MB0053

Why is Comparative Cost Theory

considered as an improvement upon
Absolute Cost Advantage Theory?
Comparative Costs Theory:
The principle of comparative costs is based on the differences in production costs of similar
commodities in different countries. Production costs differ in countries because of geographical
division of labour and specialisation in production. Due to differences in climate, natural
resources, geographical situation and efficiency of labour, a country can produce one commodity
at a lower cost than the other.
In this way, each country specialises in the production of that commodity in which its
comparative cost of production is the least. Therefore, when a country enters into trade with
some other country, it will export those commodities in which its comparative production costs
are less, and will import those commodities in which its comparative production costs are high.
This is the basis of international trade, according to Ricardo. It follows that each country will
specialise in the production of those commodities in which it has greater comparative advantage
or least comparative disadvantage. Thus a country will export those commodities in which its
comparative advantage is the greatest, and import those commodities in which its comparative
disadvantage is the least.

Assumptions of the Theory:

The Ricardian doctrine of comparative advantage is based on the following assumptions:
(1) There are only two countries, say A and B.
(2) They produce the same two commodities, X and Y.
(3) Tastes are similar in both countries.
(4) Labour is the only factor of production.
(5) All labour units are homogeneous.
(6) The supply of labour is unchanged.

(7) Prices of the two commodities are determined by labour cost, i.e.. the number of labour-units
employed to produce each.
(8) Commodities are produced under the law of constant costs or returns.
(9) Trade between the two countries takes place on the basis of the barter system.
(10) Technological knowledge is unchanged.
(11) Factors of production are perfectly mobile within each country but are perfectly immobile
between the two countries.
(12) There is free trade between the two countries, there being no trade barriers or restrictions in
the movement of commodities.
(13) No transport costs are involved in carrying trade between the two countries.
(14) All factors of production are fully employed in both the countries.
(15) The international market is perfect so that the exchange ratio for the two commodities is the
same.

Absolute advantage refers to differences in productivity of nations, while comparative

advantage refers to differences in opportunity costs.
The producer that requires a smaller quantity inputs to produce a good is said to have an
absolute advantage in producing that good.
Comparative advantage refers to the ability of a party to produce a particular good or service
at a lower opportunity cost than another.
The existence of a comparative advantage allows both parties to benefit from trading,
because each party will receive a good at a price that is lower than its opportunity cost of
producing that good.
comparative advantage
The ability of a party to produce a particular good or service at a lower marginal and opportunity
cost over another.
Absolute advantage
The capability to produce more of a given product using less of a given resource than a
competing entity.

Absolute advantage compares the productivity of different producers or economies. The

producer that requires a smaller quantity inputs to produce a good is said to have an absolute
advantage in producing that good.
The accompanying figure shows the amount of output Country A and Country B can produce in a
given period of time . Country A uses less time than Country B to make either food or clothing.
Country A makes 6 units of food while Country B makes one unit, and Country A makes three
units of clothing while Country B makes two. In other words, Country A has an absolute
advantage in making both food and clothing.

Comparative advantage refers to the ability of a party to produce a particular good or service at a
lower opportunity cost than another. Even if one country has an absolute advantage in producing
all goods, different countries could still have different comparative advantages. If one country
has a comparative advantage over another, both parties can benefit from trading because each
party will receive a good at a price that is lower than its own opportunity cost of producing that
good. Comparative advantage drives countries to specialize in the production of the goods for
which they have the lowest opportunity cost, which leads to increased productivity.
For example, consider again Country A and Country B in . The opportunity cost of producing 1
unit of clothing is 2 units of food in Country A, but only 0.5 units of food in Country B. Since the
opportunity cost of producing clothing is lower in Country B than in Country A, Country B has a
comparative advantage in clothing.
Thus, even though Country A has an absolute advantage in both food and clothes, it will
specialize in food while Country B specializes clothing. The countries will then trade, and each
will gain.
Absolute advantage is important, but comparative advantage is what determines what a country
will specialize in.

Porters Diamond Model

Porter's diamond model suggests that there are inherent reasons why some nations, and industries
within nations, are more competitive than others on a global scale. The argument is that the
national home base of an organization provides organizations with specific factors, which will
potentially create competitive advantages on a global scale.

Porter's model includes 4 determinants of national advantage, which are shortly described
below:
Factor Conditions
Factor conditions include those factors that can be exploited by companies in a given nation.
Factor conditions can be seen as advantageous factors found within a country that are
subsequently build upon by companies to more advanced factors of competition. Factors not
normally seen as advantageous, such as workforce shortage, can also be seen as a factor
potentially strengthening competitiveness, because this factor may heighten companies' focus on
automation and zero defects.
Some examples of factor conditions:

Highly skilled workforce

Linguistic abilities of workforce

Rich amount of raw materials

Workforce shortage

Demand conditions
If the local market for a product is larger and more demanding at home than in foreign markets,
local firms potentially put more emphasis on improvements than foreign companies. This will
potentially increase the global competitiveness of local exporting companies. A more demanding
home market can thus be seen as a driver of growth, innovation and quality improvements. For
instance, Japanese consumers have historically been more demanding of electrical and electronic
equipment than western consumers. This has partly founded the success of Japanese
manufacturers within this sector.
Related and Supporting Industries
When local supporting industries and suppliers are competitive, home country companies will
potentially get more cost efficient and receive more innovative parts and products. This will
potentially lead to greater competitiveness for national firms. For instance, the Italian shoe
industry benefits from a highly competent pool of related businesses and industries, which has
strengthened the competitiveness of the Italian shoe industry world-wide.
Firm Strategy, Structure, and Rivalry
The structure and management systems of firms in different countries can potentially affect
competitiveness. German firms are oftentimes very hierarchical, which has resulted in
advantages within industries such as engineering. In comparison, Danish firms are oftentimes
more flat and organic, which leads to advantages within industries such as biochemistry and
design.
Likewise, if rivalry in the domestic market is very fierce, companies may build up capabilities
that can act as competitive advantages on a global scale. Home markets with less rivalry may
therefore be counterproductive, and act as a barrier in the generating of global competitive
advantages such as innovation and development.
By using Porter's diamond, business leaders may analyze which competitive factors may reside
in their company's home country, and which of these factors may be exploited to gain global
competitive advantages. Business leaders can also use the Porter's diamond model during a phase
of internationalization, in which leaders may use the model to analyze whether or not the home
market factors support the process of internationalization, and whether or not the conditions
found in the home country are able to create competitive advantages on a global scale.

Explain Hofstedes Cultural dimensions

In the 1980ies Geert Hofstede discovered 5 fundamental dimensions of national cultures that can
be seen to illustrate different values in different national cultures. This discovery was made
through utilizing factor analysis techniques on samples drawn from the multinational corporation
IBM.

The dimensions found by Geert Hofstede can be used to illustrate which values lie deeply
embedded in people from different cultures. These values may have consequences for how
people in different cultures behave, and how they will potentially behave in a work related
context.
The five values found by Geert Hofstede are:
1. Power Distance
2. Uncertainty Avoidance
3. Masculinity vs. Femininity
4. Individualism vs. Collectivism
5. Long vs. Short Term Orientation
Power Distance
In cultures with low power distance, people are likely to expect that power is distributed rather
equally, and are furthermore also likely to accept that power is distributed to less powerful
individuals. As opposed to this, people in high power distance cultures will likely both expect
and accept inequality and steep hierarchies.
Uncertainty Avoidance
Uncertainty Avoidance is referring to a lack of tolerance for ambiguity and a need for formal
rules and policies. This dimension measures the extent to which people feel threatened by
ambiguous situations. These uncertainties and ambiguities may e.g. be handled by an
introduction of formal rules or policies, or by a general acceptance of ambiguity in the
organizational life.
The majority of people living in cultures with a high degree of uncertainty avoidance, are likely
to feel uncomfortable in uncertain and ambiguous situations.
People living in cultures with a low degree of uncertainty avoidance, are likely to thrive in more
uncertain and ambiguous situations and environments.
Masculinity vs. Femininity
These values concern the extent on emphasis on masculine work related goals and assertiveness
(earnings, advancement, title, respect et.), as opposed to more personal and humanistic goals
(friendly working climate, cooperation, nurturance etc.)
The first set of goals is usually described as masculine, whereas the latter is described as
feminine. These goals and values can, among other, describe how people are potentially
motivated in cultures with e.g. a feminine or a masculine culture.
Individualism vs. Collectivism
In individualistic cultures people are expected to portray themselves as individuals, who seek to
accomplish individual goals and needs. In collectivistic cultures, people have greater emphasis
on the welfare of the entire group to which the individual belongs, where individual wants, needs
and dreams are often set aside for the common good.
Long vs. Short Term Orientation
Long-Term Orientation is the fifth dimension, which was added after the original four
dimensions. This dimension was identified by Michael Bond and was initially called Confucian

dynamism. Geert Hofstede added this dimension to his framework, and labeled this dimension
long vs. short term orientation .
The consequences for work related values and behavior springing from this dimension are rather
hard to describe, but some characteristics are described below.
Long term orientation:
Acceptance of that business results may take time to achieve
The employee wishes a long relationship with the company
Short term orientation:
Results and achievements are set, and can be reached within timeframe
The employee will potentially change employer very often.

An economic union comprises of a

common market and a custom union.
Explain.
An economic union is a type of trade bloc which is composed of a common market
with a customs union. The participant countries have both common policies on
product regulation, freedom of movement of goods, services and the factors of
production (capital and labour) and a common external trade policy. When an
economic union involves unifying currency it becomes a economic and monetary
union.
Purposes for establishing an economic union normally include increasing economic
efficiency and establishing closer political and cultural ties between the member
countries.

Economic union is established through trade pact.

Economic unions are a natural response to the realities of globalization and represent one stage in the
process of economic integration. In theory, nations move from free trade agreements to form customs
unions and then common markets before forming economic unions. In practice, however, the path is
not always that clear. Economic unions often are characterized by a common currency and centralized
bank, in which case they are sometimes referred to as economic and monetary unions. The best
example of an economic and monetary union today is the European Union (EU). In many ways, the EU
today is a living laboratory for observing the effects of macro economic policy cooperation on regional
growth and cross-border economic, trade, and investment ties.

Globalization brings with it many changes. From a business point of view, globalization increases the
marketplace in which a business can sell its goods and services. On the other hand, globalization often
makes doing business more difficult, requiring, for example, the management of an international
supply chain, dealing with the intricacies of managing an international workforce, or marketing to
different cultures. In addition, globalization affects not only businesses; it also affects the countries
within which a business operates. Before globalization, most countries are able to be economically selfsufficient and did not rely on international trade or imported goods to survive. However, with
increasing globalization comes an increasing reliance on the goods and services of other countries.
Thus, while an international company can market its goods and services in other countries, those other
countries can market their own goods and services locally to the new company. To help facilitate the
economic realities of globalization, a number of nations are forming economic unions.
An economic union is a type of common market that permits the free movement of capital, labor,
goods, and services. Economic unions harmonize or unify their social, fiscal, and monetary policies
(often including having a united currency). Examples of economic unions include:

The African Union,

Andean Community (Comunidad Andina),

Arab Maghreb Union (Union du Maghreb Arabe),

Association of Caribbean States,

Association of South East Asian Nations,

Caribbean Community,

Commonwealth of Independent States,

East African Community,

European Union, and

Pacific Community.

Although in practice, the path from national economic self-sufficiency to economic integration varies
from situation to situation; in general, there are four stages to this transformation:

Free trade agreements,

Customs unions,

Common markets, and

Economic unions (Holden, 2003).

Free Trade Agreements

The first stage toward economic integration is represented by the free trade agreement. Free trade is
the exchange of good and services between countries or sovereign states without high tariffs, nontariff barriers (e.g., quotas), or other inhibiting requirements or processes. Free trade does not apply to
capital or labor. Free trade agreements (also referred to as preferential trade agreements) eliminate
import tariffs and quotas between the signatories to the agreement. They may apply to all aspects of

international trade between the signatories or may be limited to a few sectors. Often, free-trade
agreements include formal mechanisms that are to be used to resolve disputes. The primary
advantage of the free trade agreement is that it liberalizes trade among the member nations.
However, free-trade agreements otherwise place few limitations on the member nations. In order for a
free-trade agreement to properly function, it must also include rules of origin that apply to all third
party goods imported from outside the free-trade area.
Customs Unions
The next stage in economic integration comprises the development of customs unions. Customs are
duties or taxes that are imposed by a country, sovereign state, or common union on imported goods.
In some situations, duties or taxes may also be imposed on exported goods. Customs unions remove
internal trade barriers, and require participating states to harmonize external trade policies. Part of this
harmonization includes the development of a common external tariff. These are shared customs
duties, import quotas, preferences, or other non-tariff barriers imposed by a customs union or common
market on imports to any or all countries in the union or market. Common external tariffs are actually a
simple form of economic union. Customs union may prohibit the use of trade remedies with the union
and may also negotiate multilateral trade initiatives. Because all goods imported into a customs union
are subject to the same tariff no matter their point of origin, custom unions have no need for rules of
origin as required in free trade agreements. However, in order to gain the benefits of a customs union,
participating nations must by necessity relinquish their right to establish an independent trade policy.
As a result, member nations also experience some restriction of foreign policy.
Common Markets
The third stage in economic integration is the development of a common market. This is a group of
countries or sovereign states within a geographical area with a mutual agreement to permit the free
movement of capital, labor, goods, and services among its members. Although common markets
promote duty-free trade for the member nations, they impose common external tariffs on imports from
countries that are not members. Common markets have unified or harmonized social, fiscal, and
monetary policies. This feature of common markets severely limits the ability of member nations to
implement independent economic policies. However, common markets offer gains in economic
efficiency that could not otherwise be realized. Because of the nature of common markets, both labor
and capital can move within the area of the common market, leading to a more efficient allocation of
resources than could otherwise be achieved.
The Economic Union
The fourth stage in economic integration comprises the economic union. This is a type of common
market which permits the free movement of capital, labor, goods, and services. Economic unions
harmonize or unify their social, fiscal, and monetary policies. When economic unions also have a
common currency with a concomitant central bank for all member states, they may be referred to as
economic and monetary unions. Economic unions include significant harmonization of policy among
the member states, particularly the formal coordination of monetary and fiscal policies, and labor
market, regional development, transportation, and industrial policies.

Explain the components of International

Financial Management
The term Financial Management refers to the proper maintenance of all the
monetary transactions of the organisation. It also means recording of
transactions in a standard manner that will show the financial position and
performance of the organisation. The Financial Management can be
categorised into domestic and international financial management.
The domestic financial management refers to managing financial services
within the country. International financial management refers to managing
finance and share between the countries.
The main aim of international finance management is to maximise the
organisations value that in turn will increase the impact on the wealth of the
stockholders. When the doors of liberalisation opened, entrepreneurs
capitalised the opportunity to step their foot to conduct business in different
parts of the world.
International trade gave way for the growth of international business. For a
corporation to be successful, it is vital to manage the finance and business
accounts appropriately. The rise in significance and complexity of financial
administration in a global environment creates a great challenge for financial
managers. The contributions of different financial innovations like currency
derivative, international stock listing, and multicurrency bonds have
necessitated the accurate management of the flow of international funds
through the study of international financial management.
The International Financial Management (IFM) came to its existence when
the countries all over the world started opening their doors for each other.
This phenomenon is also called as liberalisation. But after the end of the
Second World War, the integration in terms of foreign activities has grown
substantially. The firms of all types are now opting to operate their business
and deploy their resources abroad. Furthermore, the differences between the

countries have persisted that has given rise to the prevalence of market
imperfections.
Components of International Financial Management
The components like foreign exchange market, foreign currency derivatives,
international monetary markets and international financial markets are
essential to the international financial management, which is discussed in
this section.
1. Foreign exchange market
The Foreign exchange or the forex markets facilitates the participants to
obtain, trade, exchange and speculate foreign currency. The foreign
exchange market consists of banks, central banks, commercial companies,
hedge funds, investment management firms and retail foreign exchange
brokers and investors. It is considered to be the leading financial market in
the world. It is vital to realise that the foreign exchange is not a single
exchange, but is created from a global network of computers that connects
the participants from all over the world.
The foreign exchange market is immense in size and survives to serve a
number of functions ranging from the funding of cross-border investment,
loans, trade in goods, trade in services and currency speculation. The
participant in a foreign exchange market will normally ask for a price.
The trading in the foreign exchange market may take place in the following
forms:
Outright cash or ready foreign exchange currency deals that take place
on the date of the deal.
Next day foreign exchange currency deals that take place on the next
working day.
Swap Simultaneous sale and purchase of identical amounts of currency
for different maturities.
Spot and Forward contracts A Spot contract is a binding obligation to
buy or sell a definite amount of foreign currency at the existing or spot
market rate. A forward contract is a binding obligation to buy or sell a
definite amount of foreign currency at the pre-agreed rate of exchange, on
or before a certain date.
The advantage of spot dealing has resulted in a simplest way to deal with all
foreign currency requirements. It carries the greatest risk of exchange rate
fluctuations due to lack of certainty of the rate until the deal is carried out.
The spot rate that is intended to receive will be set by current market
conditions, the demand and supply of currency being traded and the amount
to be dealt. In general, a better spot rate can be received if the amount of

dealing is high. The spot deal will come to an end in two working days after
the deal is struck.
A forward market needs a more complex calculation. A forward rate is based
on the existing spot rate plus a premium or discounts which are determined
by the interest rate connecting the two currencies that are involved. For
example, the interest rates of UK are higher than that of US and therefore a
modification is made to the spot rate to reflect the financial effect of this
differential over the period of the forward contract. The duration will be up to
two years for a forward contract. A variation in foreign exchange markets
can be affected to any company whether or not they are directly involved in
the international trade or not. This is often referred to as Economic foreign
exchange and most difficult to protect a business.
The three ways of managing risks are as follows:
Choosing to manage risk by dealing with the spot market whenever the
need of cash flow rises. This will result in a high risk and speculative strategy
since one will not know the rate at which a transaction is dealt until the day
and time it occurs. Managing the business becomes difficult if it depends on
the selling or buying the currency in the spot market.
The decision must be made to book a foreign exchange contract with the
bank whenever the foreign exchange risk is likely to occur. This will help to
fix the exchange rate immediately and will give a clear idea of knowing the
exact cost of foreign currency and the amount to be received at the time of
settlement whenever this due occurs.
A currency option will prevent unfavourable exchange rate movements in
the similar way as a forward contract does. It will permit gains if the markets
move as per the expectations. For this base, a currency option is often
demonstrated as a forward contract that can be left if it is not followed.
Often banks provide currency options which will ensure protection and
flexibility, but the likely problem to arise is the involvement of premium of
particular kind. The premium involved might be a cash amount or it could
also influence into the charge of the transaction.
2. Foreign currency derivatives
Currency derivative is defined as a financial contract in order to swap two
currencies at a predestined rate. It can also be termed as the agreement
where the value can be determined from the rate of exchange of two
currencies at the spot. The currency derivative trades in markets correspond
to the spot (cash) market. Hence, the spot market exposures can be
enclosed with the currency derivatives. The main advantage from derivative
hedging is the basket of currency available.
Figure 1 describes the examples of currency derivatives. The derivatives can

be hedged with other derivatives. In the foreign exchange market, currency

derivatives like the currency features, currency options and currency swaps
are usually traded. The standard agreement made in order to buy or sell
foreign currencies in future is termed as currency futures. These are usually
traded through organised exchanges. The authority to buy or sell the foreign
currencies in future at a specified rate is provided by currency option. These
will help the businessmen to enhance their foreign exchange dealings. The
agreement undertaken to exchange cash flow streams in one currency for
cash flow streams in another currency in future is provided by currency
swaps. These will help to increase the funds of foreign currency from the
cheapest sources.

Figure 1: Example for Foreign Currency Derivatives

Some of the risks associated with currency derivatives are:
Credit risk takes place, arising from the parties involved in a contract.
Market risk occurs due to adverse moves in the overall market.
Liquidity risks occur due to the requirement of available counterparties to
take the other side of the trade.
Settlement risks similar to the credit risks occur when the parties involved
in the contract fail to provide the currency at the agreed time.
Operational risks are one of the biggest risks that occur in trading
derivatives due to human error.
Legal risks pertain to the counterparties of currency swaps that go into
receivership while the swap is taking place.
3. International monetary systems

The international monetary systems represent the set of rules that are
agreed internationally along with its conventions. It also consists of set of
rules that govern international scenario, supporting institutions which will
facilitate the worldwide trade, the investment across cross-borders and the
reallocation of capital between the states.
International monetary systems provide the mode of payment acceptable
between buyers and sellers of different nationality, with addition to deferred
payment. The global balance can be corrected by providing sufficient
liquidity for the variations occurring in trade. Thereby it can be operated
successfully.
The gold and gold bullion standards
The gold standard was the first modern international system. It was
operating during the late 19th and early 20th centuries, the standard
provided for the free circulation between nations of gold coins of standard
specification. The gold happened to be the only standard of value under the
system. The advantages of this system depend in its stabilising influence.
Any nation which exports more than its import would receive gold in
payment of the balance. This in turn has resulted in the lowered value of
domestic currency. The higher prices lead to the decreased demands for
exports. The sudden increase in the supply of gold may be due to the
discovery of rich deposit, which in turn will result in the increase of price
abruptly.
This standard was substituted by the gold bullion standard during the 1920s;
thereby the nations no longer minted gold coins. Instead, reversed their
currencies with gold bullion and determined to buy and sell the bullion at a
fixed cost. This system was also discarded in the 1930s.
The gold-exchange system
Trading was conducted internationally with respect to the gold-exchange
standard following World War II. In this system, the value of the currency is
fixed by the nations with respect to some foreign currency but not with
respect to gold. Most of the nations fixed their currency to the US dollar
funds in the United States. With a view to maintain a stable exchange rate at
the global level, the International Monetary Fund (IMF) was created at the
Bretton Woods international Conference held in 1944. The drain on the US
gold reserves continued up to the 1970s. Later in 1971, the gold
convertibility was abandoned by the United States leaving the world without
a single international monetary system.

Floating exchange rates and recent development

After the abundance of the gold convertibility by the US, the IMF in 1976
decided to be in agreement on the float exchange rates. The gold standard
was suspended and the values of different currencies were determined in the
market. The Japanese yen and the German Deutschmark strengthened
and turned out to be increasingly important in international financial market,
at the same time the US dollar diminished its significance. The Euro was set
up in financial market in 1999 as a replacement for the currencies. Hence, it
became the second most commonly used currency after the dollar in the
international market. Many large companies opt to use euro rather than the
dollar in bond trading with a goal to receive better exchange rates. Very
recently the some of the members of Organisation of Petroleum Exporting
Countries (OPEC) such as Saudi Arabia, Iraq have opted to trade petroleum
in Euro than in Dollar.
4. International financial markets
International foreign markets provide links connecting the financial markets
of each country and independent markets external to the authority of any
one country. The heart of the international financial market is being
governed by the market of currency where the foreign currency is
denominated by the international trade and investment. Hence the purchase
of goods and services is preceded by the purchase of currency.
The purpose of the foreign currency markets, international money markets,
international capital markets and international securities markets are as
follows:
The foreign currency markets The foreign currency market is an
international market that is familiar in structure. This means that there
exists no central place where the trading can take place. The market is
actually the telecommunications like among financial institutions around the
globe and opens for business at any time. The greater part of the worlds
that deal in foreign currencies is still taking position in the cities where
international financial activity is centred.
International money markets A money market can be conventionally
defined as a market for accounts, deposits or deposits that include
maturities of one year or less. This is also termed as the Euro currency
markets which constitute an enormous financial market that is beyond the
influence and supervision of world financial and government authorities. The
Euro currency market is a money market for depositing and borrowing
money located outside the country where that money is officially permitted

tender. Also, Euro currencies are bank deposits and loans existing outside
any particular country.
International capital markets The international capital provides links
among the capital markets of individual countries. It also comprises a
separate market of their own, the capital market that flows in to the Euro
markets. The firms enjoy the freedom to raise capital, debit, fixed or floating
interest rates and maturities varying from one month to thirty years in an
international capital markets.
International security markets The banks have experienced the greatest
growth in the past decade because of the continuity in providing large
portion of the international financial needs of the government and business.
The private placements, bonds and equities are included in the international
security market.
The following are the reasons given for the enormous growth in the trading
of foreign currency:
Deregulation of international capital flows Without the major government
restrictions, it is extremely simple to move the currencies and capital around
the globe. The majority of the deregulation that has differentiated
government policy over the past 10 to 15 years.
Gain in technology and transaction cost efficiency The advancements in
technology is not only taking place in the distribution of information, in
addition to the performance of exchange or trading. This has resulted greatly
to the capacity of individuals on these markets to accomplish instantaneous
arbitrage.
Market upwings The financial markets have become increasingly unstable
over recent years. There are faster swings in the stock values and interest
rates, adding to the enthusiasm for moving further capital at faster rates.
The scope of international financial management includes management of
working capital, financing decisions and taxation.

What are the differences between

International Accounting Standards and
Domestic Accounting Standards?
Difference between domestic and international accounting:
Different countries have different accounting standards. A common belief is that these differences reduce
the quality and importance of accounting information. Accounting standards determine the financial

reporting quality and provides separately verified information about an organizations financial
performance to investors creditors.
There are differences in accounting methods, domestic businesses are not affected. The accounting system
of a domestic organization must meet the specialized and regulatory standards of its home country. But,
an MNC and its subsidiaries must meet differing accounting and auditing standards of all the countries in
which it operates. This leads to a need for comparability between businesses in the group. In order to
successfully manage and organize their operations, local managers require accounting information, which
should be prepared according to the local accounting concepts and denomination in the local currency.
Yet, for financial controllers, to measure the foreign subsidiarys performance and worth, the subsidiarys
accounts must be translated into the organizations home currency. This translation is done using
accounting concepts and measures, which are detailed by the organization. Investors worldwide look for
the highest possible returns on their capital, in order to interpret the track record, though they use a
currency and an accounting system of their own. The organization also has to pay taxes to the countries
where it does business, based on the accounting statements prepared in these countries.
We find many differences between International Accounting Standards (IAS) and Domestic Accounting
Standards (DAS). On the basis of difference between the two, two indices, namely 'divergence' and
'absence', are created. Absence is the difference between DAS and IAS; the rules on certain accounting
issues are missed out in DAS and covered in IAS. Divergence represents the differences between DAS
and IAS; the rules on the same accounting issue differ in DAS and IAS.
Measurement of differences between domestic and international accounting:
1. Literature on international accounting differences: Referring to earlier reports on international
accounting could give more information about the subject. Most of the earlier reports understand
international accounting differences as various options adopted by nations for the similar accounting
problems, which correspond to divergence concept.
2. Framework of analysis: Links between variations in accounting standards and financial reporting quality
of various countries could be clearly seen from the reports published earlier. We should consider the
institutional determinants of accounting differences such as legal origin, governance structure, economic
development, and equity market.
Legal and regulatory framework This framework refers to companies having to comply with the law
of the land they operate in. Companies involved in international business may have to comply with laws
of more than one country. This certainly poses a challenge as each country has its own set of laws. These
companies have to ascertain that their scope of business is within the regulatory framework set by the
authorities of that country.
Financial management In a domestic scenario, all the payments of a business involve the local
currency. In an international scenario, for example, a company may pay in Chinese Yuan for sourcing its
materials from China, pay wages in Malaysian Ringgits at its production base in Malaysia, and receive
payments in Euros from its customer in Germany. Hence, a company has to deal with multiple currencies,
exchange rate mechanisms, hedging of currencies, banking systems, fluctuating interest rates and so on.
Trade barriers and tariffs In a domestic scenario, a company can move its goods and services almost
freely within the country. But in international trade, companies face issues like licensing, anti-dumping
laws, quota restrictions, and tariffs for their business operations in a foreign country or region.

Accounting and taxation Domestic businesses need to comply with the accounting and taxation
standards prevailing in that country. A company with international operations has to comply with the
accounting standards and tax laws of the foreign country as well.
Culture In a domestic market, a business deals with a homogenous culture whereas .a company with
international business has to deal with heterogeneous cultures in multiple countries. The companys
management has to study different cultures and get accustomed to different languages, culture,
sentiments, and traditions of the foreign country in order to conduct business productively.
Market forces Demographics of each country have its own perceptions about different products and
services. The local, political, economic, and technological environments differ from country to country.
While these differences are at a macro level, at the micro level we have to consider several other factors.
They may be in terms of customer preferences, product placement, pricing, advertising, distribution
channels and so on. An international company has to face the challenges of multiple regional customers,
each with unique requirements.

Key components of International Strategic management

International marketing can be defined as marketing of goods and services outside the firms home
country. International marketing has the following two forms of marketing:

Multinational marketing.
Global marketing.

Multinational marketing is very complex as a firm engages in marketing operations in many countries. In
multinational marketing, a firm visualizes different countries as one market and build their brand or
service according to the business environment of the foreign countries. Global marketing indicates the
integrated and coordinated marketing activities across many different markets.
Taking into account the various conditions on which markets vary and depend, appropriate marketing
strategies should be devised and adopted. Like, some countries prevent foreign firms from entering into
its market space through protective legislation. Protectionism on the long run results in inefficiency of
local firms as it is inept towards competition from foreign firms and other technological advancements. It
also increases the living costs and protects inefficient domestic firms.

The decision of a firm to compete internationally is strategic; it will have an effect on the firm, including
its management and operations locally. The decision of a firm to compete in foreign markets has many
reasons. Some firms go abroad as the result of potential opportunities to exploit the market and to grow
globally. And for some it is a policy driven decision to globalize and to take advantage by pressurizing
competitors.
1. Segmentation
Firms that serve global markets can be segregated into several clusters based on their similarities. Each
such cluster is termed as a segment. Segmentation helps the firms to serve the markets in an improved
way. Markets can be segmented into nine categories, but the most common method of segmentation is on
the basis of individual characteristics, which include the behavioral, psychographic, and demographic
segmentations. The basis of behavioral segmentation is the general behavioral aspects of the customers.

Demographic segmentation considers the factors like age, culture, income, education and gender.
Psychographic segmentation takes into account: beliefs, values, attitudes, personalities, opinions,
lifestyles and so on.
2. Market positioning
The next step in the marketing process is, the firms should position their product in the global market.
Product positioning is the process of creating a favorable image of the product against the competitors
products. In global markets product positioning is categorized as high-tech or hightouch positioning. The
classification of high-tech and high-touch products. One challenge that firms face is to make a trade-off
between adjusting their products to the specific demands of a country and gaining advantage of
standardization such as the maintenance of a consistent global brand image and cost savings.
3. International product policy
Some thinkers of the industry tend to draw a distinction between conventional products and services,
stressing on service characteristics such as heterogeneity, inseparability from consumption, intangibility,
and perishability. Typically, products are composed of some service component like, documentation, a
warranty, and distribution. These service components are an integral part of the product and its
positioning. Thus, it is important to consider the findings of marketing research and determine customers
desires, motives, and expectations in buying a product. Firms have a choice in marketing their products
across markets. Many a times, firms opt for a strategy which involves customization, through which the
firm introduces a unique product in each country, believing that tastes differ so much between countries
that it is necessary to create anew product for each market. Standardization proposes the marketing of one
global product, with the belief that the same product can be sold in different countries without significant
changes. Finally, in most cases firms will go for some kind of adaptation. Here, when moving a product
between markets minor modifications are made to the product.
4. International pricing decisions
Pricing is the process of ascertaining the value for the product or service that will be offered for sale. In
international markets, making pricing decisions is entangled in difficulties as it involves trade barriers,
multiple currencies, additional cost considerations, and longer distribution channels. Before establishing
the prices, the firm must know its target market well because when the firm is clear about the market it is
serving, then it can determine the price appropriately. The pricing policy must be consistent with the firms
overall objectives. Some common pricing objectives are: profit, return on investment, survival, market
share, status quo, and product quality. The strategies for international pricing can be classified into the
following three types:
Market penetration
: It is the technique of selling a new product at a lower price than the current market price.
Market holding
: It is a strategy to maintain buy orders in order to maintain stability in a downward trend.
Market skimming
: It is a pricing strategy where price of the goods are set high initially to skim the revenue from the market
layer by layer. The factors that influence pricing decisions are inflation, devaluation and revaluation,
nature of product or industry and competitive behavior, market demand, and transfer pricing.

5. International advertising
International advertising is usually associated with using the same brand name all over the world.
However, a firm can use different brand names for historic reasons. The acquisition of local firms by
global players has resulted in a number of local brands. A firm may find it unfavorable to change those
names as these local brands have their own distinctive market. Therefore, the company may want to
come-up with a certain advertising approach or theme that has been developed as a result of extensive
global customer research. Global advertising themes are advisable for marketing across the world with
customers having similar tastes.

The purpose of international advertising is to reach and communicate to target audiences in more than one
country. The target audience differs from country to country in terms of the response towards humour or
emotional appeals, perception or interpretation of symbols and stimuli and level of literacy.
Standardization is required for products by some firms. Standardization helps to achieve economies of
scale and a consistent image can be established across markets. Standardization also assists in utilizing
creative talent across markets, and facilitates good ideas to be transplanted from one market to other.
International advertising can be thought of as communication process that transpires in multiple cultures
that vary in terms of communication styles, values, and consumption patterns. International advertising is
a business activity and not just a communication process. It involves advertisers and advertising agencies
that create ads and buy media in different countries. International advertising is also reckoned as a major
force that mirrors both social values, and propagates certain values worldwide.
6. International promotion and distribution
Distribution of goods from manufacturer to the end user is an important aspect of business. Companies
have their own ways of distribution. Some companies directly perform the distribution service by
contacting others whereas a few companies take help from other companies who perform the distribution
services. The distribution services include: The purchase of goods. The assembly of an attractive
assortment of goods. Holding stocks. Promoting sale of goods to the customer. The physical movement
of goods. In order to reach its target markets a company utilizes a combination of sales promotion,
personal selling, advertising and public relations, which is collectively called as promotion. Advertising is
a non-personal form of communication about an organization or its products that is propagated to a target
audience through a broadcast medium. A firm can focus on a small, clearly defined market segment by
employing this type of promotion. This promotional method is also cost efficient. A large number of
prospective customers can be reached, at a minimal cost per person. The activity of catching the attention
of prospects is known as sales promotion. It involves activities and materials that are meant to attract
customers. One motive of promotion is to gain a competitive edge; other objective is to concentrate on
this method as it provides quick return. The consumers also look forward for sales promotions before
purchasing a product. People interested in a particular industry can be brought together by organizing
overseas product exhibitions. These events have the potential to attract important visitors such as
distributors, agents, journalists, potential customers, politicians, and competitors. These events also
provide us with an ideal opportunity to get attention.
Domestic vs. International marketing
Domestic marketing refers to the practice of marketing within a firms home country. Whereas
International or foreign marketing is the practice of marketing in a foreign country; the marketing is for
the domestic operations of the firm in that country. Domestic marketing finds the "how" and why" a

product succeeds or fails within the firms home country and how the marketing activity affects the
outcome. Whereas, foreign marketing deals with these questions and tries to find answers according to the
foreign market conditions and it provides a micro view of the market at

the firms level. In domestic marketing a firm has insight of the marketing practices, culture, customer
preferences, climate and so on of its home country, while it is not totally aware of the policies and the
market conditions of the foreign country. The stages that have led to achieve global marketing are:
Domestic marketing
Firms manufacture and sell products within the country. Hence, there is no international phenomenon.
Export marketing
Firms start exporting products to other countries. This is a very basic stage of global marketing. Here,
the products are developed based on the companys domestic market although the goods are exported to
foreign countries.
International marketing
Now, Firms start to sell products to various countries and the approach is polycentric, that is, making
different products for different countries.
Multinational marketing
In this stage, the number of countries in which the firm is doing business gets bigger than that in the
earlier stage. And hence, the company identifies the regions to which the company can deliver same
product instead of producing different goods for different countries. For example, a firm may decide to
sell same products in India, Sri lanka and Pakistan, assuming that the people living in this region have
similar choice and at the same time offering different product for American countries. This approach is
termed egocentric approach.
Global marketing
Company operating in various countries opts for a common single production order to achieve cost
efficiencies. This is achieved by analyzing the requirements and the choice of the customers in those
countries. This approach is called Geocentric approach. The practice of marketing at the international
stage does not designate any country as domestic or foreign. The firm is not considered as the corporate
citizen of the world as it has a home base. The firm must not have a single marketing plan, because there
are differences between the target markets (that is domestic or international markets). There should never
be a rigid marketing campaign. A firm that is successful internationally first obtains success locally. Few
approaches that you can consider for an international marketing are:
Advertise as a foreign product
By doing so, the product will be considered as genuine and original in some countries.
Joint partnership with a local firm
finding a firm that has already established credibility will benefit a lot. The product will be considered
as a local product by following this marketing approach.

Licensing
You can sell the rights of your product to a foreign firm. Here the problem is that the firm may not
maintain the quality standard and therefore may hurt the image of the brand. Culture is a major factor
which influences marketing decisions and practices in a foreign country. For example, in the middleeastern countries the prior approval of the governing authorities should be taken if a firm plans to
advertise a product related to womens apparel, as showcasing some aspects of women clothing is
considered immodest and immoral.