Chapter 2
Trading and investing in
international business
Three ways of doing
international business:
1) International trade
Importing and exporting goods and services
2) Foreign direct investment (FDI)
Purchase of sufficient stock in a firm to obtain significant
management control
3) Foreign sourcing
The overseas procurement of raw materials, components,
and products
Domestic market or the global
market?
• Foreign sales averaged 56.6% of the total sales
of the largest 100 global companies (2008).
• Ratio of income from foreign sales to total
income averaged 51.5% for these large
multinationals.
• Without sales and profits generated from foreign
operations, the competitiveness of many of
these companies would be seriously damaged
and some of them might be unable to remain
business.
Leading exporters and importers
(2008)
Merchandise exporters
value share
Germany
1,112
9.2
US
1.038
8.6
China
969
8.0
Japan
650
5.4
France
490
4.1
Netherlands 462
3.8
UK
448
3.7
Italy
411
3.4
Merchandise importers
value share
US
1,919 15.5
Germany
909 7.3
China
792 6.4
UK
619 5.0
Japan
580 4.7
France
535 4.3
Italy
437 3.5
Netherlands 416 3.4
Leading exporters an importers
(2008)
Service exporters
US
UK
Germany
Japan
France
Spain
Italy
China
value share
389 14.1
228
8.3
169
6.1
123
4.4
115
4.2
106
3.8
98
3.5
91
3.3
Service importers
US
Germany
UK
Japan
France
China
Italy
Ireland
value share
308 11.6
219
8.3
172
6.5
144
5.4
109
4.1
100
3.8
98
3.7
78
3.0
Leading exporters and importers
• Generally, the largest exporters and importers
are the same countries. It means that once a
country participates in the global trade, its
imports and exports increase.
• Generally, services trade is one-third of the
merchandise trade.
• Trade regionalizes in time. That is, members of
the regional blocks trade more with eachother.
Major trading partners:
They are those countries where
the firm has affiliates.
Why focus on major trading
partners?
1) The business climate in the importing nation is relatively
favorable.
2) Export and import regulations are not insurmountable.
3) No strong cultural objections to buying that nation’s goods.
4) Satisfactory transportation facilities have already
established.
5) Import channel members (merchants, banks, custom
brokers, etc) are experienced in handling import
shipments from the exporter’s area.
6) Foreign exchange to pay for the exports is available.
7) The government of a trading partner may be applying
pressure on importers to buy from countries that are
good customers for that nation’s exports.
Foreign Direct Investment (FDI)
• The outstanding stock of FDI – is the book value or the
value of total outstanding stock.
The total FDI worldwide is $12.5 trillion (2006). The major
investor countries are US ($2.4 billion), UK, and France.
The proportion of FDI accounted for by the US declined
more than 47% between 1980-2006, from 36% to 19%.
The proportion of FDI accounted for by the EU increased
from 36% to 52%.
The FDI by M-BRIC countries are increasing.
Overseas Chinese investors have more than $1 trillion
assets abroad (in Malaysia, Thailand, Indonesia,
Vietnam, Philippines, and Hong Kong). They are the
major source of investment capital flowing into China.
Annual outflows of FDI
It is the amount invested each year into
other nations.
World
Developed countries
Developing countries
USA
EU
UK
Germany
1985-1995
203
182
22
43
96
26
18
1996 2000 2006(billion$)
391 1.201 1.216
332 1.098 1.023
58
99 174
84
143 217
182
819 572
34
250
79
51
57
79
Annual inflows of FDI
It shows the yearly amount of FDI coming
intı the country.
1985-1995
World
181
Developed count. 128
Developing count. 50
US
44
EU
66
UK
17
China(+Hong Kong)16
1996 2000 2006(billions$)
278 1.393 1.306
220 1,121 857
145
246 379
85
314 175
109
684 530
24
130 140
51
103 112
Does trade lead to FDI?
Historically, FDI has followed foreign trade.
• One reason is that trade is less costly and
less risky than making a FDI.
• Also, management can expand the
business in small increments rather than
through the large amounts that are
required by FDI.
Why enter foreign markets?
1) Increase profits and sales
• Enter new markets – managers are always under
pressure to increase profits and sales, and when they
face a mature, saturated market at home, they search for
new markets in other countries (especially when the
incomes and population in these markets are growing).
– New market creation: Find potential new markets.
– Preferential trading arrangement: An agreement by a small
group of nations to establish free trade among themselves while
maintaining trade restriction with other nations.
– Faster growing markets: Some new markets are growing faster
than the home market.
– Improved communications: Firms can communicate faster and
cheaper with the customers.
Why enter foreign markets?
• Obtain greater profits – It can be achieved through
increasing revenues and/or decreasing costs.
-Greater revenue: If the firm’s competitors have not
entered the market, the firm may ask higher prices for its
goods.
-Lower cost of goods sold: Lower taxes, lower interest
rates, lower wages, subsidized investments, allocation of
public land for the investments, export incentives, etc.
-Higher overseas profits as an investment motive: More
than 90% of global companies obtain greater profits
overseas.
Why enter foreign markets?
• Test market – A global market will testmarket in foreign location that is less
important to the company than its home
market and major overseas markets.
Management’s thinking is that any mistakes
made in the test-market should not
adversely affect the firm in any of its major
markets.
Why enter foreign markets?
2) Protect markets, profits, and sales
• Protect domestic market – A firm will go abroad
to protect its home market.
-Follow customers overseas: Service companies
(like accounting, advertising, marketing
research, banking, law) will establish foreign
operations in markets to prevent competitors
from gaining access to those accounts. They
know that once a competitor gains one of the
subsidiary’s management, it can get access to
all the accounts.
Why enter foreign markets?
• Attack in competitor’s home market –A
firm may set up an operation in the home
country of a major competitor with the idea
of keeping the competitor so occupied
defending that market that it will have less
energy to compete in the firm’s home
country.
Why enter foreign markets?
• Using foreign production to lower costs – A company may go abroad
to protect its domestic market when it faces domestic competition
from low-priced imports. It can enjoy low-cost labor, raw materials,
and energy.
- export processing zones: It is where, mostly foreign manufacturers,
enjoy absence of taxation, import regulations. It is a government
designated zone in which workers are permitted to import parts and
materials without paying import duties, as long as these imported
items are then exported once they have been processed and
assembled. In-bond plants (maquiladoras), for example, are
production facilities in Mexico that temporarily import raw materials,
components, or parts duty-free to be manufactured, processed, or
assembled with less expensive local labor, after which the finished
or semi-finished product is exported.
Why enter foreign markets?
• Protect foreign markets – Changing the method of going abroad
from exporting to overseas production may be necessary to protect
foreign markets.
- Lack of foreign exchange: There may be foreign exchange scarcity
in the local market. In this case, if the advantages outweight the
disadvantages, the firm may decide to produce locally to protect the
market.
- Local production by competitors: The firm may decide to produce
locally, if the demand for the product justifies that investment,
especially if the competitors are investing in that market.
- Downstream markets: A number of OPEC countries have invested
in refining and marketing outlets to guarantee a market for their
crude oil at more favorable prices.
- Protectionism: When the government sees that local industry is
threatened by imports, it may impose import barriers to protect the
local firms. The exporter then may be forced to invest in the market.
Why enter foreign markets?
• Guarantee supply of raw materials – Most of the
raw materials are in the developing countries.
Japan and Europe are totally depended on
imported raw materials. Even the US depends
on the imported aluminum, chromium,
manganese, nickel, tin, and zinc. Iron, lead,
tungsten, copper, potassium, and sulfur will soon
be added to the list. To ensure continuous
supply, firms have to invest in the developing
countries with resources.
Why enter foreign markets?
• Acquire technology and management
know-how – Many US firms invest in
foreign markets to acquire technological
and management know-how. Herbal
medicine is a production line learned from
the Chinese, for example.
Why enter foreign markets?
• Geographic diversification – Many
companies have chosen geographic
diversification as a means of maintaining
stable sales and earnings when the
domestic economy or their industry goes
into a slump. Often, in other parts of the
world economic growth makes a peak.
Why enter foreign markets?
• Satisfy management’s desire for
expansion – Stockholders and financial
analysts expect the firm to grow, so
managers feel obliged to grow, even at
times when growing makes little economic
sense. When it becomes difficult to grow in
the domestic market, the firm invests in
other countries.
HOW TO ENTER FOREIGN
MARKETS?
1) Exporting
2) Turnkey projects
3) Foreign manufacturing
Exporting – selling some of
the firm’s products in
overseas markets
Indirect expoting –
exporting via home
based exporters
1) Manufacturers’ export agents: they sell for
the manufacturer
2) Export commission agents: they buy for
their overseas customers
3) Export merchants: they purchase and sell
on their own account
4) International firms: they buy and sell goods
overseas, like mining, petroleum companies.
Direct exporting – exports
undertaken by the firm
producing goods and
services.
If business expands in export markets, firm
follows these steps:
Salesman (in the firm)
↓
Export department (in the firm)
↓
Sales company (maybe with channels
of distribution)
Turnkey projects can be
export of technology,
management expertise,
and in some cases
capital equipment.
In turnkey projects,
the contractor builds the plant,
supply the technology, provides
suppliers of raw materials and
other production inputs, train
operating personnel, run the
factory for some time and return
the factory to the owner.
FOREIGN MANUFACTURING
1) Wholly owned subsisidary
2) Joint venture
3) Licensing
4) Franchising
5) Contract manufacturing
1) Wholly owned subsidiary
a. Start by building a new plant
b. Acquire a going concern –
mostly firms buy an already
existing firm. This way it will have
one less competitor and an
established firm with customers,
suppliers, permissions taken.
c.Purchase a distribution firm
2) Joint venture
a. It can be between a company owned by an
international firm and local owners,
b.Two international companies come together
for the purpose of doing business in a third
market,
c.A joint venture between an international
company and a government firm
d.A cooperation between two or more firms
for the duration of a project, like a damn,
airport, etc.
Advantages of joint ventures:
By-pass nationalistic feelings
Acquire expertise, tax, and other
benefits
Reduce investment risks
Disadvantages of joint ventures:
Firms have to share profits
Lack of control
3) Licensing is a contractual
arrangement in which one firm
grants access to its patents, trade
secrets, or technology for a fee.
4) Franchising is a form of licensing in
which one firm contracts with
another to operate a certain type
of business under an established
name according to specific rules.
5) Contract manufacturing is an
arrangement in which one firm
contracts with another to produce
products to its specifications but
assumes responsibility for
marketing.
Strategic alliances can be established
with customers, suppliers,
competitors.
The purposes of strategic alliances
are;
to achieve faster market entry and start-up,
to gain access to new products,
to share costs, resources, and risks.