Confronting global challenges
Common challenges of international business
Ways a business can be international:
produces goods domestically and sells both domestically and internationally
produces goods abroad and sells it domestically and or abroad
Challenges of international business:
language barriers
cultural differences
managing global teams
currency exchange and inflation rates
nuances of foreign politics, policy and regulation
Stakeholder theory - businesses, to be successful it has to create value for customers,
suppliers, employers, communities, financiers, shareholders banks and others
Business cant just consider their own interests
Social responsibilities of a firm
focus on shareholder value
large/global firms need to recognise size and responsibility
markets need to understand human, community and environmental values
Links
Developments in global finance
Government control
Governments primary aims for the economy:
full employment
price stability
economic growth
redistribution of income
balance of payments stability
Fiscal policy
changes in gov spending
changes in taxation
Monetary policy
changes in money supply
changes in interest rates
The international monetary system
The IMF and World Bank
Both are involved in economic development policies for member countries
Both are influential institutions: they attach conditions to loans, which have followed the
“Washington Consensus”
The World Bank focuses on development programmes
The IMF focuses on broader development issues and financial stability; it has been crucial
in national financial crises
The IMF is a co-ordinating institution of the G20 group of countries (whichincludes a
number at risk of financial instability)
The Washington Consensus A set of rules to help developing countries
1. Reduce large deficits
2. reorder public spending to pro-growth and pro-poor
3. reduce taxes
4. liberalise interest rates - privatise central bank
5. competitive exchange rate
6. trade liberalisation
7. liberalise inward fdi
8. privatisation
9. deregulation
10. property rights
Exchange rate system
Currencies can range from fixed rate to free floating.
Pegged exchange rate – pegged to another currency, such as the US$
The peg is adopted to provide stability, and is favoured by developing and emerging
economies
Governments can come under pressure to devalue
The IMF warns against accumulating vast currency reserves, but many countries do hold large
reserves, e.g. China
The gold standard system
1870s to 1914
Marked the emergence of a global financial order
Currencies were pegged to gold
System depended on central banks adhering to external convertibility
No restrictions on international gold flows
The Bretton Woods system
it lasted 1944 to1971
Currencies pegged to the U.S. dollar.
But some flexibility for countries in setting the value of their currencies.
National capital controls allowed
Global financial markets
International capital markets
Multi national enterprises raise capital by offering shares to investors (equity funding) and by
borrowing (debt financing)
Capital markets – flows of capital, including equity and debt markets.
The financial environment has become highly globalised, due largelyto advances in computing
Equity markets
Shares in listed companies are traded on stock exchanges, launched by an IPO (initial
public offering)
Global companies often seek listings outside their home countries
In new markets where there is investment potential
In countries where regulation and costs are more advantageous
Institutional investors, such as pension funds and investment funds, have become major
investors in capital markets.
Debt financing
A bond is a loan instrument which promises to pay a fixed sum on a fixed date, and to pay
interest to the lender - Companies and governments both use bonds.
Global financial risk
Globalization has increased risks
Hedge funds are active in derivatives markets and in sovereign debt instruments
Finance is now a business activity in its own right, not just a business function.
Role in growth
Financial markets enable:
Exporters and importers to receive and raise funds in order to settle transactions.
Enables banks to borrow and lend customers in various foreign currencies.
Helps in each exchange of documents between the buyer and seller through banks.
Facilitate direct flow of savings and investments in the country.
Helps governments to raise funds by letting them borrow at a lower rate of interest
Helping to efficiently direct the flow of savings and investment in the economy to facilitate
capital accumulation and production of goods and services.
National financial crises
National financial systems can become vulnerable through a currency crisis, especially
when banks are exposed to debt in foreign currency.
Some causes of national financial crises:
Openness to volatile global financial flows.
Accumulation of too much debt: government, corporate and household debt.
Falling currency and dollar-denominated debt.
Global finance: Towards sustainability?
A challenge is to reform banking and finance to a more sustainable footing, taking in
stakeholder interests
A more sustainable financial system would feature:
A stakeholder focus.
Regulatory reform to introduce greater accountability of bankers who have caused their
banks to fail.
A more responsible approach to corporate governance
Balance of Payments
Globalisation
➡️
The exchange of ideas, capital goods across the world, driven by technology
Causes of globalisation:
Technology - communication, transport
Companies becoming larger so they can reach further
Containerisation
Reduced trade barriers
Cross-border political co-operation
Tensions in the globalised environment:
Economic
Economic integration
shifts in power
Political
Divergent political system
international cooperation
Legal
International law
national legal systems
Ecological
Global issues - climate change
national development properties
Technological
Technology transfer
national technology capacity - not being able to produce enough - micro conductors
Cultural
diversity
cultural diversity
Financial
global financial markets
regulation
intergovernmental organisations
social mobility is how easy it is for kids are able to move up the social economic ladder
Classifications of Countries
World bank use ATLS method
UN:
Developed - industrialised country with a mature economy
Economies in Transition - undertaking macro reforms and alter the way they are being
managed. Typically from a planned economy to more free market
Developing Economies - less developed economies with poor infrastructure and growth
Links:
Industry and market analysis
Markets and Sectors
The economic is split into four main sectors:
Primary:
Raw materials
fishing
farming
Secondary
Manufacturing
utilities
construction
Tertiary
Retail
financial services
Quaternary
R&D
Social media and information
ICT
Markets are where buyers and sellers come together to get information and exchange
commodities. The structure of the market is important when analysing it. Different types are in
this link:
Market Structure
(explained in detail on each link)
Analysis
This analysis helps firms, investors and governments to understand the political and socioeconomic factors within the market and how they may be used to gain a competitive advantage
Governments conduct industry analysis to understand the role and impact of government
regulation and taxation on the industry and market.
PESTLE
A strategic framework used to evaluate the external business environment:
Political
Economic
Social
Technological
Legal
Environmental
SWOT
Porters Five Forces
Porter’s ‘Five Forces’ model provides a framework to analyse industry attractiveness.
It is often used in combination with the PESTLE model.
State of Market
Competition may be more intense when:
Large number of competing firms
Firms are of similar size/market share
Market is growing slowly
Low product differentiation
Capacity added in large increments
Other factors can influence the market such as substitutes, bargaining power and Innovation
Bargaining power
Bargaining power of buyers can influence the market
Buyers have high bargaining power when:
there is low switching costs
products are undifferentiated (substitutes available )
they are able to produce the product themselves
But there is also bargaining power of suppliers. They have high supplier bargaining power when
there is:
suppliers are small number of firms
suppliers sell differentiated products
industry players have high switching cost (of switching suppliers)
industry players unable to integrate vertically backward (or supplier able to integrate forward)
firms are not important customers to suppliers
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Institutions and the business environment
What are institutions?
Public and private spheres:
Public: institutions of state, government structures and the individuals who play roles in
decision-making.
Civil society: private sphere in which people can pursue their own goals, including freedom
to join groups such as political parties and trade unions
Transaction costs – all costs necessary for buyers and sellers to buy and sell goods or
services
Transaction costs include:
Legal fees;
The costs of negotiations;
The cost of monitoring and enforcing a contract;
The cost of finding information (scoping/analysing the market);
The cost of labour to produce and deliver a good or service to the market
The cost of disposing of inventory or capital
Institutions add certainty to transactions:
Secure private property;
Provide clarity;
Enforce contracts
Why do we study institutions?
To apply economic theory to reality, we have to have a sense of economic and political
institutions
Institutions are laws, common practices, and organisations in a society that affect the economy,
firm performance and social interactions
The State
legal systems
Civil law tradition – based on comprehensive codes that set out the basic law
Common law tradition :
Originated in England.
Based on a body of judge-made law through decided cases.
Both types of legal system are now heavily supplemented by legislation, to cover new
situations and evolving business practices such as digital advances
Links:
International Trade and Globalisation
Exports – domestically produced goods and services leaving the country to be sold abroad.
Imports – foreign goods and services brought into the country to be sold domestically.
Net exports (NX) – the trade balance is equal to the value of exports minus the value of imports
(X-M)
Influences
Consumer preference
Price - domestic vs foreign
Incomes
Exchange rules
Government policies
Trade policies
Closed economies – do not interact with other economies in the world
Open economies – interact freely with other economies around the world.
Protectionism can be implemented through both direct and indirect trade barriers:
Tariffs (duties) on imports or exports – apply directly.
Import quotas
Voluntary export restraints (VERs).
Non-tariff barriers, such as local content requirements – an indirect barrier.
Subsidies to local producers out of public funds.
Export subsidies distort world markets.
Flow of capital
Net capital outflow
Also known as net foreign investment
Domestic residents purchase of foreign assets MINUS foreign purchase of domestic
assets
Capital inflow – foreigners taking capital into the country to buy assets in our country.
NCO < 0
Capital outflow – residents are taking capital out of the country to buy assets in another country
NCO > 0
Savings -Investment=NX (net exports)
Variables that influence NCO
Real interest paid on foreign/domestic assets
Perceived risk of holding foreign assets
Gov policies affecting ownership
Developing Countries
Countries with low costs and abundant labour have promoted economic growth based on
export-oriented manufacturing.
Participation in supply chains has been aided by attracting FDI, notably in electronics and
textiles:
China has been the most successful example of this development model.
As China’s economic growth has slowed, other emerging countries, such as India, have
increased manufacturing for export.
The United States is the leading merchandise importer, but has a huge trade deficit.
International trade theories
Adam Smith - absolute advantage
A country can produce a good or service in greater quantity for the same cost
Or the same quantity at a lower cost more efficiently than its competitors.
David Ricardo – theory of comparative advantage.
A country’s ability to partially specialise in products at a lower opportunity cost than their trading
partners
Paul Krugman – new trade theory
Focused on globalised production, especially for complex products.
Economies trade and specialise to take advantage of increasing returns and lower costs
(economies of scale).
First-mover advantages.
International Trade Regulation
GATT (General Agreement on Tariffs and Trade) legal agreement between countries;
Overall purpose was to promote international trade by reducing or eliminating trade
barriers such as tariffs or quotas.
Principles which form the basis of the world trading system, carried through to the World
Trade Organisation (WTO).
Most-favoured nation principle (MFN) – equal tariff treatment among member states.
National treatment – imported goods treated the same as domestic.
Principles of fairness in trading practices.
Anti-dumping agreement – allows an importing country to impose duties on goods from a
country which is exporting them at prices below those charged domestically.
World Trade Organisation (WTO)
The WTO (successor to the GATT) came into existence in 1995.
The WTO has prioritised trade liberalisation, but other concerns such as social goals, loom
large in national interests.
Regional
Free trade area – agreement to remove trade barriers among member states.
Customs union – free trade area plus a common set of trade rules for external trade of member
states.
(e.g. Mercosur – established by Treaty of Asunción in 1991 and Protocol of Ouro Preto in 1994
– Argentina, Brazil, Paraguay, and Uruguay).
Common market – free movement of goods, labour and capital among member states.
(e.g. NAFTA, North American Free Trade Agreement signed by Canada, Mexico and the US
created a trilateral trade bloc in North America came into force 1 January 1994 and superseded
the 1988 Canada – US Free Trade Agreement).
Economic union – higher level of integration, with unity of member states’ monetary policy.
(e.g. European Union)
Political union – transfer of sovereignty to supranational institutions.
The European Union
European Free Trade Area
European Economic Area
USMCA Agreement
Free trade zone between US, Canada and Mexico
Association of South East Asian Nations (ASEAN)
a free trade area.
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Links:
Internationalisation and competitive advantage
Location Theories
Least cost theory - Alfred Weber:
Transportation charges are the barest minimum, in terms of both availability of resources
and place of consumption;
Labour costs are at its lowest;
There are clusters of similar enterprises.
Classical Theory
Firms have complete information about decision parameters
Firms act rationally on a cost benefit analysis
Weber, 1929; Predӧhl, 1928
Neo-classical Theory
Firms have complete information about decision parameters
Firms act based on an analysis of the market competition, revenue, economies of scale
and production factors
Firms focus on Profit Maximisation
Hotelling, 1929; Hoover 1948, Smith 1966
Behavioural Paradigm
Firms location decision is part of a strategic investment decision
Firms acts based on multiple factors such as cost of production, risk minimisation and
growth
Firms focus on profit sufficiency rather than profit maximisation.
Pred, 1967; van Noort and Reijmer, 1999
New Economic Geography
Views the firm as a system of networks. Each network link incurs a transaction costs
Firms relocate to reduce these transaction costs and gain economies from clusters,
specialised labour markets and diffusion of knowledge
Marshal 1920, Krugman 1991, Coase
Modes of entry into foreign markets
Non-Equity Modes
Exports
Advantages:
Low initial investment
Reach customers quickly
Benefit of learning for future expansion
Disadvantages:
Potential costs of trade barriers – Tariffs and quotas
Licensing
Permits a company to use the property of the licensor, e.g. trademarks, patents and production
techniques.
Licensor benefits from licensee’s distribution network and access to the local market.
Advantages:
Avoid trade barriers
get access to local knowledge
Easier to respond to customer needs
Disadvantages:
Lack of control over operations
Difficulty in transferring tacit knowledge
creating a competitor
Franchising
Franchisor grants the franchisee the right to develop, establish and duplicate the operations of
the franchisor’s business.
An extensive legal relationship that includes a license
Advantages:
Avoids the costs and risks of opening up a foreign market
Firms can quickly build a global presence
Disadvantages:
The geographic distance of the firm from franchisees can make it difficult to detect poor
quality
Equity Modes
Joint Venture
Has 5 common objectives
Market entry;
Risk/reward sharing;
Technology sharing and joint product development
Conforming to government regulations
Advantages:
Access to local partners’ knowledge
Sharing development costs and risks
Politically acceptable
Disadvantages:
Divergent goals and interest of partners
Difficult to coordinate globally
Wholly owned subsidiary (Direct Investment)
Direct ownership of facilities in target country.
Advantages:
Protection of technology and know-how
Complete equity and operational control
Ability to coordinate globally
In the case of acquisitions, entry speed is fast.
Disadvantages:
High costs and risks.
Potential political problems and risks
In the case of greenfield (building from scratch), entry speed is low.
Indirect Investment
Purchasing stakes or units in foreign companies that trade on a foreign stock exchange.
Also referred to as foreign portfolio investment (FPI).
Includes trading in stocks and bonds
Advantages:
Time, effort and expertise to select the best funds are provided by the managed solution
fund manager.
Easier to track investment through a single portfolio.
Regulated.
Disadvantages:
Underlying instruments of the selected fund sometimes cannot be easily seen and
monitored or even understood.
Risk that the manager may get it wrong.
Foreign Direct Investment (FDI)
Greenfield Investment
Direct investment in new machinery expansion of existing facilities
Objective to create new production capacity, jobs, transfer technology and knowledge
Profits from firm may not feed back into the local economy of the host country
Advantages:
Normally feasible
Avoids risk of overpayment
Avoids problem of integration
Retains full control
Disadvantages:
Slower to start up
Requires knowledge of foreign management
High risk
High commitment
When?
Lack of proper acquisition target
In-house local expertise
Embedded competitive advantage
Brownfield (Mergers & Acquisition)
Purchase existing company in a host country
Assets and operation of host country are combined with original country to create a new
legal entity
Advantages:
Access to target’s local knowledge
Control over foreign operations
Control over own technology
Both parties have some performance incentives
Disadvantages:
Uncertainty about target’s value
Potential loss of proprietary knowledge
Potential conflicts between partners
Neither partner has control
When?
Developed market for corporate control
Acquirer has high “absorptive” capacity
High synergy
Determinants of FDI
Firm Factors
Uniqueness of product
Strategic goals
Host Country factors
Formal rules
informal norms/culture
economic orientation
Home country, market centred view
market failures
domestic vs foreign demand
supply industry
competitive rivalry
Criteria for evaluating new markets
Physical factors
Accessibility and Infrastructure:
How easy or not is it to access raw materials or export finished products?
What is the level of local and international communication links?
Are there adequate and reliable transport routes, e.g. motorways, railways, airports, ports?
Land:
What is the topography of the land?
Is it going to cost more to transport, goods, services and people to and from the location?
Is there a limitation on foreign ownership of property?
Power:
Sources of energy could restrict where industries could locate.
How close is it the national grid? How reliable is the power source?
Socio-economic (human factors)
Government policy:
Are there any tax incentives?
Government regulation of the industry.
Political system and political risks
Legal policy:
Legal forms
Potential for profit repatriation
Labour supply:
Particularly for labour-intensive industries.
The skills of the labour force.
Health of the labour force.
Access to labour within close proximity or access to transport to get labour in.
Markets:
Sophisticated consumers?
Established retail industry?
Market Size
Customer segments
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Assessment technique
Applied to assess the competitive advantage of nations
The model breaks the analysis down to different dimensions or determinants – (market
determinants and external determinants)
Examines what that country’s strengths are on each dimension or determinant – to assess how
competitive the country is globally (in a sector)
It focuses on the industry-view and the resource-based view
Links:
Labour Markets
Labour is a factor of production or input.
Firms use labour L, capital K and available technology A to produce output Y.
What is the labour market?
Includes:
Supply of labour by households - Circular flow of income
Demand for labour by firms
It is where there is an exchange between the supply of demand for labour - it is a factor
market.
Wages represent the price of labour.
Income to households
costs to firms
can be influences by trade unions and gov intervention.
Labour demand
Demand for labour reflects the demand for the output good - derived demand.
In a perfectly competitive labour market, an individual firm is a wage-taker; it takes the market
wage rate as given.
Demand for labour is derived from the demand for the final goods and services produced in the
economy:
Demand for labour is not direct demand.
For example, if there is an increase in demand for new housing, it will lead to an increase in the
demand for labour in the construction sector, including engineers, architects, builders,
electricians, etc.
Labour Supply
The supply is the number of individuals willing to work, multiplied by the hours they are wiling
and able to work.
Households supply labour, trade labour services for payment.
Higher wages usually encourages workers to supply more labour
Workers are not homogenous
They differ in physical skills and training
Each individual can make 2 choices:
enter the labour market
leisure
Efficiency wages:
The theory of efficiency wages – firms voluntarily pay above-equilibrium wages to boost
workers’ productivity.
Immigration
It effects the supply of labour based on:
Skills of migrants
Skill of existing workers
Characteristics of the host economy
Creates more competition for existing jobs.
In the short-term immigration’s effect on wages or employment of existing workers depends on:
Whether migrant workers have skills that substitute or complement those of existing workers
(Borjas, 1995).
Labour market equilibrium
In equilibrium, everyone who is looking for work at the going wage can find a job.
Workers prefer to work when the wage is high; But Firms prefer to hire when the wage is low.
The equilibrium 'balances' this out.
Determinants
Demand
Price - a rise in wages greater then a rise in productivity will raise labour cost and reduce
demand for labour.
Productivity - more output per worker increases demand for labour increases
Price of substitutes - if capital is cheaper, like machines, they could switch, Innovation
Supplementary costs - increasing national insurance contributions will lead to a fall in
demand for labour.
Supply
Wage rate
Change in preferences - non monetary advantages, changes in 'cost of working' child care
etc.
Trade unions - member benefits. influence working hours and wages through collective
bargaining
Migration - population changes
Barriers to entry - qualifications
Tax benefit incentives and disincentives
Labour subsidies
§Different versions of the efficiency wage theory suggests different reasons why firms pay high
wages.
The labour force
•Employed and unemployed together make up the labour force.
•In principle, individuals who are neither employed nor unemployed (outside the labour force)
are not part of the labour supply).
•Traditionally the labour force supports those outside the labour force.
•Labour force participation is a key for economic growth and development.
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Unemployment
The labour market is influenced heavily by Unemployment
Links:
The Global Economy
Measuring economies
Gross Domestic Product (GDP)
Real GDP is the value of final goods and services produced in a given year valued at constant
(base year) prices.
Nominal GDP is the value of final goods and services produced in a given year valued at the
same year’s prices
Aggregate GDP = aggregate demand for goods and services produced in a country
GDP per capita - the average income of people in a country, GDP/Population
Gross National Income
Gross National Income (GNI) (World Bank’s income-based country classification) – Total
domestic and foreign output earned by residents of a country, consisting of GDP plus factor
incomes earned by foreign residents, minus income earned in the domestic economy by nonresidents
GNI per capita – the average income earned per person
GNI per capita comparisons may be exaggerated by the use of official foreign-exchange rates
to convert national currency figures to U.S. dollars.
To correct for this we use purchasing power parity (PPP) instead of exchange rates as
conversion factors. PPP is calculated using a common set of international prices for all goods
and services.
Human Development Index
Ranks countries on a scale of 0 (lowest human development) to 1 (highest human
development) based on three goals of development:
A long and healthy life – measured by life expectancy at birth;
Knowledge – measured by a combination of average schooling attained by adults and expected
years of schooling for school-age children;
Decent standard of living – measured by real per capita GDP adjusted for differing purchasing
power parity.
Productivity
Total Factor Productivity (TFP) measures that portion of output that is not explained by the
amount of capital and labour used in production.
Factors of production + TFP = output of goods and services
It captures the effects of other determinants of efficiency and intensity of production e.g.:
•Government policy
•Political unrest
•Weather shocks
•Investment in research and development (technological progress)
Productivity Equation
Classifications of economies
Developing Country
less industrialised, often agricultural, low capita per income
Emerging Market
more engaged with global markets, transitioning to a modern economy, higher standard of living
Market economies
Consumer choices determine how industries and financial markets operate.
Laissez-faire capitalism – individual freedom to carry out enterprise activities with minimum
state interference.
Notion of the ‘invisible hand’ (Adam Smith) guiding the economy, but still a need for regulation,
e.g. to tame monopolies that become dominant and distort competition.
Social market model:
Social justice dimension, including social protections.
Extensive state ownership.
High human development rankings, but also high costs for business.
Mixed economies
Capitalist market elements combined with state controls.
China:
Two-system model: capitalist reforms in the economic system, but political system controlled by
the Communist Party.
India:
Considerable economic freedom and a democratic political system.
Socialist legacy of the strong role of the state.
Nationalist focus of economic development.
Asian capitalist systems
East and South East Asian market economies, e.g. Japan and South Korea.
Industrialisation in the 1970s and 1980s.
In Japan, state guided industrialisation.
Corporate groupings: Keiretsu in Japan; chaebol in South Korea.
Asian cultural heritage emphasises the company as a family.
South Korean and Japanese companies have become globalised and have excelled in sectors
such as vehicles and electronics.
Circular flow in the economy
Circular flow of income:
Aggregate Demand
Governments Goals
Full employment
•People who are willing and able to work can find employment.
•Economically inactive – people that do not want to or are unable to work (e.g. children, retired,
those in full-time education).
•Full employment is not actually 0% unemployed.
Price stability
•Ensures greater economic certainty
•Prevents the country’s products from losing international competitiveness
•Common target is a stable inflation rate of 2%.
Economic Growth
•Increased output in the short run.
•In the long run sustained productive potential
•Producing more goods and services can raise people’s living standards
Redistribution of Income
•By taxing and spending.
•Money raised is spent directly on the poor by means of benefits – e.g. housing benefit or
unemployment benefit
•Money raised is spent on education and health, particularly to benefit the poor.
Balance of Payments
stability
Value of exports to equal the value of imports.
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