tax advantages

What Are Fronting Loans?

An Example of the Tax Aspects of a Fronting Loan