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Unit-02-International Business Environment

Structure:
2.1 Introduction
Objectives
2.2 Economic Environment
National economic policies
Economic structure
Balance of payments
2.3 Political Environment
Nature of politics
Political stability
2.4 Legal Environment
Legal systems
Dispute resolution systems
2.5 Theories of International Business
Mercantilism
Absolute advantage
Comparative advantage
Product lifecycle theory
Porters diamond model
2.6 Summary
2.7 Glossary
2.8 Terminal Questions
2.9 Answers
2.10 Case-Let
2.1 Introduction
In the previous unit, you have studied about the evolution, advantages, globalisation and the
future of international business (IB). This unit covers economic, political, and legal environments
in which an IB operates and gives an insight into different theories that companies adopt while
going international.
Conducting business within your own country is different than in a global environment, where
you will be dealing with international features, prospects and challenges. It is important that
managers take an active interest in these economic, political and legal environments of a country
in order to:
analyse market conditions of different countries.
assess risk.
identify growth sectors.
make investment decisions.
In order to succeed, a company needs to gather data on national economies interpret and make
cross border comparisons using standard criteria. Knowledge of the IB environment allows
management to allocate resources so that they reap the benefits and operate with high
efficiencies in any country. For instance, garment companies use manufacturing facilities in
China and save on costs, which will be higher in the nation of origin.
Objectives:
After studying this unit you should be able to:
analyse economic environment of a country for doing business.
interpret political and legal environment.
evaluate different theories of international business.
2.2 Economic Environment
The economic environment refers to the conditions under which a business operates and takes
into account all factors that have affected it. It includes prime interest rates, legislation
concerning employment of foreigners, return of profits, safety of country, political stability and
so on.
2.2.1 National economic policies
National economic policies depend on that countrys socio-economic and cultural background.
All governments aspire to achieve four major economic objectives:
Full employment.
A high economic growth rate.
A low rate of inflation.
Absence of deficit in the countrys balance of payments.
The basic problem is that the first two objectives work against the last two. Measures such as low
interest rates, tax cuts and increase in public spending creates jobs and stimulates growth but also
causes inflation, increase in wage, and higher imports. Due to increased consumer expenditure
the countrys balance of trade worsens.
So the issue lies in balancing the effects of the policies to achieve the four given objectives.
Foreign Direct Investment (FDI) Policy
Foreign direct investment (FDI) is an investment made with an intention of establishing a long
term interest by a business enterprise in another country. It is also required that such an
enterprise holds directly or indirectly, an ownership of 10% or more of voting rights in the target
enterprise.
FDI policy, which is dictated by the Government of the host country, plays a vital role in the
economic growth of that country. Attracting FDI inflows with constructive policy is a challenge
for any nation. Developing countries offer a lot of incentives for FDI, particularly in capital
intensive sectors like power, infrastructure, transport, construction. Effective FDI policies help
the host country to portray itself as an attractive investment destination.
Main objectives of FDI policy are to provide and facilitate investor friendly business
environment, so that the foreign investors feel safe with the financial and legal framework of the
country. The Government of the host countries often formulate new or special regulatory
framework to attract FDI. The host country often needs to invest in development of domestic
infrastructure to make it investor friendly.
2.2.2 Economic structure
IB managers need to understand and assess international economic forces at work. Key variables
that need to be examined include Gross Domestic Product (GDP) per capita, regional distribution
of GDP, levels of investment, consumer expenditure, labour costs, inflation and unemployment.
Variables that are examined when assessing national economic environments include:
Economic structure The structure of a nations economy is determined by the size and rate of its
population growth, income levels and distribution of income, natural resources, agricultural,
manufacturing and services sector. Economic infrastructure is the sum of all the external
facilities and services that support the work of firms including communication, transportation,
electricity supply, banking and financial services.
Industry structure The structure of an industry is determined by factors such as:
Entry and exit barriers.
Number of competing firms.
Market share among firms in that sector.
Average size of competing units.
Market growth It is measured in terms of local currency and adjusted for inflation. Local
currency is used because conversions into other currencies are affected by exchange rate
fluctuations.
Income levels It is taken as the Gross Domestic Product (GDP) per capita and GDP is directly
proportional to the productivity of the country. Net income is another important variable and is
without tax payments from individual gross incomes.
Sector wise trends Growth activity in a country might vary significantly among certain
industries. For example, India has a vibrant software services industry.
Openness of the economy The ratio of a countrys imports and exports to its Gross National
Product (GNP) indicates its vulnerability to fluctuations in international trade. A nation with a
high foreign trade or GNP depends heavily on the economic well-being of the nations it exports
to. Conversely, closed economies have a high degree of control of the economy.
International debt - The comparison of a nations obligations to service and repay foreign debt
with its forex earnings shows its ability to remain solvent. On the other hand, a high foreign debt
servicing requirement maybe a positive indicator, suggesting that a country has borrowed heavily
to invest in its future.
Degree of urbanisation - This is an important factor because in most countries there are important
differences in incomes and lifestyles between urban and rural areas. Major dissimilarities are:
Shopping patterns - shopping frequency, average purchase value.
Nature of goods bought.
Expectations in quality and technical sophistication.
Education levels.
Ease of distribution.
2.2.3 Balance of payments
Importance - Balance of payments is a record of all transactions that occur between residents of
that country and foreigners over a specific period of time. The balance is shown monthly,
quarterly or annually. The accounts show the structure of the external trade, net position as a
lender or borrower and trends in economic relationships with the world.
The balance of payments is a good overall indicator of its economic health; the likelihood of the
countrys government imposing forex controls, import restrictions and policies such as tax
increases and interest rate hikes.
Balance of payment account - These accounts attempt to identify the reasons behind various
categories of international receipts and payments, making it possible to establish the values of
payments by domestic residents to foreigners, and vice versa, for purchase of imports, use of
services, lending, or direct foreign investment.
The account is divided into categories for long and short term financial transactions which is
initiated by the national monetary body, and involves goods and services.
Deficits and surpluses - Current account deficit, records physical imports and exports along with
international transactions in invisibles, that is non-physical items such as residents pensions,
interest and royalties from abroad, domestic firms fees for the movement of goods in other
countries, and so on. The balance of trade within the current account is the balance on physical
(visible) imports and exports.
The other major grouping is the capital account which shows the balance of transactions in
financial assets, including direct investments in foreign financial instruments, movements in
short-term assets, inter-governmental loans and changes in the countrys gold and forex reserves.
Reserves will decline if there is, for example, a current account deficit which in turn affects the
currency rate. To prevent the local currency from depreciating too far, some foreign currency
reserves will be sold, but since it is limited, this is only a temporary measure.
Self Assessment Questions
1. The two objectives of National economic policies ______ and ______.
2. FDI policy is dictated by the government of the host country. (True/False)
3. Balance of payment is an indicator of a countrys _______.
2.3 Political Environment
In the previous section, the economic environment of international business was discussed. Now,
let us focus on the political environment.
Political factors influence the economic and legal environment in which the business operates to
a larger extent, especially in contract law and rules on advertising and consumer protection. It
also affects the business practices, restrictions on market entry, tariffs charged and ability to
repatriate profits. Other factors include:
Regulatory frameworks.
Governmental control over multinational activity.
Importance of pressure groups.
Trade embargoes.
Likelihood of having insurance against losses due to political risk.
Strikes and labour unrest due to political turbulence.
Political and economic environments are often inter-related. The political environment affects the
economic environment. For example, a government which is perceived as anti-business by the
business community may lead to capital outflows resulting in the fall of the currency, lower
savings and investment and hence higher interest rates and lower economic growth.
2.3.1 Nature of politics
The nature of a government is based on the type of the government, and the policy that the
country follows.
The politics of a country are concerned with:
The direction and administration of states.
The control of aggregate social relationships.
Government is involved in the formulation and implementation of laws for a nation. The
government also has control over its territory and is the only legal representative. It can enter
into or cancel any agreements with other countries. Entire land surface on earth is controlled by
nations, except the Antarctic and Arctic regions. Thus international businesses have to deal with
nation states and are subjected to their authority.
Sovereignty - Sovereignty refers to the absolute power of the state. The two problems that
immediately arise in concern with sovereignty are:
The ability to make independent decisions since countries rely on each other for goods, markets,
economic assistance and defence.
The question of where national sovereignty lies is not clear as it may exist in the head of state,
the parliament, the prime minister, the cabinet or in the people.
National interest - National interest, as defined by the government, will depend on the cultures,
background, perceptions and experiences of the decision makers involved, which might change
over time and according to circumstances. A nations ability to define its interests depends on its
power, control over raw materials; scientific and technological knowledge; size, structure health
and education of its population; political stability and society.
2.3.2 Political stability
Political instability may arise from revolution and insurgency, involvement in foreign wars,
changes in government, bad international relations, falling national income, high inflation and
rising foreign debt, resulting in the physical destruction of a firms assets, higher taxes, import
controls and barriers on money leaving the country.
Political risk - It may emerge from social unrest due to unevenly distributed income, competing
political ideologies or ethnic groups within a nation, rise or fall of individual leaders or from
international relations. In the modern world, a countrys economic prospects depends heavily on
foreign investment and goodwill of the business community.
There are two types of political risks,namely Macro and Micro risks as explained below:
Macro risk affects all foreign firms operating in the country to an equal extent and may include
the imposition of exchange controls, special taxes, local-content rules and so on.
Micro risk applies to a particular company industry or project. For example, import restrictions
on specific products, compulsory breaking up of a firm into smaller parts, cancellation of
contracts and so on.
Self Assessment Questions
4. Political factors defines economic and legal environment in a business environment.
(True/False)
5. _______ refers to the absolute power of the state to coerce and control its citizens.
a) Sovereignty
b) National interest
c) Political stability
d) Political risk
6. The two types of political risks are _______ and _______.
2.4 Legal Environment
International businesses confront different sets of laws in various countries of operation. IB must
not only abide by the domestic laws of each nation but also by the supranational laws which
impose obligations beyond those of national legal systems. For example, the European Union.
Major disparities in national law affecting business are:
Intellectual property protection.
Consumer protection and product liability.
Competition among businesses.
Payment of bribes and other practices.
Formation and termination of contracts.
Marketing practices.
Carriage of goods.
Domestic, International and supranational law
A countrys domestic law deals with aspects of IB, and foreign citizens and firms are normally
regarded as the citizens of the country in question. Special laws are passed to guarantee the
safety of foreign investment, but in general the ordinary law of a country is applied when
conflicts arise.
International law applies to sovereign states and imposes rights and duties on nations in their
dealings with each other. It is derived from international conventions which establish rules
agreed by contesting states; from international custom accepted as law within all nations and
from internationally recognised legal principles.
An IB that is involved in a legal dispute, has to seek redressal from the national courts of the
country in which the action is heard and can not obtain relief from any international legal system.
The treaty of Rome changed everything by creating a new type of law that provided individual
persons and businesses with the right to bring cases on their own accounts to a supranational
legal body. Individuals and businesses assumed obligations extending beyond those imposed by
the national legal systems of the countries in which they functioned. That means, for example,
EU companies are subject to laws on competition established at the pan-European level, while
employees can appeal to the European Court of Justice on equal opportunities matters. Other
regional treaties of economic and political co-operation followed the European Economic
Community (EEC) in creating supranational judicial frameworks.
2.4.1 Legal systems
The legal systems of some countries are much better developed than others, particularly the
mechanisms for the administration of justice and the enforcement of court rulings. Most nations
base their legal systems on one of the following:
Common law - Common law applies throughout the english-speaking world including most
countries of the Commonwealth. These systems rely on precedent, judgements in specific cases
and on ad hoc legislation to create and interpret statutes.
Code law - Countries with Code law systems have all their laws written down in Criminal, Civil
and Commercial Codes which are used to determine all legal matters. Most continental European
countries and their former colonies have Code law systems.
Although they are quite different in principle, common law and Code law systems have
similarities in practice. A large part of the law in the common law countries derive from statutes
and legally binding regulations, while Code law relies heavily on judicial interpretations of the
meanings of the words embodied in legislative codes.
Islamic law - This is derived directly from the Koran and typically is mixed with the pre-existing
common law or civil code provisions of the country concerned. Important practical rules apply to
the conduct of business in Islamic countries, including the following:
Interest payments on financial dealings are forbidden since it is seen as improper to reward those
with excess funds while penalising those who need to borrow.
The principle of profit sharing. Islamic banks do not pay interest on deposit but give investors
profit shares that are the result of the deployment of the funds deposited.
2.4.2 Dispute resolution systems
Disputes that may occur in the course of international transactions must be resolved through
negotiation, arbitration or litigation. The issue arises when there is conflict of laws since each
nation has its set of laws, interpretations and different legal methods are applied to commercial
litigation, and conflicts between the legal systems of specific countries. Important differences
among the business laws of various countries include:
Laws concerning the circumstances, in which an offer may be withdrawn without penalty, vary
between countries.
Distinguishing between commercial and non-commercial contracts in some countries. In
commercial contracts, lower burden of proof is necessary to establish the existence of the
commercial contracts. These disputes are heard in special courts.
The intervals beyond which cases become statute barred differ. In Britain, the period for most
classes is six years whereas in France it can be up to 30 years and in Germany it depends on
whether the case concerns a commercial contract and if so, whether both parties are traders or
not.
Before suing for breach of contract in certain countries, considerations are not necessary to be
proved. Examples of such considerations are the price paid for goods, employee wages, the hire
fee paid for equipment lease and so on. Under English law, a contract cannot exist without
considerations.
National differences occurring due to the legality of exemption clauses and penalty clauses.
The necessity to protest unpaid debts prior to suing for payment. In certain countries. This means
getting a notary to ask the customer for payment or reasons for failure to do so. The latter are put
into a formal deed of protest which is then used as evidence of refusal to pay.
Nationalisation of assets - Domestic laws guarantee that foreign businesses will not be taken over
but there are no international laws in this matter. Article 2 of the United Nations Charter of
Economic Rights and Duties of States adopted by the UN General Assembly in 1974, asserts that
every state has and shall freely exercise full permanent sovereignty including possession, use and
disposal over all its wealth, natural resources and economic activity. The UN supports the
absolute right of its members to nationalise or exercise partial control over businesses operating
within its borders.
Where cases are heard - It is safe to assume that each party likes a dispute to be settled in its own
country but this is not possible when businesses from different countries are involved. Contracts
often contain jurisdictional clauses which specify that the law of a certain country will apply as
agreed by all parties to the contract. This ensures that both sides are aware of their legal rights
and obligations.
If a contract has no jurisdictional clause, then it is heard in the defendants nation, since one
cannot be compelled to attend the court abroad. Either the contract of sale will name a country or
the country with the closest connection with the contract must be chosen.
Concept of residence - Even though an MNC operates in a global environment it cannot become
an international legal entity and while its subsidiaries have to be set up through the laws of
different nations, its headquarters must be incorporated under the laws of a particular state.
Questions may arise with regard to the definition of the nationality of an MNC and this needs to
be answered adequately since the laws of the home country will govern many of its core
activities such as responsibilities and liabilities of shareholders, taxation, availability of
government grants and subsidies, and degree of employment protection for personnel. Countries
apply various legal tests when determining a companys nationality.
For example:
Place of incorporation.
Country intended to be the home nation by people forming the company.
Where decisions concerning the worldwide business are taken.
Arbitration - This refers to the process of settlement of disputes by having independent referees,
who are agreeable to both sides, adjudicate the matter.
Arbitration vs litigation
Litigation has the advantage that the rights and duties of the parties are determined by known and
definite laws and that aggrieved parties can obtain redress that is legally enforceable. There are
however a number of issues related to litigation including:
Long delays.
High costs.
Possible bad publicity from the case.
Fear of discrimination by the courts against foreigners.
Businesses may have to be suspended while the case is being heard.
Lack of business experience of the judges.
Matching words across the languages and accurately translating legal concepts are difficult tasks.
The meaning of words change during translation and the intentions of the parties may become
unclear. Hence, an important practical problem is of proper translation of documents into a
foreign language for consideration by the court.
Arbitration is faster and cheaper than litigation and cases are heard in secret so that neither party
loses public goodwill through adverse publicity. The arbitrators are themselves business people,
advised by legal experts, with practical experience of the commercial world. No problems arise
from the conflict of international laws since common sense approaches are applied to issues.
Cases are heard on neutral ground and not in the national courts of one of the parties. However,
arbitration lacks legal precision and still costs time and money.
Arbitration bodies - The main arbitration bodies are the International Chamber of Commerce, the
American Arbitration Association, the London Court of Arbitration and the International Centre
for the Settlement of Investment Disputes (ICSID). The ICSID, based in Paris is the most
preferred, and offers arbitration facilities to members and non-member companies alike.
The International Court of Justice (ICJ), based at The Hague, is a UN body that adjudcates
between states and only states that have agreed to accept the courts jurisdiction can participate in
cases.
Self Assessment Questions
7. Three of the most used legal systems are _____, _____ and ______
8. Settlement of disputes by having independent referees is called ______.
a) Litigation
b) Arbitration
c) Arbitration bodies
d) International Court of Justice
9. Two of the international arbitration bodies are ________ and _______.
Activity 1
Interpret the business environment of Sri Lanka by analysing the economic, political and legal
environments of that country.
Hint: Refer section 2.4

2.5 Theories of International Business


Introduction
The importance of cross border commerce and the globalisation of production are well
recognized and since MNCs conduct business in many new forms other than traditional
importing and exporting, international trade theory has become too limited for explaining the
current challenges to IB.
The international trade theory focuses on the following:
Type of products exported and imported.
Cost and terms of trade.
Relationship between the trade flows and characteristics of a country and their effects on
domestic factor prices.
The gain obtained from a trade and the distribution of the gain among the trading countries.
Basis for trade
Though the price difference remains the basic cause of trade, this explanation is not adequate.
The two-way flow of goods must be traced to systematic international differences in the cost and
pricing structure. Goods that are cheaper to produce at home will be exported and goods that are
cheaper to produce abroad will be imported.
The following trade theories explain the basics behind international trade:
2.5.1 Mercantilism
This was the economic theory that prevailed in the 17th and 18th centuries. This theory was
highly nationalistic, viewed national well-being to be of prime importance and favoured the
regulation and planning of economic activity as a means of national advancement.
According to this theory, the most important way for a nation to grow rich was by the acquisition
of precious metals, especially gold. Exports were viewed as favourable as long as they brought in
gold, but imports were viewed unfavourably as depriving the country of its true source of wealth
and hence trade had to be regulated.
2.5.2 Absolute advantage
Adam Smith (a social philosopher and a pioneer of politicl economics) argued that nations differ
in their ability to manufacture goods efficiently and he saw that a country gains by trading. If the
two countries exchanged two goods at a ratio of 1:1, country I gets one unit of goods B by
sacrificing only 10 units of labour, whereas it has to give up 20 units of labour if it produced the
goods itself. In the same manner, country II gives up only 10 units of labour to get one unit of
goods A, whereas it has to give up 20 units of labour if it was made by itself. Hence, it was
understood that both countries had large amount of both goods by trading.
2.5.3 Comparative advantage
Ricardo (english political economist) questioned Smiths theory stating that if one country is
more productive than the other in all lines of production and if country I can produce all goods
with less labour costs, will there be a need for the countries to trade. The reply was affirmative.
He used England and Portugal as examples in his demonstration, the two goods they produced
being wine and cloth. This case is explained using table 2.1 and 2.2.

According to him, Portugal has an advantage in both areas of manufacture. To demonstrate that
trade between both countries will lead to gains, the concept of opportunity cost (OC) is
introduced. The OC for good X is the amount of other goods that have to be given up in order to
produce one additional unit of X.

A country has a comparative advantage in producing goods if the OC is lower at home than in
the other country. The table shows that Portugal has the lower OC of the 2 countries in wine-
making while England has the lower OC in making cloth. Thus Portugal has the comparative
advantage in the production of wine whereas England has one one in the production of cloth.
2.5.4 Product lifecycle theory
This theory was proposed by Raymond Vernon in the mid-1960s and was based on the observation that
from most of the 20th century, a very large proportion of the worlds new products were developed by
American firms and sold there first. He argued that the wealth and size of the market gave American firms
a strong incentive to develop new consumer products and in addition, the high cost of labor was an
incentive to develop cost-saving innovations.
He did not agree with earlier theories and he placed emphasis on information, risk, and economies of
scale, rather than on cost. He focused on the lifecycle of the product and came up with his theory which
identified three distinct stages:
New product stage - The need for a new product, in the domestic market, is identified and it is developed,
manufactured and marketed in limited numbers. It is not exported, not in sizeable quantities, at any rate,
since it is primarily for the national market.
Maturing product stage - Once the product has become popular in the domestic market, foreign demand
increases and manufacturing facilites abroad may be set up to meet demand there. After success in the
foreign markets and towards the end of the product maturity stage, the manufacturers try and produce it in
the developing countries.
Standardised product stage - In the last stage of the life-cycle theory, the product becomes a commodity,
the price becomes optimised and the makers look for countries where it can be made with the least
production costs. One of the results of this is the product being imported into the firms home country.
Dell manufactures hardware in Asia, which is then transported to the US, its country of origin.

2.5.5 Porters diamond model


In 1990, Michael Porter analysed the reason behind some nations success and others failurein international
competition. His thesis outlined four broad attributes that shape the environment in which local firms compete and
these attributes promote the creation of competitive advantage. They are explained as follows:
Factor endowments - Characteristics of production were analysed in detail. Heirarchies are recognised, as is
distinguishing between basic factors like natural resources, climate, location and so on and advanced factors like
communications infrastructure, research facilities.
Demand conditions - The role of home demand in improving competitive advantage is emphasised since firms are
most sensitive about the needs of their closest customers. Example, the Japanese camera industry which caters to a
sophisticated and knowledgeable local market.
Relating and supporting industries - The presence of suppliers or related industries is advantageous since the
benefits of investment in advanced factors of production spill over to these supporting industries. Successful
industries within a country tend to be grouped into clusters of related industries.Example, Silicon Valley.
Firm strategy, structure and rivalry
Domestic rivalry creates pressure to innovate, improve quality, reduce costs which in turn helps create world-class
competitors.
He said that these four attributes constituted the diamond and he argued that firms are most likely to succeed in
industries where the diamond is most favourable. He also stated that the diamond is a mutually reinforcing system
and the effect of one attribute depends on the state of others. For example, favourable demand conditions will not
result in a competitive advantage unless the state of rivalry is enough to elicit a response from the firms.
Figure 2.1 gives you an illustration of Porters diamond model.
Figure 2.1: Porters Diamond Model

Self Assessment Questions


10. Name any two international trade theories.
11. The 3 stages of Product life cycle theory are ______, _______ and ______.
12. Who developed the DIAMOND model theory.
a) Ricardo
b) Smith
c) Porter
d) Raymond
Activity 2
Make a list of 5 businesses that manufacture goods outside the country of origin and import those
goods for the domestic market. Include the name of the firm, country of origin, product and its
country of manufacture.
Refer this link for guidance
http://www.businesslink.gov.uk/bdotg/action/layer?topicId=1077717231
2.6 Summary
Let us now summarise the silent features discussed in this unit about international business
environment:
The different factors affecting the environment of IB like political, economical and legal are
discussed.
The economic environment refers to the conditions under which a business operates and takes
into account all factors that have affected it.
Political factors influence the economic and legal environment in which the business operates to
a larger extent, especially in contract law and rules on advertising and consumer protection.
The legal systems of some countries are much better developed than others, particularly the
mechanisms for the administration of justice and the enforcement of court rulings. Most nations
base their legal systems on either comman law, code law or Islamic law.
Different trade theories of international trade have been discussed. Individually, none of the
theories might be relevant in todays business environment, but a collective understanding of all
these theories gives a multiple dimenson on the way trade has been practiced.
2.7 Glossary
Arbitration: The process of having a mediator to settle a dispute without going to the court.
GDP: Gross Domestic Product is the total sum of goods and services produced in a country in a year.
GNP: Gross National Product is the total value of goods and services that the countrys citizens produced
irrespective of their location in a year.
Litigation: The process of taking a party to court to settle a legal matter.
Nationalisation: The process by which a government of a country takes over control of a business that
operates within that country.
Sovereignty: The power of a state over its citizens and land.
2.8 Terminal Questions
1. Explain factors that affect the international business environment.
2. State the importance of a good FDI Policy
3. Evaluate the importance of Political stability for conducting international business
4. What are the different options available for settling disputes?
5. Discuss the relevance of Porters Diamond Model in todays business context .
2.9 Answers
Self Assessment Questions
1. Full employment, A high economic growth rate
2. True
3. Economic
4. True
5. a) Sovereignty
6. Macro and Micro risk
7. Common law, code law & Islamic law
8. Arbitration
9. International Chamber of Commerce, the American Arbitration Association, the London Court of Arbitration and
the International Centre for the Settlement of Investment Disputes (ICSID)
10. Theory of absolute advantage, Theory of comparative advantage
11. New, Maturing and Standardised
12. c) Porter
Terminal Questions
1. The factors that affect the international business environment include the economic, political and legal. These
factors are important as they help to assess risk, establish sizes and characteristics of various markets, identify
growth sectors, make investment decisions and also help in using the company resources effectively, that is
explained in section 2.1 of this unit. Refer the same for details.
2. Foreign direct investment (FDI) is an investment made with an intention of establishing a long term interest by a
business enterprise in a country other than its own. FDI policy, is dictated by the Government of the host country,
plays a vital role in the economic growth of that country. The importance of good FDI policy is to provide and
facilitate investor friendly business environment, strive to reduce corruption and encourage transparency, which are
explained in section 2.2.1 of this unit. Refer the same for details.
3. Political and economic environments are often inter-related the political environment affects the economic
environments, while economic hardship may trigger political change. Political stability is important for conducting
international business because political instability arises from revolution and insurgency, involvement in foreign
wars, changes in government, bad international relations, falling national income, high inflation and rising foreign
debt that are explained in section 2.3 of this unit. Refer the same for details.
4. International businesses confront different sets of laws in the various countries in which they operate. The
different options available for settling disputes are through domestic, international and supranational laws that are
explained in section 2.4 of this unit. Refer the same for details.
5. Porters diamond model outlined four broad attributes that shape the environment in which local firms compete
and these attributes promote the creation of competitive advantage. The four attributes are factor endowments,
demand conditions, rating and supporting industries and firm strategy, structure and rivalry. The firms are most
likely to succeed in industries or industry segments where the diamond is most favourable that are explained in
section 2.5 of this unit. Refer the same for details.
2.10 Case-Let
Maruti Suzuki India Ltd (MSIL)
In 1983, Maruti Udyog Ltd entered into a joint venture with Suzuki Motor Corporation (SMC) of
Japan to manufacture cars for the Indian market, utilising technology to make low-cost cars in large
numbers. The launch model was the Maruti 800, which brought about a revolution in the Indian
automobile industry.
Now, renamed Maruti Suzuki India Ltd (MSIL), it has two manufacturing facilities in Northern
India with a capacity of 1.2 million cars annually.
MSIL offers 14 brands in over 150 variants ranging from Maruti 800, people movers to SUV Grand
Vitara.
SMC, which had an established market in Europe started sourcing cars from MSIL, manufactured
in India under the Suzuki brand name, thus taking advantage of the low cost manufacturing in India.
In 1987, 500 cars were exported by the MSIL to Hungary and in 2009-10, sales volume crossed 1
million cars, out of which around 1,47,000 cars were exported to other countries.
MSIL exports to the more than 100 countries including Poland, Finland, Iceland, Switzerland,
Netherlands, Algeria and Italy.
In this process, MSIL became the only Indian company to manufacture and sell 1 million cars in a
year and is the largest passenger car manufacturer with over 45% market share in India.
MSILs revenue has grown constantly over the years:
Table 2.3 Maruti Sales 2004 to 2009-10

The government of Japan has honoured MSIL with a METI award for promotion of Japanese brand
in India. Maruti Suzuki is one of the six companies , and one of the two companies outside Japan, to
have received this award.
Discussion Questions
1. Which business theory will you associate with this case? (Hint: Porters diamond model)
2. What kind of approach did SMC adopt to make an entry into Indian market? (Hint: SMC utilised
technology to make low-cost cars in large numbers taking advantage of the low cost manufacturing
in India).
Source: http://www.marutisuzuki.com Retrieved on 20th September 2010

Unit-03-Culture and International Business


Structure:
3.1 Introduction
Objectives
3.2 Meaning of Culture
Need to understand cultural differences
Hofstedes cultural dimensions
3.3 Country Culture
Significance of country culture
Comparative study on country cultures of Japan, China, Brazil, France, and USA
3.4 Culture in an International Business Organisation
Cross cultural management
Comparative study on corporate cultures of Japan, China, Brazil,France, and USA
3.5 Summary
3.6 Glossary
3.7 Terminal Questions
3.8 Answers
3.9 Case-Let
3.1 Introduction
In the previous unit, you have learnt about various factors like economic, political, and legal
environments in which an international business operates. The unit gave an insight on different
theories and approaches that companies adopt while dealing with international business.
Many developments took place in late twentieth century. All these developments paved way for
the contacts to grow between people from various nations. This mainly included the globalisation
of business.
Culture is an important factor for practising international business.Culture affects all the business
functions ranging from accounting to finance and from production to service. This shows a close
relation between culture and international business.
Objectives:
After studying this unit, you should be able to:
explain culture in an international scenario.
analyse national cultures of different countries.
describe the importance of managing cultures internationally.
evaluate corporate cultures from different countries.

3.2 Meaning of Culture


In this section you will learn about the meaning of culture and the need to understand various
cultural differences.
Culture is defined as the art and other signs or demonstrations of human customs, civilisation,
and the way of life of a specific society or group. Culture determines every aspect that is from
birth to death and everything in between it. It is the duty of people to respect other cultures, other
than their culture. Research shows that national cultures generally characterise the dominant
groups values and practices in society, and not of the marginalised groups, even though the
marginalised groups represent a majority or a minority in the society.
Culture is very important to understand international business. Culture is the part of
environment, which human has created, it is the total sum of knowledge, arts, beliefs, laws,
morals, customs, and other abilities and habits gained by people as part of society.
The following are the four factors that question assumptions regarding the impact of global
business in culture:
National cultures are not homogeneous and the impact of globalisation on heterogeneous cultures
is not easily predicted.
Culture is not similar to cultural practice.
Globalisation does not characterise a rupture with the past but is a continuation of prior trends.
Globalisation is only one of many processes involved in cultural change.
3.2.1 Need to understand cultural differences
Cultural differences affect the success or failure of multinational firms in many ways. The
company must modify the product to meet the demand of the customers in a specific location and
use different marketing strategy to advertise their product to the customers. Adaptations must be
made to the product where there is demand or the message must be advertised by the company.
The following are the factors which a company must consider while dealing with international
business:
The consumers across the world do not use same products. This is due to varied preferences and
tastes. Before manufacturing any product, the organisation has to be aware of the customer
choice or preferences.
The organisation must manage and motivate people with broad different cultural values and
attitudes. Hence the management style, practices, and systems must be modified.
The organisation must identify candidates and train them to work in other countries as the
cultural and corporate environment differs. The training may include language training, corporate
training, training them on the technology and so on, which help the candidate to work in a
foreign environment.
The organisation must consider the concept of international business and construct guidelines
that help them to take business decisions, and perform activities as they are different in different
nations. The following are the two main tasks that a company must perform:
Product differentiation and marketing - As there are differences in consumer tastes and
preferences across nations; product differentiation has become business strategy all over the
world. The kinds of products and services that consumers can afford are determined by the level
of per capita income. For example, in underdeveloped countries, the demand for luxury products
is limited.
Manage employees - It is said that employees in Japan were normally not satisfied with their
work as compared with employees of North America and European countries; however the
production levels stayed high. To motivate employees in North America, they have come up with
models. These models show that there is a relation between job satisfaction and production. This
study showed the fact that it is tough for Japanese workers to change jobs. While this trend is
changing, the fact that job turnover among Japanese workers is still lower than the American
workers is true. Also, even if a worker can go to another Japanese entity, they know that the
management style and practices will be quite alike to those found in their present firm. Thus,
even if Japanese workers were not satisfied with the specific aspects of their work, they know
that the conditions may not change considerably at another place. As such, discontent might not
impact their level of production.
The following are the three mega trends in world cultures:
The reverse culture influence on modern Western cultures from growing economies, particularly
those with an ancient cultural heritage.
The trend is Asia centric and not European or American centric, because of the growing
economic and political power of China, India, South Korea, and Japan and also the ASEAN.
The increased diversity within cultures and geographies.
The following are the necessary implications in international business:
Avoid self reference criterion such as, ones own upbringing, values and viewpoints.
Follow a philosophical viewpoint that considers that many perspectives of a single observation
or phenomenon can be true.
Discover and identify global segments and global niche markets, as national markets are diverse
with growing mobility of products, people, capital, and culture.
Grow the total share market by innovating affordable products and services, and making them
accessible so that, they are affordable for even subsistence level consumers rather than fighting
for market share.
Organise global enterprises around global centres of excellence.
3.2.2 Hofstedes cultural dimensions
According to Dr. Geert Hofstede, Culture is more often a source of conflict than of synergy.
Cultural differences are a trouble and always a disaster.
Professor Hofstede carried out a detailed study of how values in the workplace are influenced by
culture. He worked as a psychologist in IBM from 1967 to 1973. At that time he gathered and
analysed data from many people from several countries. Professor Hofstede established a model
using the results of the study which identifies four dimensions to differentiate cultures. Later, a
fifth dimension called long-term outlook was added.
The following are the five cultural dimensions:
Power Distance Index (PDI) This focuses on the level of equality or inequality, between
individuals in the nations society. A country with high power distance ranking depicts that
inequality of power and wealth has been allowed to grow within the society. These societies
follow caste system that does not allow large upward mobility of its people. A country with low
power distance ranking depicts the society and de-emphasises the differences between its peoples
power and wealth. In these societies equality and opportunity is stressed for everyone.
Individualism This dimension focuses on the extent to which the society reinforces individual or
collective achievement and interpersonal relationships. A high individualism ranking depicts that
individuality and individual rights are dominant within the society. Individuals in these societies
form a larger number of looser relationships. A low individualism ranking characterises societies
of a more collective nature with close links between individuals. These cultures support extended
families and collectives where everyone takes responsibility for fellow members of their group.
Masculinity This focuses on the extent to which the society supports or discourages the
traditional masculine work role model of male achievement, power, and control. A country with
high masculinity ranking shows the country experiences high level of gender differentiation. In
these cultures, men dominate a major part of the society and power structure, with women being
controlled and dominated by men. A country with low masculinity ranking shows the country,
having a low level of differentiation and discrimination between genders. In low masculinity
cultures, women are treated equal to men in all aspects of the society.
Uncertainty Avoidance Index (UAI) This focuses on the degree of tolerance for uncertainty and
ambiguity within the society that is unstructured situations. A country with high uncertainty
avoidance ranking shows that the country has low tolerance for uncertainty and ambiguity. A
rule-oriented society that incorporates rules, regulations, laws, and controls is created to
minimise the amount of uncertainty. A country with low uncertainty avoidance ranking shows
that the country has less concern about ambiguity and uncertainty and has high tolerance for a
variety of opinions. A society which is less rule-oriented, readily agrees to changes, and takes
greater risks reflects a low uncertainty avoidance ranking.
Long-Term Orientation (LTO) Describes the range at which a society illustrates a pragmatic
future oriented perspective instead of a conventional historic or short term point of view. The
Asian countries are scoring high on this dimension. These countries have a long term orientation,
believe in many truths, accept change easily, and have thrift for investment. Cultures recording
little on this dimension, trust in absolute truth is conventional and traditional. They have a small
term orientation and a concern for stability. Many western cultures score considerably low on
this dimension.
In India, PDI is the highest Hofstede dimension for culture with a rank of 77, LTO dimension
rank is 61, and masculinity dimension rank is 62.
Self Assessment Questions
1. _______ is defined as the art and other signs or demonstrations of human customs,
civilisation, and the way of life of a specific society or group
2. The consumer tastes and preferences across countries are similar. (True/False)
3. Match the following:
a) PDI 1) tolerance for uncertainty and ambiguity.
b) Individualism 2) pragmatic future oriented perspective.
c) Masculinity 3) equality or inequality between individuals.
d) UAI 4) individual or collective achievement.
e) LTO 5) support or does not support male
achievement
Activity 1
Visit a nearby bank and observe the cultural diversities. Apply the cultural dimensions of
Hofstede and document your study.
Hint: Hofstedes five cultural dimensions.
3.3 Country Culture
In the previous section, we analysed the need to understand cultural dimensions and also studied
Hofstedes cultural dimensions. In this section, we will discuss the country culture and its
significance.
3.3.1 Significance of country culture
Every society has its own unique culture. Culture must not be imposed on individuals of different
culture. For example, the Cadbury Kraft Acquisition, 2009 was a landmark international deal, in
which a U.S. based company Kraft acquired the British chocolate giant, Cadbury which were in
complete extremes in terms of culture. Let us discuss the major cultural elements that are related
to business.
Cultural elements that relate business
The most important cultural components of a country which relate business transactions are:
Language.
Religion.
Conflicting attitudes.
Language
Language is something more than just spoken and written words. Gestures, non-verbal
communication, facial expressions, and body language all communicate a message. An
interpreter is used when two people do not speak common language. Failure in understanding the
cultural context when non-verbal communication takes place or failure in reading the person
across the table results in sending a wrong signal.
Religion
The dominant religious beliefs within a culture have a great impact on a persons approach to
business than most people expect, even if that person is not a follower of a specific culture.
Conflicting attitudes
Cultural values have a massive effect on the way business is carried out. The cultural values that
are evident in everyday life are not only shown in business but they are exaggerated. If the
cultural basics are not understood, then there is possibility that a deal ends even before the
negotiations start.
Some of the additional cultural elements which must be known are the customs and manners,
arts, education, humour, and social organisation of a society.

3.3.2 Comparative study on country cultures of Japan, China, Brazil, France, and USA
People who want to do business in other nations must know everything about that particular
nations business environment. Every country in its business environment has its own style of
communication, the way they treat women and their dressing style. Let us now discuss the
business culture followed by different nations with respect to communication styles, women in
business, and dress code. The table 3.1 shows how the business cultures differ from one nation to
another nation.
Table 3.1: Comparison of Cultures in Different Nations

Country Women in
culture Communication style Business dress code
Country business

Japan It is difficult if Japanese Discrimination towards The Japanese


is not known. The
combination of vagueness
and lack of understanding
mainstream business,
of Japanese results in women in the workplace
follow a conventional
problems which make still remains. Women are
business dress code of
decision-making very assigned to perform lower
dark suit, shirt and tie.
twisted. Body language is grade tasks. Western
Business dress must
very minimal and hence women working in Japan
be restrained and
difficult to read for the probably face difficulties
formal for women. In
untrained observer. The with Japanese male co-
business, women do
Japanese sit in a formal workers.
not wear trousers.
upright posture and look
still. Visibility of reaction
or emotion is rare.

Women have the equal


rights as men in the Men wear suits and
Translators are required if
workplace. But, traditional ties and women wear
Chinese is not known.
Confucian thinking does skirts and blouses. It
China The Chinese use
not agree gender equality. is sensible to have
restricted amount of
Foreign businesswomen are smart business
visual body language.
treated with great respect clothing.
and courtesy.

Ability to speak Brazilian


is an advantage, even
though English is spoken
Men are advised to
understood by people in
wear conservative
Brazil. Brazilians prefer
dark suits. Women are
to speak before the Business women from
less conservative in
Brazil written word. The body foreign are treated fairly
their dress sense at
language plays a vital and with respect.
workplace than
role in normal
women from other
communication. When
countries.
speaking to people they
show strong levels of eye
contact.

The French have great Women are gaining high With position, dress
love and respect for the position in French business codes differ within the
use of language. The life, particularly with strong company, industrial
logical exposition of representation in retail and sector, and region in
France well-defined ideas is France. People in
service industries. The
admired by the French. requirement for success is higher position within
The comment given by to have a suitable level of a larger organisation
them clearly states their education for women. follow a very formal
mind. It is important that dress code. In
southern region the
anything sent in writing is
business dress code is
thoroughly checked.
informal.

Americans are seen to be


aggressive and rude by
some cultures as they like
to debate issues directly
and openly. Coded speech It is a risky task to
In US women play an
and verbosity is describe dress codes
active part in business. A
considered as time for men going on
large percentage of
wasting and in time business in USA.
American executives are
pressured corporate USA, Dress will differ from
USA women and this percentage
it is a crime. Americans the formal to
is increasing every year.
seem to be friendly, and informal. Dress code
Women are treated equally
polite on their first for women is as
as men in all business
introduction. The diverse as that for
dealings.
negotiating style in men.
America is very tough.
The way they approach is
cordial, informal, and
straightforward.

Self Assessment Questions


4. The most important cultural components of a country which relate business transactions are
_______, _______, and _______.
5. The combination of Japanese vagueness and lack of understanding results in problems which
make decision-making very twisted. (True/False)
6. Coded speech and verbosity is considered as time wasting and in time pressured corporate
_______, which is a crime.
a) Brazil
b) China
c) USA
d) France
3.4 Culture in an International Business Organisation
In the previous section, we studied how culture varies from country to country and its
significance. In this section, we will discuss the culture in an international business organisation.
3.4.1 Cross cultural management
Cross cultural management is defined as the development and application of knowledge about
cultures in the practice of international management, when people involved have diverse cultural
identities.
International managers in senior positions do not have direct interaction that is face-to-face with
other culture workforce, but several home based managers handle immigrant groups adjusted
into a workforce that offers domestic markets.
The factors to be considered in cross cultural management are:
Cross cultural management skills.
Handling cultural diversity.
Factors controlling group creativity.
Ignoring diversity.
Cross cultural management skills
The ability to demonstrate a series of behaviour is called skill. It is functionally linked to
achieving a performance goal.
The most important aspect to qualify as a manager for positions of international responsibility is
communication skills. The managers must adapt to other culture and have the ability to lead its
members.
The managers cannot expect to force members of other culture to fit into their cultural customs,
which is the main assumption of cross cultural skills learning. Any organisation that tries to
enforce its behavioural customs on unwilling workers from another culture faces conflict. The
manager has to possess the skills linked with the following:
Providing inspiration and appraisal systems.
Establishing and applying formal structures.
Identifying the importance of informal structures.
Formulating and applying plans for modification.
Identifying and solving disagreements.
Handling cultural diversity
Cultural diversity in a work group offers opportunities and difficulties. Economy is benefited
when the work groups are managed successfully. The organisations capability to draw, save, and
inspire people from diverse cultures can give the organisation spirited advantages in structures of
cost, creativity, problem solving, and adjusting to change.
Cultural diversity offers key chances for joint work and co-operative action. Group work is a
joint venture where, the production of two or more individuals or groups working in cooperation
is larger than the combined production of their individual work.
Factors controlling group creativity
On complicated problem solving jobs diverse groups do better than identical groups. Diverse
groups require time to solve issues of working together. In diverse groups, over time, the work
experience helps to overcome gender, racial, and organisational and functional discriminations.
But the impact cannot be evaluated and there is always risk in creating a diverse group. A
successful group is profitable with respect to quick results and the creation of concern for the
future. Negative stereotypes are emphasised if it fails.
Factors related with the industry and company culture are also important. Diverse groups do well
when the members:
Assist to make group decisions.
Value the exchange of different points of view.
Respect each others skills and share their own.
Value the chance for cross-cultural learning.
Tolerate uncertainty and try to triumph over the inefficiencies that occur when members of
diverse cultures work together.
A diverse group is known to be more creative, where the members are tolerant of differences.
The top management level provides its moral and administrative support, and gives time for the
group to overcome the usual process difficulties. They also provide diversity training, and the
group members are rewarded for their commitment.
Ignore diversity
It may be difficult to manage diversity. It is better to ignore, which is an alternative. The
management must:
Ignore cultural diversity within the employees.
Down-play the importance of cultural diversity.
This rejection to identify diversity happens when management:
Fails to have sufficient awareness and skills to identify diversity.
Identifies diversity but does not have the skill to manage the diversity.
Recognises the negative consequences of identifying diversity probably cause greater issues than
ignoring it.
Thinks the likely benefits of identifying and managing diversity do not validate the expected
expenses.
Identifies that the job provides no chances for drawing advantages from diversity.
Strategies to ignore diversity may be possible when culture groups are given various jobs, and
sharing required resources are independent in the workplace. Groups and group members are
equally incorporated and work together. In such cases, confusion occurs when the diverse value
systems are not identified that are held by different staff groups.
3.4.2 Comparative study on corporate cultures of Japan, China, Brazil, France, and USA
The success of any multinational company depends on the techniques and cultures. Corporate
culture is an organisational culture, which is related to the management of businesses with
respect to organisational structure, strategy, and control. It states all the elements around which a
company describes and relates to its stakeholders.
Corporate culture also includes the way it organises its workers, lets them to express themselves,
and conveys its values. The corporate culture is said to be positive when the official relationships
are reasonably considered, members have a stake in company profits, and demands for
production are considered sensible. The corporate culture is said to be negative when the
opposite conditions apply and relation with management are not productive.
Table 3.2 displays the different approaches to corporate culture.
Table 3.2: Comparison of Corporate Cultures

Basis of
Approach toBusiness Management
Country Team Work
Corporate Structure Style
Culture
Information flows
from the bottom of
the company to the Consensus-building
Hierarchically top. process is used to
structured based Implementation of define an agreement
Relationship must on harmony and decisions has been before a formal
Japan come before co-operation, with actively involved in meeting to avoid any
business. individuals aware the modelling of conflict. People are
of their position policy. Individual expected be modest
within a group. personality is not and self-promotion is
seen as the not encouraged.
requisites for
effective leadership.

Consensus-oriented
despite being
Use operational hierarchical in
Subordinates are
structures, chains approach. The
not allowed to
Based on of command that importance is on
China question the
Confucian values. are hierarchical in group orientation with
decisions of
a Confucian individual
superiors.
society. requirements being
directed to the greater
good of the whole.

A managers
personal style is
Organise
considered to be Team members
hierarchical lines
importance. The understand their role
Offers business with information
key importance is and responsibilities
opportunities to flowing in a
relationship. The within the team.
Brazil future structured way.
manager and Every team member
international All important
subordinates work expects to see a chain
investors. decisions are
hard to nurture a of command within
made at senior
relationship based the team.
levels.
on trust and respect
for personal dignity.

France The role of the Follows hierarchy Decisions, once There is no


government and and functionality taken at senior encouragement for
the significance within the system. levels, are delivered team work. People
of a definite kind The CEO down the chain for wish to have
determines future
direction of the definable, personal
company. This implementation at sets of objectives
of education is
vision is then lower management rather than to work in
important.
passed down the levels. more general team
line by junior roles.
management.

The company is
an entity in its
Management style
own right and Groups of individuals
is individualistic in
survives are brought together
approach; managers
independently to complete a given
are responsible for
from its workers. task. During that
the decisions made
Senior period the group is
within their regions
Every aspect of management is together, everybody is
of responsibility.
commercial life is more rooted in the committed to the
USA Important decisions
studied and personality at the common goals, and
are discussed in
analysed. top. Americans work with dedication
open environment
like to know to assure that the
and the
where exactly goals are
responsibility for
they are, what are accomplished. Teams
the concerns of the
their are assumed to be
decision lies with
responsibilities temporary in nature.
the manager.
and to whom they
report.

Self Assessment Questions


7. The ability to demonstrate a series of behaviour is called _______.
8. Diverse groups do not require time to solve issues of working together. (True/False)
9. ____________ is defined as the development and application of knowledge about cultures in
the practice of international management, when people involved have diverse cultural identities.

Activity 2
Assume that you are the manager of Company manufacturing cellular phones. You have
to design a new model that suits the requirements of users in the country of the secondary
branch Country Q.
There is local sales-force which knows about local needs, market segments which can
buy the product, the amount that the users will pay and advertising channels which can be
used to interact with consumers. But the local sales-force do not understand modern
research methods and the main branch resources for designing new products. The
marketers of the headquarters have access to the technology and can account on research
and development carried out elsewhere, but the marketers are not local expertise and have
no contacts. The expert team of your company lay out the specifications for a phone
designed to fulfil the requirements of the budding youth market in Country Q.
How will you handle this case to expand the business in Country Q?
Hint: Cultural diversity.

3.5 Summary
Let us summarise the salient points covered in this unit on culture and international business:
Culture is an important factor for practising international business. Culture affects all the
business functions ranging from accounting to finance and from production to service.
It is important for an individual to have knowledge of the impact of cultural differences when
working in the global commercial environment.
According to Professor Hofstede, the following are five dimensions used to differentiate culture:
Power distance index (PDI).
Individualism.
Masculinity.
Uncertainty avoidance index (UAI).
Long term orientation (LTO).
The following are the cultural elements which affect business transactions:
Language.
Religion.
Conflicting attitudes.
Every country in its business environment has its own style of communication, the way they treat
women and their dressing style.
Cross cultural management is defined as the development and application of knowledge about
cultures in the practice of international management, when people involved have diverse cultural
identities.
Companies can build international competencies by improving levels of cultural awareness and
help individuals to become globally profound.

3.6 Glossary
Biscapal: People who are adept in more than one culture, and are able to view a situation through
more than one mindscape
CEO: Abbreviation for chief executive officer who is the highest ranking officer in a company
Confucianism: Political morality taught by Confucius that is the basis of Chinese jurisdiction
Consensus: An opinion or position reached by a group as a whole
Globalisation: Integration of regional economies, cultures, and societies through a worldwide
network
Homogeneous: Part or elements that are all of the same kind; opposite of heterogeneous
Individualistic: Attribute that has a markedly independent course in action or thought
Marginalise: To make unimportant in a social standing
Stereotypes: Generalisations about a specific group, such as people that share common attributes
or characteristics
3.7 Terminal Questions
1. What is the need to understand to understand cultural differences?
2. Explain Hofstedes cultural dimensions.
3. Explain the three important cultural elements.
4. Differentiate the communication styles of Japan, China, Brazil, France, and USA.
5. What is cross cultural management? Explain the cross cultural management factors.
3.8 Answers
Self Assessment Questions
1. Culture
2. False
3. (a) 3, (b) 4, (c) 5, (d) 1, (e) 2
4. Language, religion, conflicting attitudes
5. True
6. c) USA
7. Skill
8. False
9. Cross cultural management.
Terminal Questions
1. Cultural differences affect the success or failure of multinational firms in many ways. Refer to
sub-section 3.2.1 of this unit for details.
2. The five cultural dimensions of Hofstede. Refer to sub-section 3.2.2 of this unit for details.
3. The most important cultural components of a country which relate business transactions are
language, religion, and conflicting attitudes. Refer to sub-section 3.3.1 of this unit for details.
4. Refer to sub-section 3.3.2 of this unit for details.
5. Cross cultural management is defined as the development and application of knowledge about
cultures in the practice of international management, when people involved have diverse cultural
identities. Refer to sub-section 3.4.1 of this unit for details.
3.9 Case-Let

India-Japan Software Outsourcing


An Indian based software company, Company PQR has been doing business with Japan.
The company faced many issues. The first and fore-most issue faced by the company was
the Japanese language. Japanese language is considered to be one of the most difficult
languages for people of other countries to learn. The Indian employees found it difficult
to adjust to the Japanese culture based on other cross cultural diversities. It was difficult
to sign the deal because the software requirements were explained in Japanese way. The
other problem experienced by the company employees were to work in the Japanese
style. The company PQR took some steps to solve the problem. First step is that the
company attempted to train the software developers to speak Japanese at-least at basic
level. The second step is that the company tried to make the employees adjust to the
Japanese culture. To know the requirements is very short in Japanese style. But it is for
the people to derive more data to understand their needs and design the products
according to it. The requirement needs selection from top management, managers, and
also users. By focussing on all the aspects, the software developed could ultimately adjust
itself to the Japanese method of working and accomplish success.
Discussion Questions
1. What are the issues faced by Company PQR? (Hint: Language)
2. What are the steps taken by Company PQR to overcome the issues? (Hint: Train
employees)
Sources: Cross-cultural management: Text and cases

References
Paul, Justin. (2008). International Business. PHI Learning Private Limited.
Mitchell, Charles. (2000). A Short Course in International Business Culture. World Trade Press.
Mead, Richard. (2005). International Management: Cross-Cultural Dimensions. Blackwell
Publishing Ltd.
Nakata, Cheryl. (2009), Beyond Hofstede, Culture Frameworks for Global Marketing and
Management. Palgrave MacMillan.
E-References
http://www.worldbusinessculture.com/
- Retrieved on 3rd November, 2010

Unit-04-Ethics in International Business


Structure:
4.1 Introduction
Objectives
4.2 Business Ethics Factors
Importance of business ethics
4.3 International Business and Ethics
Managing ethics
Free market ethics
4.4 National Differences in Ethics
Negotiating across cultures
Ethical issues
4.5 Corporate Governance
Code of conduct for MNCs
Corporate ethical programs
Social responsibility and ethics
4.6 Summary
4.7 Glossary
4.8 Terminal Questions
4.9 Answers
4.10 Case-Let
4.1 Introduction
In the previous unit, you studied the dynamics of international business, factors like economy,
politics, legalities, culture, and various theories that affect the harmony of international business.
Ethics can be defined as the evaluation of moral values, principles, and standards of human
conduct and its application in daily life to determine acceptable human behaviour.
Business ethics pertains to the application of ethics to business, and is a matter of concern in the
corporate world. Business ethics is almost similar to the generally accepted norms and principles.
Behaviour that is considered unethical and immoral in society, for example dishonesty, applies to
business as well.
This unit covers various topics on workplace ethics, its importance and application in a global
business environment. It also gives a perspective of business ethics practised in different
countries. It includes the code of ethics, policies and procedures, and the general code of conduct
followed by multinational companies.

Objectives:
After studying this unit you should be able to:
explain business ethics.
evaluate the importance in an international context across cultures.
describe the national differences in ethics.
analyse the corporate governance of an international business.
4.2 Business Ethics Factors
During the mid 1960s and 1970s, social awareness movements raised expectations of businesses
to use their financial and social influence to address social issues such as poverty, literacy,
women rights, public health, and environmental protection. It was argued that these businesses
used community resources and profits generated by public participation to address social issues.
Hence, there arose a need for managers to take up the responsibility to understand and address
social issues guided by high ethical standards.
In this unit, let us learn the different factors that influence the ethics of a business and its
managers. Managers are influenced by three factors affecting ethical values. These factors have
unique value systems that have varying degrees of control over managers.
Religion Religion is one of the oldest factors affecting ethics. Despite the differences in religious
teachings, religions agree on the fundamental principles and ethics. All major religions preach
the need for high ethical standards, an orderly social system, and stress on social responsibility as
contributing factors to general well-being.
Culture Culture refers to a set of values and standards that defines acceptable behaviour passed
on to generations. These values and standards are important because the code of conduct of
people reflects on the culture they belong to. Civilisation is the collective experience that people
have passed on through three distinct phases: the hunting and gathering phase, agriculture phase,
and the industrial phase. These phases reflect the changing economic and social arrangements in
human history.
Law Law refers to the rules of conduct, approved by the legal system of a country or state that
guides human behaviour. Laws change and evolve with emerging and changing issues. Every
organisation is expected to abide the law, but in the pursuit of profit, laws are frequently violated.
The most common breach of law in business is tax evasion, producing inferior quality goods, and
disregard for environmental protection laws.
4.2.1 Importance of Business Ethics
Ethics is significant in all areas of business and plays an important role in ensuring a successful
business. The role of business ethics is evident from the conception of an idea to the sale of a
product. In an organisation, every division such as sales and marketing, customer service,
finance, and accounting and taxation has to follow certain ethics.
Public image In order to gain public confidence and respect, organisations must ascertain that
they are honest in their transactions. The services or products of a business affect the lives of
thousands of people. It is important for the top management to impart high ethical standards to
their employees, who develop these services or products.
A company that is ethically and socially responsible has a better public image. People tend to
favour the products and services of such organisations. Investors trust is just as important as
public image for any business. A company that practices good ethical creates a positive
impression among its stakeholders.
Managements credibility with employees Common goals and values are developed when
employees feel that the management is ethical and genuine. Managements credibility with
employees and the public are intertwined. Employees feel proud to be a part of an organisation
that is respected by the public. Generous compensations and effective business strategies do not
always guarantee employee loyalty; organisation ethics is equally significant. Thus, companies
benefit from being ethical because they attract and retain good and loyal employees.
Better decision-making Decisions made by an ethical management are in the best interests of the
organisation, its employees, and the public. Ethical decisions take into account various social,
economic and ethical factors.
Profit maximisation - Companies that emphasise on ethical conduct are successful in the long
run, even though they lose money in the short run. Hence, a business that is inspired by ethics is
a profitable business. Costs of audit and investigation are lower in an ethical company.
Protection of society In the absence of proper enforcement, organisations are responsible to
practice ethics and ensure mechanisms to prevent unlawful events. Thus, by propagating ethical
values, a business organisation can save government resources and protect the society from
exploitation.
Self Assessment Questions
1. The three factors governing ethical values are ____________, ___________, and
____________.
2. _______________ is the collective experience that people have passed on through the hunting
and gathering phase, agriculture phase, and the industrial phase.
3. A company can maximise its profits by being ethical. (True/False)
4.3 International Business and Ethics
In the previous section, you learned about ethics and its importance in business. Now let us
discuss the effects of ethics in international business.
Most countries have similar ethical values, but are practiced differently. This section deals with
the way individuals in different countries approach ethical issues, and their ethically acceptable
behaviour. With the rise in global firms, issues related to ethical values and traditions become
more common. These ethical issues create complications to Multi-National Companies (MNCs)
while dealing with other countries for business. Hence, many companies have formulated well-
designed codes of conduct to help their employees.
Two of the most prominent issues that managers in MNCs operating in foreign countries face are
bribery and corruption and worker compensation.
Bribery and corruption Bribery can be defined as the act of offering, accepting, or soliciting
something of value for the purpose of influencing the action of officials in the discharge of their
duties. Corruption is the abuse of public office for personal gain. The issue arises when there are
differences in perception in different countries. For example, in the Middle East, it is perfectly
acceptable to offer an official a gift. In Britain it is considered as an attempt to bribe the official,
and hence, considered unlawful.
Worker compensation Businesses invest in production facilities abroad because of the
availability of low-cost labour, which enables them to offer goods and services at a lower price
than their competitors. The issue arises when workers are exploited and are underpaid compared
to the workers in the parent country who are paid more for the same job. The disparity arises due
to the differences in the regulatory standards in the two countries.
4.3.1 Managing ethics
Earlier, we believed that ethics is a prerogative of individuals, but now this perception has
immensely changed. Many companies use management techniques to encourage ethical
behaviour at an organisational level. Various techniques of managing ethics like practicing ethics
at the top level management, special training on ethics, forming committees to oversee ethical
issues, and defining and implementing code of ethics are illustrated in figure 4.1.

Figure 4.1: Techniques of Managing Ethics


Let us discuss each technique in detail.
Top management The senior management of a company must be committed to ensure that ethical
standards are met. The chief executive of the company must not engage in business practices
harmful to employees, or the society. The top management must focus on ethical practices while
informing employees of their intention.
Code of ethics One of the best practices for ethics is creating a corporate ethical statement and
communicating it within the company. Such practices enhance the companys public image.
Almost all Fortune 500 companies have such codes.
Ethics committee There are ethics committees in many firms to help them deal with and advise
on work related ethical issues. The Chief Executive Officer can head the committee that includes
the Board of Directors. Such a committee answers employee queries, helps the company to
establish policies in uncertain areas, advises the Board on ethical issues, and oversees the
enforcement of the code of ethics.
Ethics hotline A companys ethical hotline helps its employees report any ethical issues they face
at work. The ethics committee then investigates these issues. Such hotline calls are treated
confidential, where the callers identity is protected to encourage employees to report on ethical
issues.
The act of reporting illegal, immoral, or illegitimate practices by former or current employees
involving its employees is known as Whistle-blowing. Whistle-blowing is favourable to a
company because employees can alert the management on possibly deviant behaviour rather than
reporting it to the media, which adversely affects the company. A case of whistle-blowing in
Xerox corporation (a pioneer in copier machines), led its Chief Financial Officer to be fined $
5.5 million and banned from practicing accountancy after reports of falsified financial statements
emerged.
Ethics training programs Most firms take ethics seriously and provide training for its managers
and employees. Such training programs help the employees become familiar with the official
policy on ethical issues. These programs demonstrate the use of these ethic policies in everyday
decision-making. Ethics training is most effective when conducted by managers and when
focused on work environment.
Ethics and law Both law and ethics focus on defining the perfect human behaviour, but they are
not the same. Law is the governments attempt to formalise rightful behaviour, but it is rarely
possible to enforce written laws. It depends on individual or business ethics to reduce unlawful
incidents. Ethical concepts are more complex than written rules since it deals with human
dilemmas that go beyond the formal language of law.
Legal rules seek to promote ethical behaviour in companies. The following are some of the Acts
which seek to ensure fair business practices in India:
Foreign Exchange Management Act (FEMA) of 1999 - FEMA regulates the cross border
movement of foreign and local currencies.
Companies Act of 1956 - Companies Act provides the complete legal framework for the
formation, running, and winding up of a company.
Consumer Protection Act of 1986 (CPA) - CPA provides and regulates the framework for the
protection of consumer rights.
Essential Commodities Act of 1955 - This act defines the goods and services that are essential for
the people at all times and provides a legal framework for the uninterrupted supply of the same.
4.3.2 Free market ethics
In this section, we will discuss the ethical aspects of competition used to explain free market
ethics. Competition is an important element that differentiates free market from command
market. Competition is a mechanism for free market production and distribution of goods and
services that are in demand. Competition in business is seen as an essential cultural trait of a free
market society. Most activities of the free market can be viewed as a competitive contest in
which businesses engage to provide products and services for a profit.
In addition to the economic nature of the free market system, there are ethic- related issues as
well. The three widely accepted factors of ethics in the free market are market ethics, the
Protestant ethics, and the liberty ethics. These three ethics set the stage for the industrial
revolution and the accompanying growth in business. During this period, industrial capitalists
were allowed to freely operate businesses, build large organisations, exploit workers, and engage
in fiercely competitive practices for profit and economic expansion.
Market ethics Market ethics is the basic system of ethics followed by a business in a free market
scenario. It covers the entire spectrum of business including sales, pricing, and competitor issues.
The Protestant ethics The Protestant ethics considered ideology as an important factor along with
the moral aspects in a capitalist scenario. As an ideology, this ethic served to legitimise the
capitalistic system by providing a moral justification for the pursuit of profit and distribution of
income.
Liberty ethics Liberty ethics encourages a person to play a participatory role on government,
encourages private property, and introduces more freedom and individualism in all spheres of
life.
Self Assessment Questions
4. ________ is an example of whistle-blowing in corporations.
5. In a international business, _____________ and ____________ are prominent ethical issues
6. ___________ is an important element that differentiates free market and command market.
4.4 National Differences in Ethics
In the previous section we examined how ethics is significant in international ethics. In this
section, let us consider the differences in understanding ethics across countries. The differences
in national cultures have an impact on the social and ethical practices of multinational firms.
Cultural norms and values that usually influence business practices are attitudes towards women,
minorities, bribery, and law. Religion and law are the key social factors that influence the type of
ethical issues.
In MNCs, managers play a key role in managing ethics. While working in a foreign country, you
cannot expect a manager to have a comprehensive knowledge of that countrys culture and social
factors that affect business. Therefore, the international manager needs to acquire adequate
knowledge of a countrys cultural, legal, and social scenarios to ascertain the important ethical
issues and to manage these issues. The approaches to understand national differences in ethics
are ethical relativism, ethical universalism, and ethical convergence. Let us discuss each of them
in detail.
Ethical relativism and ethical universalism
Ethical relativism means that each countrys outlook on ethics must be considered valid and
ethical. This implies that if bribery is not unethical in a foreign country, then it is acceptable for
an MNC to encourage bribery even if it is illegal in its home country. Ethical relativism means
that when a company deals with a host country for business, the international managers must
follow the ethical norms of the host country. Another example is the attitude towards women
employees in certain Arab countries. The attitude differs to a large extent compared to western
countries. In Saudi Arabia, women employees are segregated from their male counterparts at the
work place. All companies, MNCs or local, must comply with these rules.
The principle of ethical universalism states that there are basic moral principles that are valid
across all cultural and political boundaries. For example, all countries forbid unethical
accounting practices and tax evasion.
Both these principles have drawbacks when in international business. Ethical relativism is a
convenient way to indulge in unethical practices with cultural differences as an excuse. The
universal approach can be perceived as cultural imperialism, since business managers may
regard business practices in some countries as inferior or immoral.
Ethical convergence
Ethical convergence is defined as the practice of a uniform system of ethical codes in different countries
that are culturally and socially different.
There is a growing pressure on international business to follow a uniform set of guidelines in managing
ethical behaviour and social responsibility across the countries in which they operate. The following are
some of the advantages of ethical convergence:
The growth of international trading blocks, such as North American Free Trade Agreement (NAFTA) and
the European Union promotes common ethical practices across national cultures and borders to reduce
institutional differences. Predictable interaction and behaviour among trading partners from different
countries makes trade more efficient.
People from different cultural backgrounds increase their interactions and exposure to varying ethical
traditions. They adopt, adjust to, and imitate new behaviour and attitudes which leads to acceptance of
best practices.
International businesses have employees from different cultural backgrounds. The companies rely on their
corporate culture to provide consistent norms and values that govern ethical issues to set common
standards for employees from different cultural backgrounds.
4.4.1 Negotiating across cultures
Negotiations in international businesses face cultural barriers. When people from two different countries
try to discuss commercial issues, they have to understand and acknowledge any ethical issues that may
come up. These standards of conduct and moral judgement are the basis of an outcome. They can create
bring mistrust when the messages and views are misinterpreted. The basic concepts of fairness,
dependability, politeness, and punctuality have to be followed at all times. There are two models of
negotiating as presented by Solomon and Bertrand. They are the following:
Linear model.
Encompassing model.
Linear model Linear model relates to the Chinese culture. Figure 4.2 depicts this model. The first stage is
the discussion of the goals and principles. In China, this stage is emphasised so that foreigners understand
their commitments. The second stage deals with bargaining positions, which are the offers that are
proposed. The third stage clarifies details and the last stage involves implementing the process.

Figure 4.2: Linear Model of Negotiation


Encompassing model The encompassing model is more descriptive and includes stages that are
identical to the linear model, but focuses on the extent to which each stage is presented. Figure
4.3 illustrates this model. The Chinese base their negotiations on improving their national goals
which include national development, growth, and improvement of the overall quality of life in
China. The western companies that operate in China are expected to sacrifice their goals
whenever necessary, so that the Chinese goals are achieved.
Firms base their negotiations on corporate objectives such as product quality, profit, and
maximising shareholder value. Sacrificing such goals is against corporate responsibility, hence is
the main reason for negotiations.

Figure 4.3: Encompassing Model of Negotiation


4.4.2 Ethical issues
International business managers face ethical issues that vary based on the market and geographic
region. Some of these issues have been widely publicised in the past. Most of these issues are
related to the safety and compensation practices of manufacturing plants in emerging countries.
Ethical considerations also tend to be connected to political situations. For example, the decision
to move a companys headquarters elsewhere to reduce taxes becomes a political issue due to the
potential loss of tax revenue for that country.
Some other ethical issues are more subtle. Many firms forbid offering gifts in their home
countries. But in Japan, offering gifts and entertaining guests play a key role in building trust and
understanding with potential customers, suppliers, and government officials.
While there will always be issues about moral and ethical appropriateness, the boundary between
ethical and unethical business practices is reasonably clear in most societies. If the boundary is
not clear, the law is vague on a certain point, or firms act in an unacceptable manner, then
governments may have to taken relevant actions against the erring parties.
Businesses must refrain from engaging in illegal activities, but the legislature in some countries
is not very clear and causes ambiguity. International business manager find it difficult because
legally and culturally acceptable activities in the home country may be illegal and culturally
unacceptable in the foreign country. The international manager has to make prudent decisions at
such occasions.
MNCs deal with issues related to ethics in foreign country. Some of the issues are the following:
Conduct business in a country where the government violates human rights.
Market a product in a country that lacks adequate consumer protection and product liability laws.
Sell products with harmful side effects, where there is a high level of illiteracy that prevents the
customers from following the directions for safe usage of a product.
Be responsible for the end-user behaviour that may not be legal.
Bribe officials in a country where corruption is widespread.
Follow local laws in areas such as employee safety and environmental protection that are not as
strict as in the home country.
Change attitude towards female employees in a country where women do not enjoy the same
rights as men.
Use tax avoidance strategies.
Accomplish business goals with a firm engaged in practices that are illegal in the home country.
Multinational firms should have a moral and ethical responsibility to ensure a safe, fair,
environmentally sustainable, and legal work environment in emerging markets irrespective of the
local laws.
These are the issues that international businesses face when they conduct business in other parts
of the world, where the laws are different from their home countries.
Ethical decision making
In the previous section you learned about the various ethical issues to be considered in an
international scenario, let us discuss the process of ethical decision making.
The competitive nature of business and the emphasis on profit causes managers to violate
business ethics. For example, employing workers in a foreign country, where wages are low and
working conditions are sub-standard. Ideally, a manager must consider all the choices available
to him and make a decision that does not violate the ethics of business.
There are many differences in opinion concerning business ethics. The following are four
approaches that help managers make the right decision.
Utilitarian Maximum benefit to the most number of people is the basis of this approach. For
example, in the case of low-wage foreign workers, the cost savings helps the company perform
better, but results in layoffs in the home country. If the manager is not willing to employ low-
wage workers, the company becomes uncompetitive which in turn results in both foreign and
domestic workers being laid off. On the other hand, lower wages tend to bring down the level of
wages for everyone, which decreases their purchasing power and affects the sale of the
companys goods.
Moral rights Morality is the basis of this approach without considering the consequences. Paying
someone extremely low wages is morally wrong. Those who accept this approach believe that a
business must not exist if the workers are not paid adequately.
Universalism There are two steps in this approach. First, one needs to decide if the action being
considered has to apply to everyone under all situations. Second, the same action must be applied
to the manager.
Cost-benefit The profitability of every action is analysed. For example, the negative publicity of
paying extremely low wages weighed against being more competitive.
In conclusion, it is evident that a manager has several approaches to choose from. The manager
must take the time to analyse all the possibilities, in order to make the right decision.
Self Assessment Questions
7. Ethical business practice in one country might differ from another country in practice.
(True/False)
8. _________ and ________ are the two models of negotiating.
9. _________ is defined as the practice of a uniform system of ethical codes in different
countries that are culturally and socially different.
10. Utilitarian, moral rights, universalism, and cost-benefit are approaches to ____________.
Activity 1
Compare and describe the cultural differences between the US and India that give rise to
problems concerning business ethics.
Refer this link for guidance
http://now2gether.org/submissions/Shen/DifferencebetweenAmerica&India.pdf
4.5 Corporate Governance
Corporate governance refers to the mechanism to monitor managers of a company to ensure that
they fulfil the legal requirements of their role. Governance rests solely with the Board of
Directors, but the composition of the Board differs across countries. Hence, various bodies from
different countries have suggested methods of constituting a board. Some of these corporate
bodies include the Cadbury Committee and the Veinot Report in France.
Governance norms differ across countries, accounting standards, employment laws, and legal
framework. Table 4.1 illustrates the differences in some of the important corporate governance
issues in some of the developed countries.
Table 4.1: Corporate Governance Practices in Developed Countries

Practices Britain Germany Italy Japan USA

Independent
Yes No Yes Yes Yes
auditors

Rotation ofEvery 5 7 Every 9Every 7


No Every 5 years
auditors years years years

Executive pay
on
Advisory No Yes Yes No
shareholders
approval

Nomination of
independent
No No Yes Yes No
directors by
shareholders

Majority of
independent Recomm- Recomm-
No No Yes
directors onended ended
the Board

Separate Recomm- Yes Voluntary Voluntary Voluntary


Chairman andended
CEO

4.5.1 Code of conduct for MNCs


The code of conduct for MNCs refers to a set of rules that guides corporate behaviour. These
rules prescribe the duties and limitations of a manager. The top management must communicate
the code of conduct to all members of the organisation along with their commitment in enforcing
the code.
Some of the ethical requirements for international companies are as follows:
Respect basic human rights.
Minimise any negative impact on local economic policies.
Maintain high standards of local political involvement.
Transfer technology.
Protect the environment.
Protect the consumer.
Employ labour practices that are not exploitative.
When a manager of an international firm faces an ethical problem, certain models help in solving
these ethical issues. Figure 4.4 depicts the process flow for an ethical decision making in an
MNC.
The first task is to consider the ethical and legal consequences of the issue and whether the
action or its consequences are in accordance with the law, both in the home and host country.

Figure 4.4: Steps in Ethical Decision Making


The second task is to perform an ethical analysis, followed by a cultural and a personal ethical
analysis. An international manager begins with these analyses at different point but at some
point, a personal moral judgement is made. During any of these stages if the answer is negative,
the decision making is deferred.
4.5.2 Corporate ethical programs
Multinational firms face a wide array of ethical challenges as a result of increased competition
due to globalisation. A formal corporate ethical program is important to any organisation. The
following are some of the elements that a corporate ethical program uses:
Formal ethical codes that articulate expectations about ethics.
Ethics committees that are empowered with developing policy and evaluating actions of the
company and its employees.
Ethics communication systems where the employees report any misconduct.
Ethics officers charged with coordinating policies, educating employees on ethics. and
investigating allegations.
Training programs aimed at helping employees recognise and respond to ethical issues.
Given the broad range of potential ethical issues a multinational firm may encounter, the code of
conduct must meet the expectations of the various parties involved. The code of conduct must
satisfy the following:
Be economically viable.
Address major issues that are important to the companys stakeholders.
Engage important stakeholders in formulation and implementation.
Specify performance standards that can be measured.
4.5.3 Social responsibility and ethics
International businesses face many challenges while undertaking social actions as part of their
corporate strategy. Corporate social strategy helps overcome such challenges. Starting a
corporate social strategy includes the following:
Be socially responsible.
Be responsive to stakeholders in each country.
Be able to treat employees, customers, suppliers. and the local community in a fair and just way.
Abide by the host governments regulations and policies.
Ensure that the employees and personnel of the company follow corporate policies.
Recognise emerging issues in the host countries and communities.
Conduct business in accordance with the values, customs, and moral principles of society.
Organisations that adhere to these strategies are better equipped to react to global challenges and
corporate responsibilities. They are better prepared to prevent crises, anticipate changes, and
avoid situations that compromise the values and principles of the organisation.
Self Assessment Questions
11. Social responsibility is an integral part of business ethics. (True/False)
12. Respecting human rights is not a basic ethical requirement for an MNC. (True/False)
13. Corporate _________ rests solely with Board of Directors.
Activity 2
Devise a model for corporate governance for an Indian company that does business outside
India, keeping in mind the current challenges that businesses face.
Hint: Refer section 4.5.

4.6 Summary
Now let us summarise the salient features in this unit on ethics in international business:
Ethics is significant in all areas of business and plays an important role in ensuring a successful business. People
tend to favour the products and services of a company that is ethically and socially responsible. The different factors
that influence the ethics of a business and its management are religion, culture, and law.
With the rise in global firms, issues related to ethical values and traditions become more common. Bribery,
corruption, and worker compensation related issues are the most common ethical issues that MNCs face.
Negotiations across countries include the linear model where the principles are first agreed up on, then the various
positions are negotiated and details of the agreement are finalised, followed by the process of implementation. The
other model for negotiations is the encompassing model, which is more descriptive and includes the same stages as
the linear model, but focuses on the extent to which each stage is presented.
Four approaches that help managers make ethical decision include utilitarian, moral rights, universalism, and cost
benefit approaches. The code of conduct for MNCs, refer to a set of rules that guides corporate behaviour. These
rules prescribe the duties and limitations of a manager.
Organisations following corporate social strategies like treating customers in the home and foreign country in the
same way, recognising potential issues, and abiding by the host government regulations are better equipped to react
to global challenges and corporate responsibilities.
4.7 Glossary
Articulate: Express oneself easily in clear and effective language.
Bribery: The financial inducement offered to persuade someone to act improperly in favour of the person offering the bribe.
Whistle-blowing: The act of reporting a wrongdoing by a current or former employee of a company.
4.8 Terminal Questions
1. Discuss the business ethic factors.
2. Explain the importance of business ethics.
3. Describe different techniques for managing ethics.
4. Analyse different models of negotiating.
5. Explain various steps involved in the ethical decision making process of an MNC.
4.9 Answers
Self Assessment Questions
1. Law, religion, and culture
2. Civilisation
3. True
4. Xerox
5. Bribery and corruption and worker compensation
6. Competition
7. True
8. Linear and encompassing model
9. Ethical convergence
10. Ethical decision making
11. True
12. False
13. Governance
Terminal Questions
1. Ethics is the system of moral values and principles of human conduct and its application in life. Religion, culture
and law are the main factors governing business ethics. These are explained in sub-section 4.2.1 of this unit. Refer
the same for details.
2. Business ethics is important to an organisation because it leads to better public image, increased credibility of
management, helps in better decision making, and profit maximisation. These are explained in sub-section 4.2.1 of
this unit. Refer the same for details.
3. The techniques that can be used for managing ethics at a work place include formation of ethics committee,
implementation of code of ethics, setting up an ethics hotline and training programs on ethics and so on. These are
explained in sub-section 4.3.1 of this unit. Refer the same for details.
4. There are two types of negotiation that is widely used in business, linear and encompassing model. These are
explained in sub-section 4.4.1 of this unit. Refer the same for details.
5. Legal aspects are considered in the first step of decision making followed by a companies ethical code, cultural
analysis and a personal moral judgement. These are explained in sub-section 4.5.1 of this unit. Refer the same for
details.
4.10 Case-Let
Satyam Computer Services Ltd.
In December 2008, Satyam announced acquisition of two companies - Maytas Properties and Maytas Infrastructure owned by
the family members of Satyam's founder and Chairman Ramalinga Raju. Within a day of the announcement, the deal was
withdrawn because of the adverse reaction from institutional investors and the stock markets. Issues were raised on the
corporate governance practices of Satyam, with investors seeking answers from the Board about the acquisition because the
transaction was evidently made within the promoters family.
After the deal was aborted, four of the prominent independent directors resigned from the board of the company. In early
January 2009, Ramalinga Raju confessed that the revenue and profit figures of Satyam had been inflated for past several years.
The revelation further deepened concerns about poor corporate governance practices in the company.
After this debacle, questions were raised about the corporate governance structure in Satyam, its code of conduct, roles and
responsibilities of different committees under the Board, whistle blower policy and so on. Several industry bodies questioned
the role played by the independent directors of Satyam in approving the Maytas deal.
The events that unfolded after Mr. Rajus confessions to his illegal activities placed the future of thousands of employees and
the well-being of their dependents at risk, jeopardised projects worth millions of dollars, and portrayed Indian companies
inherently corrupted. Regulators and several Indian corporate companies acted quickly to persuade clients and the business
community to prove Satyams case was an isolated event. People with vast experience and knowledge of Indian business
processes were brought in to assist in preventing a total collapse of Satyam Computers, which was later bought by Tech
Mahindra.
Discussion Questions
1. Analyse the instances where the ethics system failed in preventing the fraud. (Hint: Auditing)
2. Formulate a sample code of conduct for Satyam Computers. (Hint: Refer discussions in section 4.4 of this unit)

References
Bhalla V. K. and Shiva Ramu S. (2008). International Business Environment and Management, Anmol Publications.
Bhatia SK. (2004). Business Ethics and Corporate Governance, Deep and Deep Publications Ltd.
Chauhan PL, KakkadRatish, Patel Rupal H. (2006). International Business, ShanthiPrakashan.
Cherunilam Francis. (2010). International Business Environment, Himalaya Publishing House.
K. Aswathappa. (2010). International Business, Tata McGraw-Hill Publications Co Ltd.
McDonald Frank and Burton Fred. (2002) International Business, International Thomson Computer Press.
Weiss Joseph. (2009). Business Ethics Concepts and Cases, Cengage Delmar learning India Pvt. Ltd.
E-References : www.managementhelp.org/ethics/ethics.htm - Retrieved on 3rd October 2010
Version: 1.0, Build: 1 | Copyright 2011, Sikkim
Unit-05- Country Risk Analysis
Structure:
5.1 Introduction
Objectives
5.2 Overview of Country Risk Analysis
History
Rating agencies
5.3 Purpose of Country Risk Analysis
5.4 Methodology
Data sourcing
Tools
5.5 Contents of Analysis
Country history
Corporate risk
Dependency level
External environment
Domestic financial system
Ratios for economic risk evaluation
Strength and weakness chart
5.6 Risk Premium
5.7 Summary
5.8 Glossary
5.9 Terminal Questions
5.10 Answers
5.11 Case-Let
5.1 Introduction
In the previous unit you studied about the importance of ethics at the workplace and its
application in a global business environment. Work ethics involves a set of moral values and
certain standards of behaviour. Ethics is important in all aspects of life as it forms the basis of a
cultured society.
This unit deals with the concept of country risk analysis and its purpose. Country risk analysis is
the evaluation of possible risks and rewards from business experiences in a country. It is used to
survey countries where the firm is engaged in international business, and avoids countries with
excessive risk. With globalisation, country risk analysis has become essential for the
international creditors and investors.

In this unit, you will learn about the purpose, importance and various methodologies to analyse a
countrys risk profile. You will also be introduced to the concepts of contents of analysis and the
risk premium.
Objectives:
After studying this unit you should be able to:
explain country risk analysis.
discuss the importance of analysing a countrys risk.
interpret the methodologies involved in country risk analysis.
analyse a countrys risk profile.
5.2 Overview of Country Risk Analysis
Country Risk Analysis (CRA) identifies imbalances that increase the risks in a cross-border
investment. CRA represents the potentially adverse impact of a country's environment on the
multinational corporation's cash flows and is the probability of loss due to exposure to the
political, economic, and social upheavals in a foreign country. All business dealings involve
risks. An increasing number of companies involving in external trade indicate huge business
opportunities and promising markets. Since the 1980s, the financial markets are being refined
with the introduction of new products.
When business transactions occur across international borders, they bring additional risks
compared to those in domestic transactions. These additional risks are called country risks which
include risks arising from national differences in socio-political institutions, economic structures,
policies, currencies, and geography. The CRA monitors the potential for these risks to decrease
the expected return of a cross-border investment. For example, a multinational enterprise (MNE)
that sets up a plant in a foreign country faces different risks compared to bank lending to a
foreign government. The MNE must consider the risks from a broader spectrum of country
characteristics. Some categories relevant to a plant investment contain a much higher degree of
risk because the MNE remains exposed to risk for a longer period of time.
Analysts have categorised country risk into following groups:
Economic risk This type of risk is the important change in the economic structure that produces a
change in the expected return of an investment. Risk arises from the negative changes in
fundamental economic policy goals (fiscal, monetary, international, or wealth distribution or
creation).
Transfer risk Transfer risk arises from a decision by a foreign government to restrict capital
movements. It is analysed as a function of a country's ability to earn foreign currency. Therefore,
it implies that effort in earning foreign currency increases the possibility of capital controls.
Exchange risk This risk occurs due to an unfavourable movement in the exchange rate. Exchange
risk can be defined as a form of risk that arises from the change in price of one currency against
another. Whenever investors or companies have assets or business operations across national
borders, they face currency risk if their positions are not hedged.
Location risk This type of risk is also referred to as neighborhood risk. It includes effects caused
by problems in a region or in countries with similar characteristics. Location risk includes effects
caused by troubles in a region, in trading partner of a country, or in countries with similar
perceived characteristics.
Sovereign risk This risk is based on a governments inability to meet its loan obligations.
Sovereign risk is closely linked to transfer risk in which a government may run out of foreign
exchange due to adverse developments in its balance of payments. It also relates to political risk
in which a government may decide not to honor its commitments for political reasons.
Political risk This is the risk of loss that is caused due to change in the political structure or in the
politics of country where the investment is made. For example, tax laws, expropriation of assets,
tariffs, or restriction in repatriation of profits, war, corruption and bureaucracy also contribute to
the element of political risk.
Risk assessment requires analysis of many factors, including the decision-making process in the
government, relationships of various groups in a country and the history of the country. Country
risk is due to unpredicted events in a foreign country affecting the value of international assets,
investment projects and their cash flows. The analysis of country risks distinguishes between the
ability to pay and the willingness to pay. It is essential to analyse the sustainable amount of funds
a country can borrow. Country risk is determined by the costs and benefits of a countrys
repayment and default strategies. The ways of evaluating country risks by different firms and
financial institutions differ from each other. The international trade growth and the financial
programs development demand periodical improvement of risk methodology and analysis of
country risks.
5.2.1 History
Earlier, the cross-border business risk was an issue that affected those who had transactions or
assets to receive from foreign customers. In the 1970s, the financial institutions were not well
equipped to deal with country risk. However, to improve the business; they enhanced their
exposure in foreign markets which required capital. In many cases, the loans were contracted
without regular notice to credit dealings of both the borrower and the country.
Since the 1980s, problems concerning the payback of those credits started affecting countries
such as Mexico, Poland, and Brazil, whose defaults caused heavy losses for the international
banks. As a result, this caused huge loss for investors and shareholders. So, the financial
institutions started adopting new analytical ways, maximum risk policies and strong credit
procedures, all those supported by reliable data.
5.2.2 Rating agencies
The rating agencies use country credit risk ratings and provide a periodical and organised skill of
data. It deals with a cross-border analysis. There are several agencies like Standard and Poors,
Moodys, Economist Intelligence Unit, Euro money, Institutional Investor, Political Risk
Services, Business Control Risks Information Services, Environmental Risk Intelligence,
international banks in general and others institutions. The rating agencies provide information
and analysis of economic sectors, companies, and operations assigning its related ratings.
The credit rating agencies issue credit ratings based in the European Union and are used by
investors, borrowers, issuers, and public administrations to help them make investment and
financial decisions. These ratings are used as a reference for calculating their capital
requirements for calculating risks in their investment activity.
The Standard and Poors, and Moodys rating approach divide countries in categories and the four
first levels of each one are considered as investment grades (better quality of the asset in risk
terms). Based on their assessment of a bond issue, the agencies give their view in the form of
letter grades, which are published for use by investors. For the typical investor, risk is judged not
by an instinctively formulated probability distribution of possible returns but by the credit rating
assigned to the bond by investment agencies. In their ratings, the agencies rank issues according
to the probability of default. Both agencies have a Credit Watch list that makes aware the
investors when the agency considers a change in rating for a particular borrower.
Investing agencies credit rating
Let us now study credit rating by various investing agencies.
Moodys
The table 5.1 represents Moodys credit rating.
Table 5.1: Moodys Credit Rating

Rating Description

Aaa Best quality

Aa High quality

A Upper medium grade

Baa Medium grade

Ba Acquire speculative elements

Normally lack characteristics of a


B
desirable investment

Caa Poor standing: may be in default

Speculative in a high degree; often in


Ca
a default

Lowest grade; extremely poor


C
prospects

Standard and Poors


The given table 5.2 represents Standard and Poors credit rating.
Table 5.2: Standard and Poors Credit Rating

Rating Description

Highest rating - extreme capacity to pay


AAA
interest or principal

AA Very strong capacity to pay

A Strong capacity to pay

BBB Adequate capacity to pay

BB Uncertainties that lead to inadequate


capacity to pay

Greater vulnerability to default, but


B
currently has capacity to pay

CCC Vulnerable to default

For debt subordinated to that with CCC


CC
rating

For debt subordinated to that with CCC -


C
rating or bankruptcy petition has been filed

D In payment default

Source: http://www.gwu.edu/~ibi/minerva/spring2001/renato.ribeiro.pdf
This section analysed the concept of country risk analysis and credit rating by investing agencies.
The next section discusses the purpose of country risk analysis.
Self Assessment Questions
1. The ___________ provide information and analysis of economic sectors, companies, and
operations assigning its related ratings.
2. __________ arises from a decision by a foreign government to restrict capital movements.
a) Transfer risk
b) Political risk
c) Location risk
d) Economic risk
3. The rating agencies have come up with country credit risk ratings and provide a periodical and
organised skill of data. (True/False)
5.3 Purpose of Country Risk Analysis
Let us now understand the purpose of country risk analysis.
Risk arises because of uncertainty and uncertainty occurs due to the lack of reliable information.
Country risk is composed of all the uncertainty that defines the risk of country exposure. The
assessment of country risk is used to incorporate country risk in capital budgeting and modify the
discount rate.
CRA regulates the estimated cash flows and explores the main techniques used to measure a
countrys overall riskiness. It is mainly used by MNCs, in order to avoid countries with excessive
risk. It can be used to monitor countries where the MNC is engaged in international business.
Analysing the country risk helps in evaluating the risk for a planned project considered for a
foreign country and assesses gain and loss possibility outcomes of cross-border investment or
export strategy.
Activity 1
Discuss on how monitoring of credit rating activities are carried out.
Hint: Refer these links for guidance
http://europa.eu/legislation_summaries/internal_market/single_market_services/financial_service
s_transactions_in_securities/mi0009_en.htm
http://www.prnfunding.com/factoring-process
5.4 Methodology
Country detailed risk refers to the unpredictability of returns on international business
transactions in view of information associated with a particular country. The techniques used by
the banks and other agencies for country risk analysis can be classified as qualitative or
quantitative. Many agencies merge both qualitative and quantitative information into a single
rating. A survey conducted by the US EXIM bank classified the various methods of country risk
assessment used by the banks into four types. They are:
Fully qualitative method - The fully qualitative method involves a detailed analysis of a country.
It includes general discussion of a countrys economic, political, and social conditions and
prediction. Fully qualitative method can be adapted to the unique strengths and problems of the
country undergoing evaluation.
Structured qualitative method The structured method uses a uniform format with predetermined
scope. In structured qualitative method, it is easier to make comparisons between countries as it
follows a specific format across countries. This technique was the most popular among the banks
during the late seventies.
Checklist method - The checklist method involves scoring the country based on specific
variables that can be either quantitative, in which the scoring does not need personal judgment of
the country being scored or qualitative, in which the scoring needs subjective determinations. All
items are scaled from the lowest to the highest score. The sum of scores is then used to determine
the country risk.
Delphi technique The technique involves a set of independent opinions without group discussion.
As applied to country risk analysis, the MNC can assess definite employees who have the
capability to evaluate the risk characteristics of a particular country. The MNC gets responses
from its evaluation and then may determine some opinions about the risk of the country.
Inspection visits Involves travelling to a country and conducting meeting with government
officials, business executives, and consumers. These meetings clarify any vague opinions the
firm has about the country.
Other quantitative methods The quantitative models used in statistical studies of country risk
analysis can be classified as discriminant analysis, principal component analysis, logit analysis
and classification and regression tree method.
Note: Refer this link for examples and detailed description of country risk assessment methods
tps://www.shsu.edu/~eco_hkn/CRISK_revised04.pdf
5.4.1 Data sourcing
The basic data is important to analyse a country. The economic, financial and currency risk
components are based on the variables (quantitative and qualitative variables). The variables
must consider the particularities of each country and the needs of the model used. The standard
variables are used to maintain the regular analysis comparable with similar works of other
countries. Therefore, the first step is to make sure that the historical series of official data are
reliable, consistent and comparable. The standard economic variables that are found mainly in
the varied approach adopted by financial institutions and rating agencies, are associated with the
countrys real ability to repay its commitments. The balance of payments (summary account of
economic transactions among a country and the others nations of the world, during a period) and
its evolution through the years means a strong source of data. The exchange rate (currency risk)
is another important variable considered, as it balances the transactions (balances the prices of
goods, services, and capital) between residents and non-residents. The analysis must consider the
historical behavior of the exchange rate and the policy which made clear whether the country
follows a rational economics approach or it uses the exchange rate as a tool to maintain a forced
macroeconomic equilibrium.
Apart from the macroeconomic variables which deal with the external sector of the economy,
there are some other relevant variables such as the interest rate, level of investments, public debt
and its service, internal savings, consumption, GDP or GNP, money supply, inflation rate and so
on.
The analysis must be accomplished with qualitative variables, which consider social aspects as
population, life expectancy, rate of birthday, rate of unemployment, level of literacy and so on.
The social-political aspects are necessary for all kind of analysis as they describe the whole
setting of the running economy.
5.4.2 Tools
The risk management demands a regular follow up regarding governmental policies, external and
internal environment, outlook provided by rating agencies, and so on. Following are the tools
recommended:
Chain of value - Includes the main countries that sustain trade relationships with the nation,
broken by sectors and products.
Strength and weakness chart - Focus the key aspects that warn the country.
Table of financial markets performance - Follow up the behavior of bonds and stocks already
issued and to be issued.
Table of macroeconomic variables - Provides alert signals when the behavior of any ratio
presents a relevant change.
Self Assessment Questions
4. _____________ explores the main techniques used to measure a countrys overall riskiness.
5. Which of the following methods involve a detailed analysis of a country and includes general
discussion of a countrys economic, political and social conditions and prediction?
a) Structured qualitative method
b) Checklist method
c) Fully qualitative method
d) Regression tree method
6. The standard variables must be used to maintain the analysis regular and comparable with
similar works about other countries. (True/False)
7. The __________ method involves scoring the country based on specific variables that can be
either quantitative or qualitative.
5.5 Contents of Analysis
The content of country risk analysis mainly involves country history, corporate risk, dependency
level, external environment, domestic financial system, ratios for economic risk evaluation and
strength and weakness chart.
5.5.1 Country history
The historical brief helps to identify aspects that interfere in the future behavior of the country,
reducing the ability to payback any external commitment. The main historical data provides a
good understanding of the key factors which draw the behaviour of the society, the government,
the private sector, the legal environment, the economical, political, and the relationships to
neighbour nations and the world as a whole.
The organisation of the government and its features like political and administrative organisation
are also relevant aspects to be approached. The political forces which act in the country, their
representatives and the main national issues must be focused. The other considerations include
social aspects and their key-indicators like population growth rate, unemployment ratio, infant
mortality rate, composition of the population and life expectancy. The geographic positioning
and its related strengths and weaknesses are also critical aspects.
5.5.2 Corporate risk
Both country risk studies and business risk analysis enhances wealth from the available
resources, in terms of capital, natural resources, technology and labour forces. This clarifies that
those kind of analysis procures extensive knowledge from the business approach for companies,
including financial theory.
5.5.3 Dependency level
The next step after the history in brief, is a clear definition about how the country is positioned in
the world in terms of its wide relationships, economic block in which it belongs to, importance of
international trade and so on. All these aspects are significant to identify the dependency level of
the country. The financial dependency to meet the needs of a country is also a strong concern for
the analyst. In this case, the maturity of debts (internal and external) and the available sources of
financing also help to measure the freedom grades of the country.
In case of output spread throughout the economy, the analyst can break the GDP`s economic
sector, evaluate its composition in terms of values of participation of each one and the level of
regional concentration. It is similar to corporate approach when analysing the income structure.
The same approach can be made in case of the international trade where the analyst must break
up each part of the trade balance in sectors, countries and economic blocks, goods, identifying its
composition and level of concentration (percent and value). It would be convenient to get the
ratio between the trade balance and the GDP (sum of imports and exports over the GDP).
Financial issues also must be clarified, as how much is been supported by domestic or external
savings. At this moment, the conclusions can be listed to point out the parts that remain
significant for the understanding about dependency level of the country and its freedom levels.
The conclusions about the approach towards the dependency level and the level of concentration
in producing and trading goods are the key factors to understand the economys trend.
5.5.4 External environment
The external trade is an important factor to the development of societies. Globalisation has
brought international business to the center of the discussions and the external environment has
become vital for all countries.
Thus, a complete vision on economic trends, the behavior of financial markets, the forecasts for
conflicts among nations, the improvement of the economic blocks, the level of openness of the
world economy, financial crisis and international liquidity is a framework over which the
analysis must start.
The analyst must select the issues that are closely related to the country dealt with, to figure out
the impact of the most likely situation and to apply over the country`s economic variables. The
dependency level, external landscape, its trends and the ratio between GDP and external trade
will provide useful information to connect the external sector to the domestic sector in order to
identify opportunities and threatens.
5.5.5 Domestic financial system
The banking sector has implemented many actions to avoid losses, after the international crisis.
Basel Committee has defined some strong measures to be followed by the financial houses and
Central Banks are trying to monitor their jurisdictions. Apart from those procedures, recently
Asia and Turkey crisis have shown that the inspection is not enough to keep the reliability of
some domestic system. The international banks had developed many tools to deal with
international crisis. When domestic banks do not have a consistent risk management policies and
adequate provisions to theirs credits, the country risk happens to be the worst. Therefore, the
analysis must consider the health of the domestic financial system, by evaluating information
provided by the Central Banks and, from the principal banks of the country. Accessing Centrals
Bank policies and supervising procedures also help to evaluate the health of the financial system.
5.5.6 Ratios for economic risk evaluation
Cross-border economic risk analysis evaluates the probable macroeconomic ratios among some
variables. They can be separated into two groups such as domestic and external. The figures must
be presented in historic series (at least five years) to provide information about its progress,
which can be real values, percentages, or relations. The mainly used ratios and variables in case
of domestic economy are the following:
Gross domestic product (GDP) - The real value must be broken up by sector (agriculture,
construction, services and manufacturing), by private and public sector and by principal goods
and services.
GDP per capita - Its growth determines the country`s productivity. Many rating systems use this
ratio because it helps to clarify the efficiency of the countrys growth rate.
GDP growth rate - The annual rate can be also broken up in the same way, to mention the sectors
or products that have a specific behavior for better understanding of the economy`s trend.
Unemployment rate - It deals among several aspects, with the labor factor and give details on
performance of the whole economy, conditions presented by the internal market and the political
environment. This ratio, combined with growth rate data, the analysis reveal strategic issues that
the economic policy must approach.
Internal savings or GDP - This ratio work with the tendency of saving of the whole economy.
Gross domestic savings can be broken by economic agents (householders, firms and
government).
Investment or GDP - This percentage reveals how strong could be the economy in the future as it
gives a potential rate of capital improvement, named the gross fixed capital formation. It is
important to break this information up in sectors to understand about the growth of economy.
Gross domestic fixed investment or variation of GDP - The ratio assesses the quality of the
previous (since around five years before) investment decisions in terms of its efficiency in
growing the GDP.
Gini Index - It estimates the income distribution among different groups in society. This ratio,
combined with the development of GDP per capita, it reveals about the strength of internal
market.
Growth domestic fixed investment or gross domestic savings - The ratio that describes the
domestic savings maintains the investment made at the economy. This ratio, combined with
domestic fixed investments and net capital imports, specifies the dependency of the economy on
foreign resources.
We discussed on macroeconomic variables that deals with the amount or quality of the product
provided by the economy, in a certain period of time. But, the fiscal side is also important
because it helps to understand the role of the government and its significance in the entire
economy. Thus, the following ratios are considered:
Budget deficit or GDP - The growth of this ratio denotes how the dissavings increase the
resource gap. A solution must be found to balance the outcome and to straighten the economic
fundamentals.
Internal debt or GDP - This ratio combined with the budget deficit and GDP ratio, reveals about
how much the public sector uses the savings of the country.
The monetary policy is essential as it deals with the price stability. An economy which presents
less instability in its prices of goods and services, provides huge facilities to decision makers
based on their predictions to expected returns of investments and a firm social, economical and
political environment. All these aspects request a systematic approach over price indicators such
as the following:
Real interest rate - This is a dominant measure about the assurance of economic agents, which
deals with their prospect on the future of the economy. The price of the currency has an inverse
relation with the investment and when it rises, the whole economy shows a decline on its
performance. The advancement of the rate must be measured after extracting the effects of the
inflation during the period.
Percentage increase in the money supply - This reveals how policy makers deal with the
variations on the stock of currency that is considered during the analysis of the government
budget to identify whether the public sector forces the supply of currency in order to support
current shortfalls.
The mainly used ratios and variables in case of external economy are the following:
External debt or GDP - This ratio represents the whole external debt importance to one year flow
of production. If the ratio is lower, the external financial position of the economy will be
improved.
Short term debts and reserves - This ratio shows how much the reserves are committed by
amortisations in the short run. The debts maturity is essential to identify whether a country have
problems to repay its liabilities.
Exchange currency rate - This is a well-known type of country risk. The exact price of the
currency in market terms is necessary for the economic stability and the growth of the country.
The exchange rate contributes to a profitable allocation of resources in the whole economy apart
from preventing artificial losses or gains of competitiveness and their impacts in the trade
balance. Many countries are implementing a flexible exchange rate system in order to better set
the price of their currencies. Thus, the exchange rate forms an essential part of country risk
analysis and must be strictly followed to make out any unusual behavior.
External debt services and exports - The developing markets find their main source of funds to
produce strong foreign currency to support amortisations from the external debts. The exports
must be large enough to pay interest and principal on the exceptional foreign debt. The foreign
currency will not be available to meet payments, if the exports are not large. This financial ratio
brings a sensible application of the countrys ability to pay, similar to a cash flow coverage ratio.
5.5.7 Strength and weakness chart
In order to explain the significant aspects provided by the analysis, the strength and weakness
chart can be used to merge each strength and weakness with the related scenario. The below
given tables 5.3 and 5.4, contain some variables that are put up from combined experiences about
an imaginary country. It is a model of relationships among several variables (quantitative and
qualitative) to show their interdependency and the complexity of analysis.
Table 5.3: Strength Chart

Strength factors Possible outcome

Increase in IDH performance High


Lesser social demands
government approval rate

Population profile allows economic


Enough supply of labor force
equilibrium

Support for private economic


Well-defined social-economic plans
decisions

No constrains in terms of raw


Available environmental resources
materials

Budget equilibrium on the short run No more pressures over interest rates

Relevant internal market Opportunity for private profits

Sustainable GDP growth rate Reduction of unemployment rate

Strong and well managed private


Entrepreneur culture
sector

Modern and well-regulated bankingLess risk in a volatile situation


system

Rise in the growth fixed capital


Positive forecasts for future growth
formation

Floating exchange rate Flexibility for market adjustments

Sustainable decrease on interest rates Better conditions for investments

Room to deal with liquidity


High level of reserves and imports
constrains

Long-term maturity public internal


Budget compatible debt services
debt

Efficacious monetary policy Less volatility of returns for investors

Import profile concentrated in capital


Positive forecasts for future growth
goods

History of no external conflicts Stability in external relationship

Table 5.4: Weakness Chart

Weakness factors Possible outcome

Increase in the strategic raw materials


Rise in foreign currency expenditures
prices

Economic block integration remain


Limited trade improvement
slow

External environment presentingDiverse contagious risks. Rise in


instabilities spreads

Income concentration Social pressures

Risk of government`s income


Restrictions to sustain GDP`s growth
reduction

Slowdown in developed countries Limited market for exports

Decrease in commodities export


Risk of trade balance deficit
prices

Strong resource gap External flows dependency

Low levels of literacy and skill labor


Productivity restrictions
forces

Expressive ratio internal debt or GDP Sterilisation of private savings


Reductions on capital inflows Risk of currency devaluation

Investors concerns on the financial


Liquiditys lack to developing nations
markets

Worsening in the terms of trade Pressure over current account balance

Worsening in the ratio external debt


Risk of downgrade in country grades
and GDP

Improve in the ratio CA deficit and


Improvement in capital flows needs
GDP

Forecasts for trade balance deficit Improvement in capital flows needs

Raise in international interest rates Increase in the external debt

Source: http://www.gwu.edu/~ibi/minerva/spring2001/renato.ribeiro.pdf
The depicted charts stress the risks shown during the analysis and it must be assessed in terms of
the observed macroeconomic performance provided by the ratios mentioned earlier.
5.6 Risk Premium
Several restrictions exist to build econometric models to deal with country risk analysis as a
whole. The most familiar models are used for capital market investment, where the prices of the
assets and theirs related instabilities helps to follow the behavior of securities. However,
managing credit risk demands a score to distinguish different sorts of risk among nations. In this
case, after receiving the outcomes from the macroeconomic and social ratios, it is possible to
make a rating to block those countries that show similar behavior.
Peer analysis splits the countries according to the observed performance and an automatic rating
system can be applied to similar countries. The approach remains essential to confirm the
recognised scores. Thus, the analyst contributes to define the final risk level. Depending on the
uses of the analysis, an exposure limit can also be defined. Its value is obtained from a strategic
definition provided by the in charge of this issue and must be consistent with the attributed
country ratings when defining each exposure limit.
Activity 2
Discuss on how country risk must be built in for valuations in emerging markets.
Hint: Refer this link for guidance
- http://gcg.universia.net/pdfs_revistas/articulo_104_1227718800862.pdf
Self Assessment Questions
8. Which among the following is a dominant measure about the assurance of economic agents,
which deals with their prospect on the future of the economy?
a) Real interest rate
b) Exchange currency rate
c) GDP growth rate
d) Unemployment rate
9. Gross domestic fixed investment estimates the income distribution among different groups in
society. (True/False)
10. The growth of __________ ratio denotes how the dissavings increase the resource gap.
5.7 Summary
Let us summarise what we have learnt in this unit on country risk analysis:
Country risk analysis (CRA) identifies imbalances that increase the risks in a cross-border investment.
Country risk is composed of all the uncertainty that defines the risk of country exposure. The assessment of country
risk is used to incorporate country risk in capital budgeting and modify the discount rate.
Country detailed risk refers to the unpredictability of returns on international business transactions in view of
information associated with a particular country.
The content of country risk analysis mainly involves country history, corporate risk, dependency level, external
environment, domestic financial system, ratios for economic risk evaluation and strength and weakness chart.
Managing the credit risk demands a score to distinguish different sorts of risk among nations.
5.8 Glossary
Capital budgeting: The process in which a business determines whether projects such as building a new plant or
investing in a long-term venture are worth pursuing.
Deficit: Excess of expenses over income or liabilities over assets.
Expropriation: Legally The act of removing property from an owner.
Macroeconomics: The branch of economics which deals with aggregates such as capital and labour, and their
interactions in an economy as a whole.
5.9 Terminal Questions
1. Explain country risk analysis.
2. Discuss the importance of analysing a countrys risk.
3. Describe the methodologies involved in country risk analysis.
4. Interpret contents of analysis.
5. Analyse a countrys risk profile.
5.10 Answers
Self Assessment Questions
1. Rating agencies
2. a) Transfer risk
3. True
4. Country risk analysis
5. c) Fully qualitative
6. True
7. Checklist
8. a) Real interest rate
9. False
10. Budget deficit or GDP

Terminal Questions
1. When business transactions occur across international borders, they bring additional risks compared to risks in domestic
transactions. Refer to section 5.2 of this unit for more information.
2. Country risk analysis regulates the estimated cash flows and identifies the relevance of country risk analysis. Refer to section
5.3 of this unit for more details on importance of country risk analysis.
3. Many agencies merge both qualitative and quantitative information into a single rating. Refer to section 5.4 for details.
4. The content of country risk analysis mainly involves country history, corporate risk, dependency level, external environment
and so on. Refer to section 5.5 of this unit.
5. The most familiar models are used for capital market investment, where the prices of the assets and theirs related instabilities
helps to follow the behavior of securities. Refer to section 5.6 for details.

5.11 Case-Let
Enterprise Risk Management: ABC Life Insurance Company
ABC Life Insurance Company, a privately held company, was well aware of its insurance risks, but it needed a perfect view
of the probable impact of major risks on its overall assessment. The company wanted to build an Enterprise Risk
Management (ERM) plan to enhance rating agency discussions on ERM, confirm recent risk easing decisions and apply this
agenda to its other business units. ABC Life Insurance's actuaries,
functioning with their chief financial officer, corporate management, life operations senior management and disaster
recovery team, established a framework to determine the worst-case scenarios involving insurance, operational and
reputational risks that could decrease its stakeholder value.
Problem
During their risk analysis, the team found out a worst-case scenario of largest decrease in the enterprise value of the
company. In addition, other major events included an attack on the computer network and issues with non-guaranteed
insurance elements affecting the company severely.
Solution
The ERM framework provided a measure to estimate the company's enterprise risk value and better understand the impact of
severe risks on stakeholder value. As a result, the company developed new processes on managing the situation. The
immediate results in implementing the ERM framework also helped ABC Life to confirm the efficacy of its recent ERM
easing efforts.
Result
ABC Life Insurance team is now expanding the well-known ERM framework to its property and casualty branch and the
overall corporation. The framework helped assess the risk tolerance level for the company's senior leadership in making
strategic decisions to navigate future risks.
Discussion Questions
1. Why ABC Life Insurance Company established an ERM framework?
(Hint: ABC Life Insurance wanted to build an ERM plan to enhance rating agency discussions on ERM. Refer to the section,
Enterprise Risk Management: ABC Life Insurance Company for more details.)
2. Identify the role of ERM framework in handling the issues of worst-case scenario.
(Hint: The ERM framework provided a measure to estimate the company's enterprise risk value. Refer to the section,
Solution for more details.)
Source: http:// www. soa. org/ news and publications/newsroom/ erm/country -life.aspx

References
Michael Frenkel, Alexander Karmann, Bert Scholtens, L.J.R Scholtens (2004). Bank Sovereign risk and financial crisis: Springer
Publications.
Jeff Madura (2008): International Financial Management, 9th edition: Thomson South-Western Publications.
E-References
http://www.gwu.edu/~ibi/minerva/spring2001/renato.ribeiro.pdf
http://findarticles.com/p/articles/mi_m1094/is_1_35/ai_59964458/- Retrieved on 1st October, 2010

Unit-06-International Human Resource Management


Structure:
6.1 Introduction
Objectives
6.2 International Organisational Structures
Factors influencing organisation structure
Types of structures
6.3 Introduction to International Human Resource Management
Managing international human resource activity
Domestic versus international human resource management
Expatriate staff
6.4 Scope of International Human Resource Management
National differences in HRM practices
Strategies for international human resources management
International employee relations
Staffing policies in international business
6.5 Summary
6.6 Glossary
6.7 Terminal Questions
6.8 Answers
6.9 Case-Let
6.1 Introduction
In the previous unit you learned about country risk analysis, its purpose, and methodology. In
this unit you will learn about the structure of MNCs and various dimensions and strategies for
international human resource management.
As businesses metamorphoses into multinational companies and as the world evolves into a
global marketplace, international firms need to be supported by adequate human resources.
Human Resource Management (HRM) practices are necessary in order to procure, allocate, and
utilise human resources particularly managerial manpower in an efficient manner. While many
aspects of traditional HRM policies and procedures are applicable when a company operates
abroad, the integration of the various regulatory aspects and diverse cultural dimensions makes it
necessary for a company to dwell into international HRM to operate efficiently at an
international level.
Objectives:
After studying this unit, you should be able to:
interpret the types of international organisational structures.
describe the international HRM process.
examine the various aspects in expatriate employment.
discuss the scope of HRM.
explain the staffing policies of a multinational corporation.
6.2 International Organisational Structures
The structure of an organisation plays a vital role in HRM. It is important to understand the
structure before getting into the discussion on HR practices.
Organisational structure of an international business plays a very important role in realising the
goals of the company. International companies need appropriate structure to conduct their
business effectively in a competitive economy. The structure of an international business is more
complex than in the case of a purely domestic firm. The more assets and employees a firm has in
its foreign offices, the more languages, cultures, and time zones it has to cope with resulting in a
more complex structure.
The structure has to be well-designed and be based on the business strategy. It is important that
various structural components are considered properly. The following are the objectives of a well
designed organisational structure:
Have the right people take right decisions at the right time.
Establish reporting hierarchy and accountability.
Facilitate easy flow of information in the organisation.
Provide a positive work environment that encourages efficiency.
Integrate and coordinate activities.
A multinational firm shares large amounts of information between the headquarters and its
various offices and subsidiaries across the world. Hence, integrating and coordinating
organisational activities is imperative in the organisational structure.
There are various factors that influence the design of organisational structures. Let us discuss
some of these factors in detail.
6.2.1 Factors influencing organisation structure
The major factors that influence organisational structure can be classified very broadly in two as
follows:
Environment.
Technology.
Environment
Environmental factors include both internal and external factors affecting the organisational
structure. Let us briefly discuss these factors.
Internal environment - Internal environment includes factors controlled by the management or
based on the functions of management. The way management functions contribute to the design
of the organisation structure. Some of the management approaches affecting organisational
structure are as follows:
Ethnocentric management: Decision making is controlled by the head office and most of the
managers are from the parent company.
Polycentric management: Decisions are largely decentralised and managers in the subsidiaries
are mostly from the host country
Geocentric management: Decision making is decentralised and managers from across the globe
make decisions, affecting operations internationally. In this approach, manager in country A can
make decisions affecting the operations in country B.
The size of an organisation influences its structure. Bigger companies with multiple divisions
add to the level of complexity of organisational structure. Increase in organisation size prompts
for an increasing number of employees to keep up with the organisations growing business. It
also brings in the need for additional rules and regulations to maintain optimum levels of
efficiency and productivity. The need for decentralisation increases when the company grows in
size.
External environment - External environment refers to a wide array of factors beyond the
company's control. These factors can be classified as follows:
Environmental risks The instability caused by the differences in culture, government policies,
strength of the economy, availability of qualified employees, industry cycle, stability of the
financial system and so on constitute environmental risks.
Strategy for expansion These include the strategies that a company adopts to enter new markets
or expand its business (refer sub-section 1.2.4 and 1.3.1 of Unit 1). The structure of a business in
turn depends on the strategy adopted by the company.
Technology
Technology plays an important role in the design of an organisation structure. The application of
technology at different levels like employee, division and organisation determines the design of
the structure. An organisation may use the technology at different stages like inputs like raw
material, production stage, and delivery stage. The sophistication of technology determines the
design of a modern business organisation.
Irrespective of the organisational structure, every firm uses technology and facilitates
communication across job profiles in the organisational structure. Every department of the
organisation uses technology and a wide variety of these departments include technology experts
among their employees. The technology and the professionals working in this field must support
and connect every area of the organisation.
The integration of Information Technology (IT) facilitates communication among employees. A
conscious effort must be made to maintain relationships with each group. IT representatives must
provide updates to the employees about their various products and applications. In return, the
employees must provide feedback on these products and application to the IT department. These
relationships within departments are often overlooked and are lost due to immediate
organisational design challenges. Hence, relationships with all future participants must be
maintained through well planned communication.
Technology and the knowledge-based economy are not constrained by the physical objects and
materials of an organisation. Information is flexible and can be structured and organised in a
number of ways. For example, videoconferencing and telecommuting allow members of project
teams from different departments to work together regardless of their geographic location or
department. Thus, technology enables departments within organisations with easier
communication
6.2.2 Types of structures
Organisations adopt the most suitable structure based on the various factors that we discussed in
the previous section. Let us now discuss some of the most commonly used structures for
international business.
Export structure - A domestic company has to make provision for an exclusive export division.
Instead of using an agent, if this division undertakes all the export activities, then it needs to
maintain a minimal staff for the following functions:
Maintain export documentation like shipping, insurance, finance, and customs.
Conduct international marketing research to understand procedures and regulations.
Distribute products in the foreign markets.
Indulge in sales and marketing, advertising, promotions, mail order catalogues and so on.
International division structure - An international division is established in a company when
there are substantial branches or subsidiaries operating in foreign countries. This division
controls all the foreign operations of the organisation. Since all the foreign operations are under
one authority, control and communication are easy. Figure 6.1 depicts an organisation with an
international division.

Figure 6.1: International Division Structure


Functional structure - In this structure, each functional department is responsible for activities
around the world. For example, the finance department is responsible for the organisations
finance activities around the world. This is the case with all the other functional departments,
such as marketing, manufacturing, and human resources management. This design is used by
international firms that have a narrow product line with limited number of products.
Figure 6.2 depicts an organisation with a functional structure.
Figure 6.2: Functional Structure
From the figure you can see that each division directly deals with countries A and B.
Regional structure - In this structure, international operations are organised by dividing the entire
globe into different geographic regions. Strategic decisions are made in the headquarters and the
regional manager is responsible for all operational issues within the region. Figure 6.3 depicts the
regional structure in an organisation.

Figure 6.3: Regional Structure


From the figure you can see that regional managers for Europe and Asia Pacific regions report directly to
the company headquarters while taking charge of their respective countries.
Foreign subsidiary structure - In this structure, each of the companys foreign subsidiary reports directly to
the headquarters. This structure eliminates the necessity of a regional manager. Though strategic decisions
are taken at the headquarters, each subsidiary acts autonomously for their local operations. Figure 6.4
depicts the foreign subsidiary structure in an organisation .
Figure 6.4: Foreign Subsidiary Structure
From the figure you can see subsidiaries based in USA, UK, France, and Japan report directly to
the headquarters in India.
Product division structure - International companies that have a diversified product range across
diversified markets can opt for product based organisational structure. Global responsibility for a
product or a group of products is on separate operational divisions within the company. This
organisational structure as depicted in figure 6.5 is followed most commonly by multinational
consumer goods companies.

Figure 6.5: Product Division Structure


From the figure you can see that product managers report directly to the headquarters while they
are responsible for all the operations in their respective countries.
International matrix structure - This structure is the most complex form of organisational
structure. This form of structure is suitable where several functional divisions from across the
globe performing related duties are grouped together into an international product division.
These product divisions can then plan, design, develop, produce the products or services
required. The product divisions are dissolved or the teams are assigned to some other division
after the project is executed. Figure 6.6 provides you an idea of the international matrix structure.

Figure 6.6: International Matrix Structure


In the matrix structure, you can see that different product managers work with different
departments across the globe, breaking all the divisional barriers.
Self Assessment Questions
1. A well designed _______ facilitates efficient communication in an organisation.
2. Technology and the environment are factors that influence organisational structure.
(True/false)
3. ________ is the most complex form of organisational structure.
a) Product division structure
b) Functional structure
c) International matrix structure
d) Foreign subsidiary structure
6.3 Introduction to International Human Resource Management
In the previous section you learned about international business organisational structures. In this
section, you will learn about the ways in which HRM deals with workforce management and its
relationship with the organisation. The purpose of HRM is to make the most use of the firms
human resources so that both employer and employee benefit from their association. The
following are some of the functions of HRM:
Plan, recruit and terminate employees.
Educate and train employees for career development.
Provide compensation and terms of employment for employees.
Facilitate communication between employers and employees.
Settle disputes and negotiate on wages and working conditions.
International Human Resource Management (IHRM) is the process of recruiting and managing
the services of an organisations personnel across the globe, to achieve its goals.
6.3.1 Managing international human resource activity
Employees are an asset to the organisation. HRM activities need to be designed to utilise the
employees potential to the maximum. This can be achieved through their involvement with the
organisation and by increasing the employees commitment to the business objectives of the
organisation. The employees are trained to accept change, be innovative, and become quality
conscious and flexible. HRMs task is to integrate personnel into the organisations corporate
ideologies and to constantly help the workforce to be more productive and efficient, thereby
making the business more productive.
Figure 6.7 illustrates some of the important activities involved in HRM.
Figure 6.7: HR Activities
As depicted in figure 6.7, human resource planning, recruitment and selection, training and
development, performance management, remuneration, repatriation and employee relations play
an active role in the organisations efficiency. Let us now discuss some of the important activities.
Human Resource Planning (HRP) - HRP is a very important aspect in the process of HRM. It is
the process of assessing staffing requirement for the future and taking care of the adequate and
timely supply of human resources for the same. In an international scenario, HRP plays a greater
role in achieving the global objectives of the organisation, as the sourcing of HR is spread across
countries. Some of the challenges in international HRP are as follows:
Identify the key top management executives.
Design organisational structure and responsibilities of international managers.
Provide adequate training to managers and equip them for a multicultural experience.
Maintain the career focus of the international managers by providing adequate developmental
opportunities.
Integrate multiple business units across the globe to a common strategic objective.
Recruitment and selection - Hiring employees is a challenge for any international business. The
international HR managers have to make sure that they hire the most suited candidates. This
means that possessing the right skill is not the only criterion. They must also look at the
adaptability of the potential employees to the corporate culture and beliefs of the organisation.
The HR manager also needs to make sure the organisation hires new employees with flexibility
to adapt to foreign cultures.
6.3.2 Domestic versus international human resource management
Fundamentally, domestic HRM and IHRM have the same processes and objectives. IHRM
differs from the domestic HRM in terms of its scope and its challenges because of the
internationalisation of business and its managers. Let us discuss some of the factors that
differentiate IHRM from domestic HRM.
The scope of the HR activities is larger because the organisation deals with multiple countries
and employees from several cultures.
International workforce requires greater involvement of management at a personal level.
The approach is complex because of the potential cultural mix in the workforce.
Risk management is an integral part of the IHRM policies.
Expatriates are subject to tax at home and in the host country. Hence, tax policies have to be
devised in a way that they do not penalise the employee for moving to another country.
Relocation of staff involves providing immigration and travel services, providing housing,
medical care, schooling for employees children, pre-departure training, international allowances
and so on.
The laws in the host country vary from those in the parent country. The human resource
department must be equipped to deal with all potential issues and ensure that the newly relocated
employees and their families are able to function properly in the foreign country.
Differences in government policies of foreign countries requires the human resource team to
ensure that all the expat employees adhere to the norms set by the government.
6.3.3 Expatriate staff
Expatriates play a major role in international businesses. Multinational companies place a lot of
effort in selecting employees. By employing staff from the parent country in the companys
various international locations, the senior management ensures that the foreign subsidiary runs
according to the requirements of the head office. The senior management also ensures that
experienced employees with the right attitude and capabilities are involved with foreign
operations and are fully aware of company policies. Expatriates also tend to have greater product
knowledge and managerial expertise than the locals.
The following are some of the disadvantages in employing expatriates:
Problems with the local language, customs, culture, and business practices.
Time to settle in the new environment, which has a negative impact on the employees
productivity.
Prejudices towards certain ethnic groups may arise during foreign posting.
Imposed management style that the host country employees are not comfortable with and may
find inappropriate.
Obstruction of opportunities for local staff.
Expatriate selection
Selection of expatriate employees is a highly specialised function in HRM. The following factors
are important while recruiting an expat employee:
Technical competency.
Interpersonal skills.
Ability to cope with the foreign environment.
Ability of the expatriates family to adjust to the foreign environment.
Figure 6.8 presents the different criteria for recruiting expatriate employees. The HR team must
consider the candidates personal expectations, as well as the candidates family comfort, in
moving to a foreign country.

Figure 6.8: Expat Selection Criteria


After the HR team selects the right candidate, they provide proper support and information to the
employee and family for a smooth transition. This step is critical to the success of employing the
expatriate and in turn the success of the international business unit. Before posting the newly
recruited employee to the international location, the company must do the following:
Provide the employee and family with cultural and language orientation with the intention of
familiarising the new country to them.
Make provision for pre-assignment visits so that the employee, spouse and family can find
appropriate accommodation, schools, recreational options and so on.
Assign mentors who are familiar with the experience of relocation, preferably from the home
country.
Counsel the family about the challenges of moving to a new country so that they can prepare
themselves.
Expatriate failure
Globally, there has been a failure rate of more than 25 percent amongst expat employees. Despite
the training and efforts undertaken by the HRM, the expats underperformance and failure has
been a matter of concern for the multinational companies. Most cases of expatriate failure have
been due to the following reasons:
Spouses inability to adjust.
Marital stress.
Employees inability to adjust.
Home sickness.
Hostility towards host nationals.
Loss of confidence.
Family tension and conflict.
Personal or emotional maturity.
Inability to cope with larger international responsibilities.
Difficulties with new environment.
Personal or emotional problems.
Lack of technical competence.
Self Assesment Questions
4. Planning, recruiting, and termination are some of the functions of ______________
management.
5. The expats underperformance and failure is not a matter of concern for the multinational
companies. (True/False)
6. HRM activities need to be designed to utilise the employees potential to the maximum.
(True/False)
7. Which of the following is not an important activity involved in HRM
a) Human resource planning
b) Recruitment and selection
c) Remuneration
d) Project planning
Activity 1
Play the role of an international HR manager and devise a plan in 500 words to help with the
transition of an expatriate employee and his family to an Indian city.
Hint: Domestic versus international human resource management
6.4 Scope of International Human Resource Management
In the previous section we studied the role and other aspects of selecting expatriate employees. In
this section, we will discuss the scope of IHRM. The three main dimensions of international
human resources management are as follows:
Human resource activities.
Countries of operation.
Origin of employees.
Human resource activities - HR activities in an IHRM context involves procurement, allocation,
and utilisation of workforce. These functions in turn cover all the six activities of human
resources management, that is, human resource planning, hiring, training and development,
remuneration, performance management, and employee relations.
Countries of operation - The countries of operation in an IHRM perspective involves the host
country in which the overseas operation is located, the home country that houses the
headquarters of the company, and other countries that supply labour and finance.
Origin of employees - The origin of the workforce of an international business can be classified
into three types - parent country nationals, host country nationals, and third country nationals.
6.4.1 National differences in HRM practices
In this section, let us discuss the factors that determine human resources management practices
in each country. The different factors are economic, social, cultural, legal, labour market,
business stakeholders, role of the state, the workforce and so on. Differences that arise at a
national level are as follows:
Degree of employee participation in decision-making by the management.
Legal regulations of employee relations and rights of employees.
The importance of market forces when deciding remuneration and employment conditions.
Cultural background of the key people involved in human resources management.
Across various countries, the same jobs can vary with respect to motivation, commitment, pay
scale, skill set, and education. Other factors that determine national differences are length of
employment that has an effect on the attitude of personnel towards the organisation, age and
gender, expectation regarding working hours, and so on. The attitude of managers from different
countries also varies in many aspects. Some of these aspects include the following:
Management style.
Values and ethics.
Approach to decision making.
Approach to problem solving.
Expectations in relation to remuneration.
Importance given to management models and techniques.
Attitude to risk.
6.4.2 Strategies for international human resources management
The success of a multinational company depends on the techniques and strategy adopted to
select, train, develop, manage, and motivate its workforce. An organisation achieves its
objectives only with competent employees. The main reasons for organisations to formulate a
human resources strategy are as follows:
Capable of competing on an international level with rivals when they have most efficient
employees.
Employee expense is a large part of the total spending of a multinational firm.
Capacity to innovate, add new business lines, and enter new markets depend more on its
employees than on capital investment.
Emphasis on the computerisation of administrative and manufacturing functions has a large
impact on the structure of employment within a business. There is lower demand or unskilled
labour.
Need for specialist skills, which are attained over time and experience, to increase organisational
complexity.
Employees have to be treated based on the specific labour laws that the host countries follow.
A proper human resources strategy is needed if the management emphasises on human relations.
It thus, encourages a professional approach to human resources management. Problems with the
strategies discussed earlier include the following:
The lack of genuine commitment to execute the strategy since strategies are sometimes
formulated as a formal procedure based on the norms of the headquarters.
The differences in opinion over a worthwhile human resources strategy may arise between the
human resources department at the head office and the subsidiaries.
The necessity for all the organisations employees to be aware of the human resource strategy
through proper communication between management and the workforce. Without proper
employee involvement, it is difficult to implement the HR strategies.
Improper HR strategies lead to various organisational issues that are not obvious in the short
term.
Influences on international human resources management
External factors that influence human resources strategies are as follows:
Legal factors related to the workforce on issues such as the right to strike, employee protection,
participation in management decisions, setting of minimum wage levels.
Political environment, which refers to the attitude of the host country government, guidelines on
employment, and industrial relations.
Economic factors including inflation, unemployment, competition, and growth prospects.
Social trends such as participation of women in the workforce, attitude towards working hours,
demands for improvement of working life quality, changes in living standards, opportunities for
education and so on.
Technological factors that affect working methods, needs to impart new skills on the workforce,
flexibility of labour, and the impact of new technologies on the management.
The internal factors that affect the international human resources strategies are as follows:
The level of decentralisation of the company.
Morale of the employees.
Ability of unskilled workers to complete jobs.
Background, educational level, and technical skills of the local workforce.
Trade union activity within the subsidiaries.
Attitude of the important stakeholders towards employee relations.
Perspectives of top managers.
6.4.3 International employee relations
Employee relations deal with all the formal and informal relationships between employees and
the management. There is a greater emphasis on cooperation than on conflict in the management
of employee-relations. It is important for the management to recognise the importance of
harmony within the workforce across various countries. The management should credit increased
competitiveness to employee relations policies for better employee cooperation.
Some of the major decisions the management must consider while devising an employee
relations strategy are as follows:
Decide whether to recognise trade unions.
Implement procedures that affect employee relations and the way managers approach employee
relations. For example, selection, recruitment, appraisal, training, and promotion.
Check if external agencies used by the management help in resolving conflicts.
Divide the profit between the business owners and workers.
Communicate effectively with employees.
Know the extent to which employee representatives are involved in making decision at a
management level.
Generally, MNCs customise the employee relations policies for each subsidiary or country
depending on that countrys labour laws and practices. Because of the differences in the approach
by different countries, companies cannot use a standardised model across its international
operations. The state of employee relations in the subsidiaries is important in controlling labour
costs and helping the organisation grow. This is a cause of concern to the parent company.
Headquarters advises on the following aspects:
The firms philosophy on workers relation with the management and the role of trade unions.
Various solutions to employee relations.
Cost factors that arise due to the companys overall strategy.
Comparison of success of employee relation policies in other countries.
Pay scales and employment conditions in various countries.
Measures to improve productivity in other countries.
Management aims to apply consistent policies to its subsidiaries throughout the world, though
such policies need not be identical. It is also vital for managers in subsidiaries to be completely
aware of the relationship between management and employees to create harmony. Harmony
results in greater competitiveness and efficiency.
6.4.4 Staffing policies in international business
The international human resources manager needs to formulate staffing policies before starting
of the process of hiring employees. The four main policies regarding staffing are explained as
follows:
Ethnocentric approach
The key managers are from the parent country. The strategy is important during the early stages
of the business because a part of the business that was successful in the home country needs to be
transferred to the host country. Some of the reasons for this approach are as follows:
The lack of qualified employees from the host country.
The need for a united corporate culture.
The maintenance of good communication, coordination, and control with headquarters.
The following are the disadvantages of the ethnocentric approach:
Host country employees being deprived of promotion.
The time taken by the home country managers to adapt to the host countries.
The sensitivity of the expatriates to the needs and expectations of their host country subordinates.
Polycentric approach
This approach requires host country nationals to manage subsidiaries. The benefits of such a
policy are that there are fewer possibilities of language issues, expensive training periods, and
cultural adjustment issues. The disadvantage of this approach is that the local managers may find
it hard to bridge the gap between the subsidiary and the parent company. There may also be
language issues, loyalties to the host country that conflict with the needs of the multinational
organisation, and cultural differences between the home country managers.
Region-centric approach
Managers from various countries in the region are employed within the geographic region of a
business. Although they operate with a certain amount of independence, they are not moved to
the home country. This is a flexible approach and locals are hired when regional expertise is
needed whereas employees from the parent country are brought in if product knowledge is
required. The disadvantage of this approach is that managers in the region may not understand
those at the head office and adequate number of managers with international experience cannot
be hired. This approach serves as a step towards a geocentric approach.
Geocentric approach
The best suited employees for vital positions are hired throughout the company without taking
into account the nationality of the employees. The success of this approach is based on the
following five assumptions:
Availability of highly skilled employees at the subsidiaries.
International experience required to succeed in top positions.
Ambitious and promising managers who can be readily transferred from one country to another.
Adaptability of managers to different countries after international exposure over a period of time.
This approach helps a company create a pool of efficient international managers, comfortably
working in a number of cultures.
Self Assesment Questions
8. The workforce of a multinational are of three types parent country nationals, host country
nationals, and _____________.
9. Ethnocentric and polycentric approaches are examples of ____________ policies.
10. Remuneration is one of the key staffing policies in an international business. (True/False)
11. The nationality of the employees is not taken in to account while hiring for the company in
geocentric approach. (True/False)
12. Which of the following is not an approach under staffing policy?
a) Geocentric approach
b) Biometric approach
c) Polycentric approach
d) Ethnocentric approach
Activity 2
Using resources on the Internet analyse the HR practices that an Indian MNC employs to recruit
and retain its expat employees.
Hint:
http://www.streetdirectory.com/travel_guide/183845/human_resources/need_for_effecting_recrui
tment_and_hr_practices.html
6.5 Summary
Let us summarise the points covered in this unit on international human resource management:
The structure of an organisation plays a vital role in HRM. Internal and external environment
contribute the structure of an organisation. Business strategy plays an important role in the
structure of an organisation.
The different types of international organisational structures are export structure, international
division structure, functional structure, regional structure, international subsidiary structure,
product structure, and international matrix structure.
IHRM is a vital component in the functioning of a multinational enterprise. IHRM helps deal
with the factors that make the workforce more efficient and the organisation more competitive.
Though there are many strategies and policies regarding the deployment of personnel across
various countries, the one that best aligns the needs of the parent country and employees in
foreign subsidiaries is the one that yields the best results.
International staffing policies depend on the approach adopted by an organisation. The four
approaches are ethnocentric, polycentric, region-centric, and geocentric approach.
6.6 Glossary
Home country: The country where a companys headquarters is located.
Host country: A country other than the home country where a company operates in.
Remuneration: The total package, which includes salary, bonuses, allowances, stock options and
so on, that the employee receives from the employer.
6.7 Terminal Questions
1. Analyse different structures in an international organisation.
2. Explain the function of human resource planning.
3. List the key factors affecting the recruitment of expats.
4. State the key national differences in HRM practices.
5. Discuss the different approaches to staffing in an international business.
6.8 Answers
Self Assessment Questions
1. Organisational structure
2. True
3. c) International matrix structure
4. Human resource
5. False. The expats underperformance and failure has been a matter of concern for the
multinational companies.
6. True
7. d) Project planning
8. Third country
9. Staffing
10. False. Remuneration is not one of the key staffing policies in an international business.
11. True
12. b) Biometric approach
Terminal Questions
1. Export, international division, functional, regional, international subsidiary, product and
international matrix are some of the organisational structures in the international business. These
are explained in sub-section 6.2.2 of this unit. Refer the same for details.
2. Human resource planning is the process of assessing the staffing requirement for the future
and taking care of the adequate and timely supply of human resources in an organisation. These
are explained in sub-section 6.3.1 of this unit. Refer the same for details.
3. Technical competency, willingness to work in a foreign country, adequate growth opportunity,
spouse and familys willingness to adapt in a new country are some of the factors affecting the
recruitment of expats. These are explained in sub-section 6.3.3 of this unit. Refer the same for
details.
4. Employee participation in decision making, legal framework of employee relations,
individualism, collectivism, cultural background, and so on are the common national differences
in HRM practices. These are explained in sub-section 6.4.1 of this unit. Refer the same for
details.
5. Ethnocentric, polycentric, region-centric and geocentric are the approaches taken by HRM in
an international business. These are explained in sub-section 6.4.4 of this unit. Refer the same for
details.
6.9 Case-Let
IHRM at Unilever
Unilever Plc. is the worlds largest Fast Moving Consumer Goods (FMCG) Company with a turnover of
39.8 billion and is the leader in Home and Personal Care Products, Foods and Beverages. It employs
163,000 people in more than 100 countries worldwide. Unilevers products are sold in over 170 countries
around the world.
Their manufacturing facilities are spread across many countries and they also export products to countries
where they do not have manufacturing operations. Currently, they have 264 manufacturing sites
accurate management of the flow of international funds through the study of international
financial management.
In this unit, you will study about international financial management, covering in brief the
components of international financial management. We will also study about its scope covering
the aspects of financial decisions, taxation and management of working capital.
Objectives:
After studying this unit, you should be able to:
differentiate domestic and international financial management.
describe the various components involved in the international financial management.
discuss the scope of international financial management.
7.2 Overview of International Financial Management
In this section we will discuss about the evolution of international financial management and also
distinguish between the domestic and 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.
7.2.1 Evolution
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.
As a result, the fundamental financial decisions have now advanced to cross-border complexities.
The choices to be made with respect to investment, capital raise, acquisition activity,
restructuring as well as various aspects of financial policy requires financial considerations.
Whenever decisions are taken, the managers must analyse difference in tax rules, country risk
factors, exchange rates and variation in legal rules.
IFM has four distinct modules are as follows:
Currencies and asset prices - The basic mechanisms of exchange rates, assets prices in global
markets and currencies that influence stock prices are explained in his module.
Multinational financial decision making - The decisions of multinational firms pertaining to
capital structure, tax optimisation and risk management are clarified.
In addition, this module covers the following aspects:
? The way in which the firms take advantage of subsidiaries around the world.
? The association of firms with local firms.
? The exposure of firms towards the trade rates.
? The tax considerations feature into internal financial decision-making.
Cross-border valuation and financing - The financial decisions and valuation techniques to be
modified in a cross-border setting is covered in this module.
In addition, this module covers the following aspects:
? The consideration on the price of capital around the world.
? The assessment of investments in order to rise the markets.
? The profit made by the firms through their financing and investment decisions as a result of
market imperfection.
Institutions and finance - The inconsistent formal and informal institutional arrangements will
result in a major impact on financial decision making. It focuses on the differences in legal rules,
particularly variation in the legal protection of creditors and shareholders affecting investment
and reforming decisions. In addition, the emphasis on the significance of informal institutional
arrangements and relationship building, emerging markets using cases on merger and acquisition
is also covered.
7.2.2 Domestic versus international financial management
The management of finance in domestic and international business is considerably different. The
four major aspects which distinguish international management from domestic financial
management are the introduction of foreign exchange, political risks, market imperfection and
enhanced opportunity set. They are explained as follows:
Foreign exchange risks - The foreign exchange risks states the fluctuation or variation in the
prices of currency which will have a tendency to convert a profitable deal to a loss making one.
This creates a situation of additional risk to the finance manager.
Political risks - The political risks may include any changes that will result in the economic
environment of the country. For example, Taxation rules, Contract Act and so on. It is pertaining
to the management of the country which can alter the rules of the game in an unanticipated
manner.
Market imperfection - By the integration in the world economy, the differences across the
countries have resulted with respect to the transportation costs and different tax rates. Inadequate
markets can force a finance manager to struggle for best opportunities across the countries
border.
Enhanced opportunity set - When business is undertaken in a country other than native country, it
will help them to expand the chances in business. In addition, it will enhance the opportunity for
the business and it diversifies the overall risk.
The goal of international financial management is to increase the wealth of shareholders just like
in domestic financial management. The goals are not only limited to the shareholders, but also to
the suppliers, customers and employees. It is also understood that any goal cannot be achieved
without achieving the welfare of the shareholders. Increasing the price of the share would mean
maximising shareholders wealth. The management of the organisation must decide the currency
in which the value of the shares are maximised.
The international trade is being promoted and shaped by international institutions called the
Bretton Woods Institutions: International Monetary Fund (IMF), World Bank and World Trade
Organisation (WTO) through its legal initiatives such as the General Agreement of Trade and
Tariffs (GATT), General Agreement on Trade in Services (GATS) and so on.
Multi-National Corporations (MNC) have come into existence due to the liberalisation and
international agreements. The MNCs enjoy greater freedom when compared to the normal
companies because of international setting and best opportunities. Without the knowledge in
International Financial Management, it can be hard for MNCs let alone any international
business entity, to continue in the market because international financial markets have a totally
diverse shape and analytics in contrast to the domestic financial markets. A sound knowledge in
International Financial Management can assist an organisation to accomplish similar competence
and effectiveness in all markets.
Activity 1
Play the role of a financial manager of a XYZ company and describe the way you would manage
the finance and accounting of your company.
Hint: The four major aspects.
Self Assessment Questions
1. International financial management is also called as ______.
2. The political risks may include any changes that will result in the economic environment of
the country. (True/False)
3. The _______ may include any changes that will result in the economic environment of the
country.
a) Foreign exchange
b) Political risks
c) Market imperfection
d) Enhance opportunity set
7.3 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.
7.3.1 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.
7.3.2 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 7.1 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 7.1: 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.
7.3.3 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.
7.3.4 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.
Self Assessment Questions
4. A _______ needs a more complex calculation.
5. The greater part of the worlds deal in foreign currencies is still taking place in the cities where
international financial activity is centered. (True/False)
6. The ________ provides links among the capital markets of individual countries.
a) Foreign currency markets
b) International security markets
c) International capital markets
d) International money markets
7.4 Scope of International Financial Management
The list of all functions, activities and the decision regarding the management of international
business defines the scope of IFM.
7.4.1 Management of working capital
The device of finance is the working capital management. The management of current assets and
current liabilities are associated with the working capital. The main goal of working capital
management is to guarantee that the firms maintain its operations normally and has adequate
cash flow to satisfy short-term debt and forthcoming operational expenses.
Let us discuss some of the working capital policies which serve as guidelines to business. They
are as follows:
Liquidity policy - The manager can increase the amount of liquidity in order to reduce the risk of
business. If the production has high amount of cash and bank balance, then business can simply
pay its dues at maturity. It is the responsibility of the finance manager to know that the excess
cash will not produce the required earnings. Instead, return on investment will decrease.
Therefore liquidity policy should be optimised.
Profitability policy - In this case the finance manager will maintain low amount of cash in
business and aim to invest maximum amount of cash and bank balance. It will guarantee that the
profit of business will rise due to increasing of investment in a correct way. But the risk of
business will also increase because liquidity of business will reduce and can ruin the business.
So, profitability policy must be done following the liquidity policy and provide for proper
management of the working capital.
Need for working capital management
After understanding the nature of production, we can make an estimation of the working capital.
If the company produces under a large scale and continues producing goods, then in that case we
need a high amount of working capital.
The high amount of working capital will decrease the return on investment, whereas low amount
will increase the risk of business. Therefore it is necessary to get optimum level of working
capital where both the profit and risk will be balanced. If the manager supervises the cash,
nonpayer and inventory, then the working capital will repeatedly optimise.
7.4.2 Financing decisions
The way of arranging finance refers to the raising of capital. The financing decision has to
consider the following factors:
Flexibility - The financing decisions made today will have an impact on the future. If the
business anticipates increasing its capital in the future, it cannot exploit the use of debt today.
Hence correct flexibility with future financing decisions must be taken.
Risk - There are chances to increase risk by financing with the use of debt. There exists a limit
on the amount of debt to be used to finance our business. A high amount of debt can result in
economic failure.
Income - Financing can persuade earnings and thus influence return on equity. If we are anxious
concerning returns to equity shareholders, then the financing decision will require to be adjusted.
Income is also influenced by the capability to receive benefit of tax deductions for interest on
debt.
Control - If we have concerns regarding control over the organisation, in that case we have to
judge how financing will change control. Financing decisions are associated to either ownership
(equity) or creditors (debt).
Time - To take the advantage of market place, the financing decision needs to be timed. The type
of securities to be sold, length of maturity to be used for debt financing should be decided.
Refinancing risk
One of the main aims of financing decisions is to go with the maturity of liabilities with the life
expectancy of assets. This will allow the liabilities to be self-liquidating. There are chances of
facing refinancing risk if the maturity of liabilities is less than the life expectancy of assets. Here,
the capital has to be raised to pay off liabilities. In the either case there will be abundance of
assets around to pay off debts if the maturity of liabilities is longer than the life expectancy of
assets.
Inflation
As a result of using debt financing in periods of high inflation, one will pay back the debt with
currencies that are worthless. While expectations of inflation increase, the rate of borrowing will
raise since creditors must be compensated for a loss in value. Since inflation is a main motivating
force behind interest rates, the financing decision should be aware of inflationary development.
7.4.3 Taxation
For the worldwide operation of firms, taxation plays a vital role. Taxation has become the core of
various financing decisions which includes international investment decisions, international
working capital decisions, fund raising decisions and the decisions related to dividend and other
payments. The tax decision is also relevant in domestic firms also.
The managing of taxation is an extremely difficult issue for the international corporations. The
various reasons are given as follows:
The firms are supposed to work in several tax jurisdiction or authorities where the tax rates are
diverse and also the administration of the tax system is not uniform.
The ultimate load of tax in the framework of international firms is determined by means of a
more complex interaction of varying descriptions of the tax base.
The difference in tax treatment in different nations will direct to distortions in worldwide trade
and investment. The companies which are situated in the low-tax country can have a periphery
over other firms in worldwide market. There are possibilities to divert the investment to those
countries that have low cost rates.
The overlapping takes place between the international firms with different tax jurisdictions,
utilise the arbitrage opportunities and retain an edge over the domestic firms.
The bases of international tax system are:
Tax neutrality - The neutrality of international tax system is important because it must not affect
the economic efficiency. If the tax is neutral then it will not influence the locality of the
investment or nationality of the investor. The capital can shift from a nation with lesser return to
a nation with higher return. Therefore, resources will be allocated well, and the gross world
output in turn will be high.
Tax equity - The principle of tax equity states that all equally positioned tax players contribute in
the cost of operating the government according to the equal rules. The idea of equity can be
understood in two ways. The first one states that the input of each tax player must be consistent
with the amount of public services as received. The second idea is that the contribution of each
tax player must be in terms of their ability to pay. The ability to pay means the one with greater
ability is likely to pay a larger amount of tax.
Avoidance of double taxation - The avoidance of double income states that one must not be taxed
twice for the same income. However, if the post-tax income is sent to the foreign countries then
in that case the receiver of such income is taxed again. This implies the same income is subjected
to double taxation. As an alternative, the requirements of foreign tax credits may be formed in
the domestic tax system.
There also exist some tax laws which prevent the tax through artificial transactions such as
transfer pricing. In addition, the corporate structures will help to reduce the overall tax burden to
the enterprise.
Self Assessment Questions
7. The device of finance is the ______ management.
8. The financing decisions made today will have an impact on the future. (True/False)
9. The principle of _______ states that all equally positioned tax payers should contribute in the
cost of operating the government according to the equal rules.
a) Tax equity
b) Tax neutrality
c) Avoidance of double taxation
d) Taxation
Activity 2
Using resources on internet analyse how the financial management takes place in different
countries.
Hint: www.bjreview.com
7.5 Summary
Let us summarise the points covered in this unit about international financial management:
The International Financial Management came to its existence when the countries all over the
world started opening their doors to each other. This phenomenon is also called as liberalisation.
The four major aspects which distinguish international management from domestic financial
management are introduction of foreign exchange, political risks, market imperfection and
enhanced opportunity set.
Components of International Financial Management are foreign exchange markets, foreign
currency derivatives, international monetary system and international financial markets.
The scope of international financial management includes management of working capital,
financing decisions and taxation.
The policies of working capital management are the liquidity and profitability policy. The
financing decisions consider the factors like flexibility, risk, income, control and time. The bases
of international tax system include the tax neutrality, tax equity and avoidance of double
taxation.
7.6 Glossary
Arbitrage: The purchase of securities on one market for immediate resale on another market in
order to profit from a price difference.
Denominated: To express in terms of the monetary unit.
Equity: Funds provided to the business by the sale of stock.
Hedging: It is the method of reducing the risk of loss caused by price variations.
Inflation: A persistent increase in the level of consumer prices or a persistent decline in the
purchasing power of money, caused by an increase in available currency and credit beyond the
proportion of available goods and services.
Liquidity: The term refers to the volume of transactions. With sufficient buyers and sellers, a
market enjoys continuous offers, bidding, and consummated transactions, thus achieving market
liquidity.
7.7 Terminal Questions
1. Explain domestic versus international financial management.
2. Discuss about the foreign currency derivatives.
3. Explain the need for international financial market.
4. State the management of working capital.
5. Explain the importance of taxation.
7.8 Answers
Self Assessment Questions
1. Liberalisation
2. True
3. Political risks
4. Forward market
5. True
6. International capital
7. Working capital
8. True
9. Tax equity
Terminal Questions
1. Foreign exchange, political risks, market imperfection and enhance opportunity set are the
four major aspects which distinguish international management from domestic financial
management. These are explained in the subsection 7.2.2. Refer the same for details.
2. A currency derivative as a financial contract in order to swap two currencies at a predestined
rate. These are explained in the subsection 7.3.2. Refer the same for details.
3. Deregulation of international capital flows, gain in technology and transaction are the causes
normally given for the enormous growth in the trading of foreign currency. These are explained
in the subsection 7.3.4. Refer the same for details.
4. The working capital policy which serves as guidelines to business are liquidity policy,
profitability policy and the need of working capital management. These are explained in the
subsection 7.4.3. Refer the same for details.
5. The managing of taxation is an extremely difficult issue for the international corporations. The
basis of international tax system includes tax neutrality, tax equity and avoidance of double
integration. These are explained in the subsection 7.4.3. Refer the same for details.
7.9 Case-Let

XYZ Fruit Beverage Company


M/s. XYZ Company was in the business of making fruit beverages. The said M/s. XYZ
intended to expand its market and started exporting fruit beverages to Japan. Subsequently, it
so happened that the Japanese Government, imposed higher tax on the fruit beverages
imported from other countries into Japan. The Japanese Government with intention to protect
its own domestic market imposed a lesser tax to domestic producers compared to the foreign
producers.
Discussion Questions
1. What do you think would be the strategy of XYZ Company in protecting their business
interests?
(Hint: The XYZ Company can work out a possible option of a joint venture with the
domestic producer which would help them pay similar tax to that of domestic producers.)
2. How relevant is the concept of political risk to the managerial decisions of a Company and
whether sufficient recourse is available in the international forum to mitigate such risks?
(Hint: The Japanese Government introduced new tax rules for foreign alcohol. However the
countries do not have the liberty to impose unfair rules rather every country has to treat
everybody equally. As a risk mitigation strategy, the XYZ Company through its country can
approach the WTO Dispute Settling Union (DSU) against such discriminatory rules.
Sources: http://www.nuigalway.ie/law/GSLR/1998/case6.html

References
Sharan, Vyuptakesh. (1998). International Financial Management, Fifth edition. PHI learning
Private Limited.
Kevin. (2009). Fundamentals of International Financial Management. Pearson Publications.
Gary Shoup.(1998).The International Guide to Foreign Currency Management.
E-References
http://www. brainmass.com
http://finance.mapsofworld.com/foreign-exchange-market/ - Retrieved on 1st November 2010
Unit-08-International Marketing
Structure:
8.1 Introduction
Objectives
8.2 Overview of International Marketing
Domestic vs. International marketing
Nature of international marketing
8.3 Global Marketing Strategies
Segmentation
Market positioning
International product policy
International pricing decisions
International advertising
International promotion and distribution
8.4 Branding for International Markets
Valuation of brands
Challenges of international branding
8.5 Summary
8.6 Glossary
8.7 Terminal Questions
8.8 Answers
8.9 Case-Let
8.1 Introduction
In the previous unit you learned about finance management at an international level. We learnt
the differences between domestic and international financing. The unit also familiarised us with
the components of international financial management and the scope of these components.
International marketing refers to marketing of goods and products by companies overseas or
across national borderlines. The techniques used while dealing overseas is an extension of the
techniques used in the home country by the company.
In this unit you will cover all the aspects of international marketing like strategies, policies,
valuation of brands and the different ways of circumventing the difficulties and challenges.
Objectives:
After studying this unit you should be able to:
describe international marketing process.
distinguish between domestic and international marketing.
discuss global marketing strategies.
explain branding for international markets.
discuss the challenges of international branding.
8.2 Overview of International Marketing
Selling usually centres on the needs of the seller whereas marketing focuses on the needs of the
customer (buyer). The aim of business is to attract and retain a customer, which can be done
through price competition and product differentiation.
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 visualises different countries as one market and
build their brand or service according to the business environment of the foreign countries. A
regiocentric approach is taken to plan a product and consolidate the manufacturing processes.
Therefore, international marketing is beneficial in preparing a firm to deal globally as it
establishes a business stronghold on various foreign markets. Global marketing indicates the
integrated and coordinated marketing activities across many different markets.
8.1.1 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 regiocentric approach.
Global marketing - Company operating in various countries opts for a common single product in
order to achieve cost efficiencies. This is achieved by analysing 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 middle-eastern 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.
8.1.2 Nature of international marketing
Operating in a foreign market depends on the level of control the firm has on the operations in
the foreign country and it also depends on the capital expenditure. Once the decision to invest in
the foreign market has been made, the mode of operation has to be established. Listed below are
the important modes of operation:
Exporting (direct or indirect).
Joint ventures.
Direct investment.
Exporting
Exporting is the process of selling goods in a foreign country keeping in mind the customer base
of the foreign country. The goods are manufactured in the home country of the firm. There are
two types of exporting methodologies, namely direct exporting and indirect exporting.
Direct exporting is the activity of directly shipping goods to a foreign country or market. For
example, a car manufacturer may manufacture cars in home country and directly ship the cars to
a foreign country like Ferrari. Indirect exporting is the process of utilising an intermediary firm,
who in turn would distribute the product in the foreign market on the instructions of the firm. For
example, a car manufacturer may employ a local distributor or a partner while selling cars in a
foreign country.
From a firm's perspective, exporting involves the least risk. This is so because no capital
expenditure or additional finance has been allocated for the product. Thus, the chance of the
existence of sunk costs or general barriers is limited. On the contrary, a firm may have less
control when exporting into a foreign market, due to limited control on the supply of the goods
within the foreign market.
Joint ventures
A joint venture is an understanding to work together between two or more firms with the aim of
gaining a benefit from a given economic activity. The directives of some countries often state
that all foreign investment in it should be through joint ventures. The level of risk is
comparatively more when compared with exporting as the control of the firm which gets into a
joint venture is limited.
Direct investment
Here, a firm invests capital in a foreign country to construct a manufacturing facility or fixed or
non-current asset. The aim of the firm is to manufacture a product within that country.
With direct investment, comes more control of the firm, attached with more risk. The return on
investment has to be determined and calculated as with any capital expenditure in addition to
recovering any related sunk costs.
Self Assessment Questions
1. For a firm to be successful internationally it is not necessary to be successful locally.
(True/False)
2. Culture of a country influences the marketing strategy of the firm. (True/False)
3. _________________ involves a firm, shipping goods directly to a foreign market.
4. Direct investment involves ________________ in the overseas market.
5. A joint venture is an understanding between
a) Two or more firms
b) Two or more countries
c) The firm and its subsidiary
d) Two or more parties
Activity 1
Find out few countries where direct foreign investment is not entertained.
Hint: China, Saudi Arabia.
8.3 Global Marketing Strategies
After getting an overview of international marketing, we shall now discuss the strategies
followed in global marketing.
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.
To counter this scenario firms must learn how to enter foreign markets and increase their global
competitiveness. Firms that plan to do business in foreign land find the marketplace different
from the domestic one. Market sizes, customer preferences, and marketing practices all vary;
therefore the firms planning to venture abroad must analyse all segments of the market in which
they expect to compete.
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 globalise
and to take advantage by pressurising competitors.
But, the decision to compete abroad is always a strategic down to business decision rather than
simply a reaction. Strategic reasons for global expansion are:
Diversifying markets that provide opportunistic global market development.
Following customers abroad (customer satisfaction).
Exploiting different economic growth rates.
Pursuing a global logic or imperative to harvest new markets and profits.
Pursuing geographic diversification.
Globalising for defensive reasons.
Exploiting product life cycle differences (technology).
Pursuing potential abroad.
Likewise, there can be other reasons like competition at home, tax structures, comparative
advantage, economic trends, demographic conditions, and the stage in the product life cycle. In
order to succeed, a firm should carefully look at their geographic expansion and global
marketing strategy. To a certain extent, a firm makes a decision about its extent of globalisation
by taking a stance that may span from entirely domestic to a global reach where the company
devotes its entire marketing strategy to global competition. In the process of developing an
international marketing strategy, the firm may decide to do business in its home-country
(domestic operations) only or host-country (foreign country) only.
8.3.1 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 behavioural,
psychographic, and demographic segmentations. The basis of behavioural segmentation is the
general behavioural 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.
Once you are done with the segmentation of market, you can choose one or more segments to
carry out trade. This process of selecting or choosing the potential market segment is known as
targeting. The three basic criteria for targeting are: potential competition, the current size and
growth rate of the market, and compatibility and feasibility. After the target market has been
ascertained firms should select a global marketing strategy.
Marketing in less developed countries offers several advantages to organisations. They can take
advantage of the huge unexploited markets and avail tax benefits. By focusing on less-developed
countries, firms can increase their market share and become market leaders. Less-developed
countries usually offer special benefits for the firms who are willing to establish their operations
in their countries. Thus, for firms marketing at a global level, less-developed countries provide
them with advantage.
8.3.2 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 favourable image of the product against
the competitor's products.
In global markets product positioning is categorised as high-tech or hightouch positioning. The
classification of high-tech and high-touch products is shown in figure 8.1.
The classification of high-touch products is shown in figure 8.2.

Figure 8.1: 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 standardisation such as the maintenance
of a consistent global brand image and cost savings. This is task is not easy.
8.3.3 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 (variation in standards among
providers, frequently even among different locations of the same firm), 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.
We often think of a product in terms of fulfilling the need of our own culture. However, the
functions served by that product may be very different in other cultures, for example, cars play a
large transportation role in the U.S., but they are impractical to drive in Japan, and thus, there
cars are used for individual indulgence or act as a status symbol. 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 customisation, 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
a new product for each market. On the other hand, standardisation proposes the marketing of one
global product, with the belief that the same product can be sold in different countries without
significant changes. For example, Intel microprocessors are the same irrespective of the country
in which they are sold.
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. For example, in U.S. fuel is
relatively cheap, therefore cars have larger engines than the cars in Asia and Europe; and then
again, much of the design is identical or similar.
8.3.4 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 behaviour, market demand, and transfer pricing.
The approach taken by company towards pricing when operating in international markets are
ethnocentric, polycentric, and geocentric. A company following an ethnocentric approach, will
maintains the same price throughout the world. In the polycentric approach, the regional
managers of the company are allowed to fix the product prices based on the circumstances in
which they operate. In the geocentric approach, the company takes a medium position between
fixing a single price globally and fixing different prices based on the requirements of
subsidiaries.
Price can be defined by the following equation:

The pricing decision enables us to change the price in many ways, some of them are:
Sticker price changes - The simplest way of changing the price is by changing the price tag. By
doing this you are going to get the same thing, but for a different amount.
Change quantity - When sticker prices are increased, the response of consumers is unfavourable
and usually changes in quantity are noticed less.
Change quality - Another way to effectively increase profit is through reducing the quality of the
product.
Change terms - For a firm it is a possible to save money by altering the terms of operations or
transactions with consumers. For example, earlier most software manufacturers provided free
support for their programs but now services are being charged.
8.3.4.1 Transfer pricing
Transfer pricing is the process of setting a price that will be charged by a subsidiary (unit) of a
multi-unit firm to another unit for goods and services, which are sold between such related units.
Transfer pricing is a critical issue for a firm operating internationally. Transfer pricing is
determined in three ways: market based pricing, transfer at cost and cost-plus pricing. The Arms
Length pricing rule is used to establish the price to be charged to the subsidiary.
Transfer pricing can also be defined as the rates or prices that are utilised when selling goods or
services between a parent company and a subsidiary or company divisions and departments that
may be across many countries. The price that is set for the exchange in the process of transfer
pricing may be a rate that is reduced due to internal depreciation or the original purchase price of
the goods in question. When properly used, transfer pricing helps to efficiently manage the ratio
of profit and loss within the company. Transfer pricing is a relatively simple method of moving
goods and services among the overall corporate family.
Many managers consider transfer pricing as non-market based. The reason for transfer pricing
may be internal or external. Internal transfer pricing include motivating managers and
monitoring performance. External factors include taxes, tariffs, and other charges.
Transfer Pricing Manipulation (TPM) is used to overcome these reasons. Governments usually
discourage TPM since it is against transfer pricing, where transfer pricing is the act of pricing
commodities or services. However, in common terminology, transfer pricing generally refers
TPM.
TPM assists in saving the organisations tax by shifting accounting profits from high tax to low
tax jurisdictions. It also enables to fix transfer price on a non-market basis and thus enables to
save tax. This method facilitates in moving the tax revenues of one country to another. A similar
trend can be observed in domestic markets where different states try to attract investment by
reducing the Sales tax rates, and this leads in an outflow from one state to another. Therefore, the
Government is trying to implement a taxing system in order to curb tax evasion.
8.3.5 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 unfavourable 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 differ 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. Sometimes, globalised firms use the same advertising agencies and centralise
the advertising decisions and budgets. In other cases, local subsidiaries handle their budget,
resulting in greater use of local advertising agencies.
Standardisation is required for products by some firms. The issues encompassing advertising
standardisation tend to parallel issues corresponding to product and positioning standardisation.
Standardisation helps to achieve economies of scale and a consistent image can be established
across markets. Standardisation also assists in utilising creative talent across markets, and
facilitates good ideas to be transplanted from one market to other. The challenges to the approach
of standardisation are cultural differences, differences in product life cycle stages and unusual
country regulation. Additionally, local advertising professionals may oppose advertising
campaigns imposed from outside.
International advertising can be thought of as a 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. This
industry is growing worldwide. International advertising is also reckoned as a major force that
mirrors both social values, and propagates certain values worldwide.
8.3.6 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 international marketing, companies usually take the advantage of other countries for the
distribution of their products. The selection of distribution channel is helpful to gain the
competitive advantage. The distribution channel is also dependent on the way to manage and
control the channel. Selecting the distribution channel is very important for agents and
distributors.
In order to reach its target markets a company utilises 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 organisation 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 organising 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.
Self Assessment Questions
6. Firms that serve global markets can be segregated into several clusters based on their
differences. (True/False)
7. Advertising is a paid form of ______________communication about an organisation or its
products.
8. Promotional mix is a blend of advertising, personal selling, sales promotion and ___________.
9. Globalised advertising is associated with the use of the same ______ name across the world.
10. Transfer pricing is considered to be a relatively simple method of moving goods and services
among the overall corporate family. (True/False)
11. __________ is the process of ascertaining the value for the product or service.
12. This is not the way to change the price of a product:
a) By tricking
b) Sticker price
c) Changing quality
d) Changing quality
Activity 2
Find out the stages in the process of international promotions and distributions of a multinational
company.
Hint: http:// www. ehow. Com /list _ 6781615_ examples - advertising-trade-show-
exhibitions.html
8.4 Branding for International Markets
Global marketing strategies provide with the techniques and methods to sell a product. Once the
product is sold the image of the product has to be maintained. We will discuss about this
branding here in this section.
With the spread of markets and the increase in competition on a global scale, firms are expanding
their operations overseas, either through investments or acquiring firms in other countries. Firms
are also entering into strategic alliances with firms in other countries or exporting directly of
indirectly to target countries. At the same time markets are getting more integrated due to the
spread of media, the expansion of international retailers, and the mobility of people, goods, and
firms across national borders. To respond to this global market, international firms need to have
coordinated and integrated international branding strategy in place.
International branding is different from marketing in domestic markets in a number of ways.
Firstly, the macro-marketing environment such as legal, cultural, technological, and economic
aspects in which a firm operates in the overseas market is different.
The intended audience must be considered while developing an intra-organisational marketing
communication strategy. A successful promotional strategy is one, which is communicated
clearly and distributed thoroughly to their intended audience. In addition, it is important to
ensure that consistent branding and non-contradictory messages are eliminated.
8.4.1 Valuation of brands
Brand value can be defined as the branding efforts that build customer confidence and loyalty by
adding unique advantages to the firms product or service. The concept of brand value surpasses
the concepts of tangible product and basic brand. This facet of brand value distinguishes a brand
from a product. The three levels of brand value are:
Core functionality.
Emotional values.
Added value services.
The core functionality deals with the core physical product; emotional value characterise the
intangible aspects of a brand that fits the psychological profile of the target customer. Added
values concentrate on bringing in extra futures and are critical to the brand, which would
enhance the usage of the brand for the customers.
8.4.2 Challenges of international branding
A challenge to international branding is to maintain a balance between being global and being
local. Brand ideas, values, and concepts have to remain the same, but the methods to
communicate them and to make them familiar to customers have to vary. Brand values and ideas
can principally be same, but the propagating methods cannot.
The task of building a strong brand is hard and complicated. The firm has to honour the promises
made by the marketing theme. Two conflicting challenges an international brand has to face is to
remain easily recognised at any global location and simultaneously should be able to blend with
the local culture, traditions and customers' way of perception.
In the international branding process the challenges increase many fold. Therefore, the process of
building a strong brand is a complicated and challenging task.
Self Assessment Questions
13. Brand value builds customer confidence and loyalty. (True/False)
14. International branding is all about differentiating between being global and being local.
(True/False)
15. The task of building a brand is
a) Complicated
b) Easy
c) Critical
d) Moderate
8.5 Summary
Let us summarise the points covered in this unit about international marketing:
Selling a product involves considering the need of the customers. In order to build the customer
base, the firms have to take up an advertising activity.
Firms both global and local have to advertise their products in order to inform the customers
about the benefits and features of the product. International marketing or advertising differs from
domestic or local marketing as the communication process is across cultures, geographic
conditions, and tastes and preferences of the people.
A firm has to develop global marketing strategies in order to deal with protectionism. The goal of
a firm to move to a foreign country is to exploit the market there.
The different approaches for global marketing are segmentation, market positioning, branding,
promotions, competitive pricing and so on.
Segmentation is the process of dividing the market into clusters. And then positioning the
product with respect to the segment and target audience.
The pricing decision has to be competitive as there could be local firms competing.
A global firm usually have products introduced in other countries. And these products will have
some brand following. In order to bring the existing brand into a new country the firm has to
carry-out research and find out the response of the customers to this campaign. This is called as
promotion.
8.6 Glossary
Arms Length pricing rule: This is defined as the price a buyer willing to pay to for an identical
item under identical terms and conditions.
Foreign investment: It is the long term participation of a firm in a foreign country to do business.
Non-current asset: An asset that will not convert to cash within the next year.
Return on investment: A relative measure based on the profit to investment.
Sunk costs: It is the cost that has already been incurred and which cannot be recovered.
8.7 Terminal Questions
1. Bring out the differences between foreign marketing and domestic marketing.
2. Write a note on global marketing strategies.
3. What is transfer pricing?
4. What are the factors considered while branding a product or service in an international
market?
8.8 Answers
Self Assessment Questions
1. False
2. True
3. Exporting
4. Manufacturing
5. a) two or more firms
6. False
7. Non-personal
8. Public relations
9. Brand
10. True
11. Pricing
12. a) by tricking
13. True
14. False
15. a) complicated
Terminal Questions
1. International marketing is different from domestic marketing in a sense that the customer
preferences and tastes are not known. There are cultural differences and other issues. These are
explained in sub-section 8.2.1. Refer the same for details.
2. Different global marketing strategies are market segmentation, market positioning, advertising
and so on. These are explained in section 8.3 Refer the same for details.
3. Transfer pricing is usually used by companies to reduce the tax levied on them. This is
explained in sub-section 8.3.4.1 Refer the same for details.
4. Branding must not have contradictory messages, the intended audience must always be kept in
mind. The branding process is a complicated task. These are explained in section 8.4 Refer the
same for details.
8.9 Case-Let

Flatbread Goes Around the World


ABC Ltd. is located near El Mante, Mexico, and produces corn flour and other flour products,
which it processes into tortillas and related snacks for markets worldwide. Its brand names
include X, Y, and Z. Its customers include supermarkets, mass merchandisers, smaller
independent stores, restaurant chains, food service distributors, and schools. The company was
established in 1949. In the early 1970s, ABC Ltd. introduced its product on the Central American
markets, specifically in Costa Rica. In 1976 it expanded to the United States and in 1987 it began
expanding its operations across the globe, opening plants in Honduras, El Salvador, Guatemala
and Venezuela. It now has plants in Europe and most recently China.
The Asian market presents a very exciting development for ABC Ltd. The company established
their presence on continental China in the first instance and then gradually expanded their
penetration of markets across Asia to the Middle East. It has already established distributorships
in Japan, Korea, Singapore, Hong Kong, Thailand, the Philippines, Taiwan and India.
How has a Mexican company with a niche food product like corn flour succeeded so well in
international markets?
The answer is that the firm has focused on emerging markets which tend to follow the same path
of development. In these emerging markets the customer demand is predictable as it follows a
pattern and this is evident in every major economic segment. What ABC Ltd. is following in their
international expansion is the tried and tested method of leveraging the similarities across from
market to market and growing their company accordingly. The root of the success of ABC Ltd.
has been their ability to observe the life cycle of emerging markets around the world and expertly
time their entry into these markets.
However, the other key factor has been their ability to adapt their products to local market tastes.
Their key competitive advantage in international markets is based not on their product but the
ability to roll any kind of flour, from corn to wheat to rice, into saleable flatbread. In India, many
people eat a flatbread made form wheat called Naan, but do not eat corn tortillas. So, ABC Ltd.
plans to sell corn tortillas in India. The Chinese dont eat many corn tortillas, but they buy wraps
made by ABC Ltd. for Peking duck. ABC Ltd. also follows a policy of deploying a senior
beachhead team to enter the new market in which they are building a presence. In China, the
beachhead team had skills honed through many years of experience in Latin America and was
already primed to develop the necessary market insights to feed into their marketing campaign.
Thus, observed trends in China such as a decrease in home cooking among dual-career
professionals, increasing penetration of fast food chains, an increase in cold storage in
supermarkets and rapid improvements in the logistics and distribution channels were all utilised
in thinking through the ABC Ltd. market-building strategy in China.
Discussion Question
1. Evaluate the reasons behind the success of ABC Ltd. (Hint: Focusing on emerging markets)
Source: http://estore.bized.co.uk/freecontent/300081F9.pdf

References
Colin Gilligan, Martin Hird (1986). International marketing: strategy and management.
Kumar N (2002). International Marketing, First Edition. Anmol Publication.
Roger Bennett, Jim Blythe (2002). International marketing: strategy planning, market entry.
Sean De Burca, Richard Fletcher and Linden Brown (2004), International marketing : an SME
perspective, London : FT - Prentice Hall.
Michael R. Czinkota, Ilkka A. Ronkainen.(2001), International marketing, Fort Worth ; London : Harcourt
College Publishers.
Vern Terpstra, Ravi Sarathy (2000), International marketing, Dryden Press.
Michael R. Czinkota, Best Practices In International Marketing, The Harcourt College Publishers Series
In Marketing.
E-References
http://www.consumerpsychologist.com/international_marketing.html
http://www.slideshare.net/chanvich/international-pricing-decisions-for-upload
Retrieved on 31st October 2010

Unit-09- International Accounting Practices


Structure:
9.1 Introduction
Objectives
9.2 International Accounting Standards
Domestic vs. international accounting
National differences in accounting
Legal systems
9.3 Accounting for International Business
Classification of accounting systems
Harmonising of accounting systems
9.4 International Regulatory Bodies
9.5 International Financial Reporting Standards
9.6 Summary
9.7 Glossary
9.8 Terminal Questions
9.9 Answers
9.10 Case-Let
9.1 Introduction
In the previous unit you learned about international marketing, strategies, and branding for
international markets. In this unit you will learn about international accounting standards,
regulatory bodies, and international financial reporting standards.
International accounting practices need certain publicly-traded companies to follow some
accounting rules while presenting financial statements, so that the reader can easily compare
between different companies.
This unit covers various factors involved in accounting practices followed by MNCs. It explains
various regulators and accounting standards followed by different countries and regions across
the world. It discusses accounting in an international perspective. It includes international
regulatory bodies and also the international financial reporting standards.
Objectives:
After studying this unit, you should be able to:
explain international accounting practices.
differentiate between the domestic and international accounting practices.
describe the international regulatory bodies.
discuss the international financial reporting standards.
9.2 International Accounting Standards
Accounting is understood as the language of business. International Accounting Standards is a
set of standards, which state how certain types of transactions and other events should be
reflected in financial statements. International accounting refers to international comparative
analysis, accounting measurements, and reporting issues distinctive to multinational business
connections. It also refers to harmonisation of global accounting and financial reporting through
political, organisational, professional, and standard-setting activities.
Accounting Standards are the key mandatory and regulatory mechanisms for training on
financial reports and conducting successful audit for the same. It is used almost in all countries
throughout the world. They are concerned with the structure of measurement and discover rules
for preparation and arrangement of financial statements. They emerge as a set of authoritative
statements related to exact type of transactions, events, and other costs that are recognised and
reported in the financial statements. They are designed to supply practical information to diverse
users of the financial statements such as shareholders, creditors, lenders, organisation, investors,
suppliers, competitors, researchers, regulatory bodies, and so on. These statements are designed
and approved to develop and benchmark the quality of financial reporting.
A financial reporting system of international standard is required to attract foreign and also
present and potential investors at home, which can be achieved by harmonising the accounting
standards.
9.2.1 Domestic vs. international accounting
Different countries whether domestic or international, have different accounting standards. A
common belief is that these differences reduce the quality and the importance of accounting
information. Accounting standards determine the financial reporting quality and provides
separately verified information about an organisation's financial performance to investors
creditors.
International businesses encounter number of accounting problems that do not stop domestic
businesses. The accounting system of a domestic organisation must meet the specialised 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 organise
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 organisations home currency. This translation is done using
accounting concepts and measures, which are detailed by the organisation. 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 organisation also has to pay
taxes to the countries in which it does its business, based on the accounting statements it prepares
in these countries. Besides this, when a parent corporation tries to combine the accounting
records of its subsidiaries to produce consolidated financial statements, extra complexities occur
because of the changes in the value of the host and home currencies in due course.
There are many differences between Domestic Accounting Standards (DAS) and International
Accounting Standards (IAS). Based on the list of differences between the DAS and IAS, two
indices are created-'absence' and 'divergence'. Absence measures the differences between DAS
and IAS as an extent to which, the rules on certain accounting issues are missed out in DAS and
covered in IAS. Divergence represents the differences between DAS and IAS as an extent to
which, the rules on the same accounting issue differ in DAS and IAS.
Measurement of differences between IAS and DAS
You can measure the differences between IAS and DAS in the following way:
Literature on international accounting differences - You can use various data sources to measure
international accounting differences in earlier literature. Most of the earlier studies understand
international accounting differences as different options adopted by various nations for the
similar accounting issues, which correspond to divergence concept.
Framework of analysis - Earlier studies established various links between differences in
accounting standards across countries and financial reporting quality. We should consider the
institutional determinants of accounting differences such as legal origin, governance structure,
economic development, and equity market.
9.2.2 National differences in accounting
One of the major problems encountered by an international business is lack of consistency in
accounting standards of various countries. Organisations show opposite financial results because
of the differences in accounting standards.
Differences in accounting standards exist because of diverse political, legal, economic, and
cultural systems existing across the countries. Accounting standards and practices are also
prejudiced by the sources of capital used to fund business. Figure 9.1 shows the influencing
factors on a countrys accounting practices.
Figure 9.1: Influences on a Countrys Accounting System
You might think that certain historical developments had a uniform effect on accounting systems
all over the world. Of course there are some similarities and also there are many accounting
systems, as much as countries and no two systems are alike. The main reason for these
differences is basically environment. Accounting systems develop from and reflect the
environments they serve. The reality of the world is that, environments have not evolved equally.
While accounting practices were developing, there were differences in the private ownership,
industrialisation, inflation, and so on. When there are differences in economic conditions, it is
not surprising to find differences in accounting practices. However, economic factors are not the
only influences you find. Educational systems, legal systems, political systems, and socio
cultural features also influence the need for accounting and the direction and speed of its
development. Today, the key reason for understanding different national accounting systems lies
in the increasing globalisation of business.
9.2.3 Legal systems
Law system is divided into civil law and common law countries worldwide. In countries like US,
Australia, UK and New Zealand accounting procedures originate from decisions of independent
standards setting boards, such as US Financial Accounting Standards Board (FASB), and so on.
Each board works with professional accounting groups. The common law countries accountants
follow, Generally Accepted Accounting Principles (GAAP), which provides a 'true and fair view'
of the organisation's performance, based on the standards approved by these professional boards.
Many civil law countries also have a similar approach of GAAP. Functioning within the
limitations of these standard accountants provides freedom to implement their professional
judgment in reporting a 'true and fair' representation of the organisation's performance.
Countries following civil law are likely to codify their national accounting measures and
standards. In these countries, accounting practices are determined by the law. To assist the legal
role, all business accounting records must be officially registered with the government.
The way in which the accounting practices are imposed depends on the legal system. Most of the
developed countries depend on both private and public enforcement of business performance,
even though the public or private combination varies from country to country. The degree of the
legal system is a major restriction in the growth of accounting standards by the accounting
profession. In some countries, the accounting policies are restricted to detailed legislation, which
is passed by governments. This restriction forms a major problem to the international accounting
bodies that are determined to increase harmonisation of national accounting frameworks. This is
because, such government-controlled regimes are inclined to be less flexible, and discover
private sector influences as less acceptable.
Self Assessment Questions
1. Accounting Standards are the key mandatory and regulatory mechanisms for training on
financial reports and succeeding audit of the same. (True/False)
2. __________ and ___________ are the two indices created based on the differences between
IAS and DAS.
3. GAAP stands for generally accepted accounting principle. (True/False)
Activity 1
The link below provides an article on International Accounting Standards. Find out how the
standards helped to bring financial stability in the market and also discuss how it affected the
companies.
Hint: Refer link: www.iasplus.com/dttpubs/dtiias.pdf
9.3 Accounting for International Business
In the previous section you learnt about international accounting standards and the national
differences between accounting standards. In this section you will cover accounting for
international business.
An organisation's first contact to international accounting occurs as an outcome of an import or
export opportunity. In exports, a domestic organisation may receive an unwanted inquiry, or
obtain order from a foreign buyer. If this foreign buyer needs an addition of credit, then the buyer
is examined once before exporting. This process is not as easy as it appears.
The buyer is not always a scheduled buyer in the international credit rating directories. Either the
seller will have to ask its bank to have foreign affiliations to check the buyer's credibility or the
seller can ask the buyer to supply financial information. The buyer might be ready to supply
financial statements, but these statements might be complicated for domestic organisations to
understand. The statements might be in a foreign language, and based on accounting assumptions
and measures that are strange to the organisation's accountants. Most of the organisations that are
new to international business must get assistance either from a bank or from an accounting
organisation with international proficiency. If the foreign buyers pay in their own currency, the
selling organisation becomes familiar with the possible gains and losses from changes in the
exchange rate that occurs between the moment the order is booked and the moment the payment
is received.
The selling company also has to deal with many international details, such as special
international shipping and insurance documents, customers declaration forms, international legal
documents, and so on. Here, again the services of lawyers, shippers, bankers, and accountants
with international knowledge are essential.
In case of a probable import, the foreign seller has all the responsibilities, therefore the
international accounting aspects are not disturbed. Yet, if the foreign seller requires payments in
his or her currency, or if the domestic buyer wishes to gain information about the dependability
of the foreign supplier, the buyer might consult an international bank, lawyer, or accounting firm.
9.3.1 Classification of accounting systems
All accounting systems are planned to supply information to people who take decisions. So, it is
essential to classify accounting systems. The classification of accounting systems in financial and
cost systems leads to this difference between the people, who take decisions. Investors, creditors,
government agencies, tax authorities and others are people who involve in the accounting
systems, but are outside the organisation. Whereas, managers are within the organisation and
they also take part in the accounting decisions.
Financial accounting
Information in financial accounting is planned for decision makers and not for people who
manage the organisation daily. These users are normally outside the organisation. The
information for public organisations is public, and normally available on the websites of the
organisations. Managers in the organisation are sincerely concerned about reports that produce
the financial accounting, but the information would not be sufficient for making operational
decisions of the organisation. Individuals, who take decisions by using information from the
financial accounts, are normally interested in comparing their own organisation with other firms.
For example, deciding whether to invest in the organisations like Apple Computer or Microsoft.
An important characteristic of financial accounting information is that, it is comparable between
organisations. This means that, when an investor looks at revenues from Apple Computers, these
revenues signify the same thing for Microsoft. Due to this, financial accounting systems are
characterised by a series of regulations that describe how transactions should be treated.
Cost accounting
Cost accounting information is planned for managers. As managers take decisions only about
their own organisation, there is no need for the information to be compared with similar
information from other organisations. Instead, the significant principle is that the information
must be appropriately decided. Cost accounting information is generally used in financial
accounting information, but first we should concentrate on its benefit to managers in making
decisions. The accountants handle the cost accounting information, and add value by providing
excellent information to managers who take decisions. The cost accounting system results from
the decisions made by managers about an organisation. Some aspects of cost accounting in
regard to its clients, with GAAP and ethics are given below:
Cost accounting and GAAP - The key principle of financial accounting is to supply information
about the organisation and the performance of the management to the investors or creditors. The
financial information organised for this purpose is governed by the Generally Accepted
Accounting Principles (GAAP), which supply consistency in the accountancy data used for the
purpose of reporting from one organisation to another. The information of cost accounting used
to estimate the expenditure of goods sold, inventory assessment, accounting and other financial
information used for external reports should be arranged in accordance with GAAP.
Clients of cost accounting - The administration must consider customer as important out of all
the participants in a business. Without customers, the organisation loses its capability and reason
to exist. The cost information itself is a product with its individual customers. The major problem
with accounting system occurs, when managers utilise accounting information that was designed
for external reporting, in decision-making.
Cost accounting and ethics - The design of costing systems is finally about the payment of costs
to various activities, products, projects and corporate units, and people. The method in which this
is done, affects prices, reimbursement and payment. Based on the events, the cost accounting
systems plan the potential to misuse and fraud the customers, employees or shareholders. As user
or preparer of the cost information, you should be aware of what it implies, and how the
information is utilised. The most important point is that, you should be aware of when the system
has the potential to be ill-treated.
9.3.2 Harmonising of accounting systems
Though there are many differences in accounting standards and practices, a number of forces are
leading to harmonisation. Some of these forces are:
A movement to present information well-matched with the requirements of investors.
The global mixing of capital markets, which means that investors have easier and quicker access
to investment opportunities around the world, and thus require financial information that is more
equivalent to other accounting standards.
The need of MNCs to increase the capital outside their home-country capital markets, while
generating few diverse financial statements.
Regional, political and economic harmonisation, such as, the hard work of the European Union
(EU), which affects accounting, trade and investment issues.
Pressure from MNCs for consistent standards, which allows for reduced costs in each country,
and in reporting that is used by investors in the organisations home-country.
Differences in accounting systems are confusing and expensive to international business.
Superiority in these systems makes it complex for organisations to examine their foreign
operations and for investors to understand the relative performance of organisations that are
based in different countries. To help in solving such problems, many accounting professionals
and national regulatory bodies are trying to harmonise diverse national accounting practices. It is
also important to understand the arguments in favour of harmonisation.
Arguments supporting harmonisation
Harmonisation of accounting and exterior financial reporting assists in the optimal global
delivery of private-sector finance. Harmonisation is concerned with reducing the diversity that
exists between accounting practices, in order to improve the comparability of financial reports
prepared by companies from different countries. Investors should be able to realise a more
proficient portfolio of organisations on national, as well as, international scale. This will benefit
the investor. When global capital markets operate properly, then the financial information
disclosed to the market-place must be global. Figure 9.2 highlights for and against
harmonisation.
Figure 9.2: Arguments for and Against Harmonisation
The standard of accounting disclosure needs and auditing vary from country to country, and
makes cross-border investigation very difficult. These differences present a barrier to investors as
they feel uncomfortable about the information presented to them, which is very different from
what exists in their home-country.
Harmonisation of accounting and auditing practices help to reduce the size of the barrier.
Investors must deal with diverse accounting practices and disclosures, and have trust in the
figures presented by accepting the standard of auditing. Harmonisation programme helps in this
task.
Self Assessment Questions
4. Information in _______________ is planned for decision makers and who are not involved in
the daily management of the organisation.
5. Cost accounting information is planned for _________.
6. Customer is important of all the participants in a business whom the administration must
consider. (True/False)
9.4 International Regulatory Bodies
In the previous section we covered accounting for international business. In this section you will
learn about the various international regulatory bodies.
Certain regulatory bodies are active in bringing out harmonisation of accounting standards.
Efforts of some of the bodies are explained.
European Union
The most obvious effort towards harmonisation is seen in the European Union. The European
Commission sets directives, which are orders to the member countries, to bring their laws inline
with EU needs, within some transition period. The earlier accounting directives addressed the
following:
The nature and design of financial statements.
The measurement support on which the financial statements are to be organised.
The significance of consolidated financial statements.
The need that auditors must make sure that the financial statements reflect a true perspective of
the operations of the organisation that is being audited.
Though the EU has enhanced the comparability of financial statements, the directives do not
cover several essential issues. Additionally, some directives provide options, and member
countries understand the directives differently. Thus, EU organisations listing outside their home
countries must supply the following two sets of financial statements, they are:
Home country statements.
Reconciliation statements.
United Nations
The United Nations is interested in international accounting since the early 1970s, under a
'Group of Eminent Persons'. This further led to the establishment of Intergovernmental Working
Group of Experts on International Standards of Accounting and Reporting (ISAR) by the UN
Economic and Social Council.
The ISAR attempts to support the developing countries, by creating recommendations on the
accessibility and comparability of information disclosed by international businesses.
The discussions of the ISAR are reported in annual publications, and cover the accounting
developments worldwide, and also reports on accounting issues of significance to global
accounting.
The ISAR is presently concerned about developing discussions on the international environment
reporting, and the role and responsibilities of accountants and auditors.
Organisation for Economic Cooperation and Development (OECD)
The OECD was established by world's 24 developed countries such as Australia, Austria,
Belgium, Canada and so on, for promoting world trade and international economic growth. It
considers the matters from the perspective of economically developed countries. The council of
OECD has established a committee on International Investment and Multinational Enterprises
(MNEs). This committee has established a Working Group on Accounting Standards.
The Working Group has recently published a 'Clarification of the OECD Guidelines', and
published reports as an element of an 'Accounting Standards Harmonisation' series. Most
recently, the OECD has established a 'Centre for European Economies in Transition', which
along with Working Group has prepared workshops, seminars, and meetings, to recognise the
purpose and constituents of accounting systems in these countries.
International Accounting Standards Committee (IASC)
International Accounting Standards Committee was created in the year 1973. It has issued a
series of standards planned to harmonise the national management of accounting issues. The
chief objective of IASC is the encouragement of comparability of financial statements between
countries, by establishing standards for inventory assessment, depreciation, delayed income
taxes, and so on.
An important accomplishment of the IASC has been the creation of the International Accounting
Standards (IAS). The publication and global recognition of these standards is necessary for the
harmonisation efforts of the IASC.
The International Federation of Accountants (IFA)
The International Federation of Accountants was founded in the year 1977. It completely
supports the work of the IASC, and recognises the IASC as having responsibility and authority to
issue rules on international accounting standards. IFA has parallel responsibility of IASCs
objective of developing international guidelines for auditing, ethics, education and management
accounting.
Other international regulatory bodies are Governmental Accounting Standards Board,
Independence Standards Board, International Accounting Standards Board, International
Organisation for Securities Commission, National Association of State Boards of Accountancy,
Public Company Accounting Oversight Board, UK Accounting Standards Board and so on.
Self Assessment Questions
7. The European Commission sets directives which are orders to member countries to bring their
laws inline with EU needs within some transition period. (True/False)
8. _____________________considers the matters from the perspective of economically
developed countries.
9. The International Federation of Accountants was founded in the year ______________.
Activity 2
The link below provides an article on various International Regulatory Bodies. Find out the
responsibilities of OECD and WHO.
Hint: Refer link: http://www.iraup.com/results.php?page_name=int_org
9.5 International Financial Reporting Standards
After learning about the different international regulatory bodies, we shall now discuss about
reporting standards used in international finance.
International Financial Reporting Standards (IFRS) are principle-based values; interpretations
and the structure followed by the International Accounting Standards Board (IASB).
Structure of IFRS
International Financial Reporting Standards comprise of the following:
International Financial Reporting Standards (IFRS) - standards issued after 2001.
International Accounting Standards (IAS) - standards issued before 2001.
Interpretations developed from the International Financial Reporting Interpretations Committee
(IFRIC) - issued after 2001.
Standing Interpretations Committee (SIC) - issued before 2001.
Framework for the Preparation and Presentation of Financial Statements (1989).
Framework
The framework used for the preparation and presentation of financial statements states the basic
rules for IFRS.
Objective of financial statements
A financial statement should reproduce true and fair view of the business dealings of the
organisation, because these statements are used by different constituents of the society. They
should reflect the true vision of the financial situation of the organisation.
Underlying assumptions
IFRS approved two basic accounting models, which are:
Financial capital preservation in nominal monetary units.
Financial capital preservation in units of invariable purchasing power.
The four underlying assumptions in IFRS are given below:
Accrual basis - The result of dealings and other measures are recognised when they happen.
Going concern - An entity will persist for the predictable future.
Stable measuring unit assumption - Financial capital safeguarding in nominal monetary units or
in conventional historical cost accounting. That is, accountants believe that changes in the
purchasing power of the functional currency will be up, but not adequately significant for them
to decide on financial capital safeguarding in the units of regular purchasing power during low
inflation and deflation as authorised in IFRS, in the Framework.
Units of constant purchasing power - Financial capital preservation in units of regular purchasing
power during low inflation and deflation, that is, the denial of the constant measuring unit
statement. Measurement in units of constant purchasing power (inflation - adjustment) remedies
the destruction caused by historical cost accounting.
Qualitative characteristics of financial statements
There are some qualitative characteristics of financial statements. These are as given below:
Understandability.
Reliability.
Comparability.
Relevance.
True and fair view or fair presentation.
Elements of financial statements
The financial position of an enterprise is mainly provided in the Statement of Financial Position.
The fundamentals of financial statements are given below:
Asset - An asset is a resource guarded by the enterprise as an effect of past procedures, from
which potential economic benefits are likely to flow to the enterprise.
Liability - A liability is a present requirement of the enterprise that is rising from the past
procedures, the conclusion of which is likely to result in an outflow from the enterprise'
possessions, that is, assets.
Equity - Equity is the outstanding concentration on the assets of the enterprise after subtracting
all the liabilities under the historical cost accounting model. Equity is well-known as owner's
equity. Under the units of invariable purchasing power model, equity is the regular real value of
shareholders equity.
The financial performance of an enterprise is mainly provided in an income statement or profit
and loss statement. The elements of an income statement or the elements that determine the
financial performance are as follows:
Revenues - Increase in economic profit during an accounting period, in the type of inflows or
enhancements of assets, or diminishing of liabilities that effect to increase equity. But it does not
comprise the contributions made by the equity participants, that is, owners, partners and
shareholders.
Expenses Reduction in economic benefits in an accounting period, in the form of outflows, or
reduction of assets or committing to liabilities that effect in decreasing equity.
Measurement of the elements of financial statements
Measurement is the method of determining the monetary amounts. But it does not comprise the
contributions made by the equity participants, that is, owners, partners and shareholders. The
components of the financial statements are documented and approved in the balance sheet and
income statement. A number of diverse measurement bases are engaged in various degrees, and
in changing combinations in financial statements. These measurements include the following:
Historical cost - Assets are entered at the amount of cash or cash equivalents paid or the fair cost
of the consideration given to obtain them at the time of their purchase. Liabilities are recorded at
the amount of earnings received in exchange for the commitment, or in some situations (for
example, income taxes), at the amounts of cash or cash equivalents likely to be paid to convince
the liability in the normal course of business.
Current cost - Assets are approved at the amount of cash or cash equivalents that needs to be
paid, if the similar or an equivalent asset was acquired at present. Liabilities are approved at the
undiscounted amount of cash or cash equivalents that would be necessary to settle the
requirement at present.
Realisable (settlement) value - Assets are approved at the amount of cash or cash equivalents that
could, at present, be obtained by exchanging the asset in a methodical removal. Assets are
accepted at the current discounted value of the future net cash inflows that the item is likely to
produce in the typical course of business. Liabilities are carried at the current discounted value of
the future net cash outflows that are likely to be essential to resolve the liabilities in the typical
course of business.
The measurement basis that is generally adopted by entities in preparing their financial
statements is historical cost. This is generally combined with other measurement bases.
Self Assessment Questions
10. _______________ is one of the underlying assumptions of IFRS.
11. Equity is the outstanding concentration on the assets of the enterprise after subtracting all the
liabilities under the historical cost accounting model. (True/ False)
12. Which among the following is not an element of financial statements?
a) Asset
b) Liability
c) Equity
d) Accountability
9.6 Summary
Let us now summarise the salient points you learnt in this unit on the international accounting
practices:
Accounting standards are the type of compulsory and regulatory mechanisms for training on
financial reports and conducting successful audit for the same. It is used in almost all countries.
International businesses meet number of accounting problems that do not stop domestic
businesses. There are many differences between both Domestic Accounting Standards (DAS)
and International Accounting Standards (IAS). Considering the list of differences, two indices
are created-'absence' and 'divergence'.
Law system is divided into civil law and common law countries in the world.
Harmonisation of accounting and exterior financial reporting helps in the best international
delivery of private-sector finance. Harmonisation of accounting and auditing practices help to
diminish the size of the barrier.
Certain regulatory bodies are dynamic in bringing harmonisation of accounting standards. Some
of them are European Union, United Nations, and so on.
International Financial Reporting Standards (IFRS) are principle-based values; interpretations
and the arrangement followed by the International Accounting Standards Board (IASB).
9.7 Glossary
Benchmark - It is used to evaluate performance in the organisation.
Depreciation - it refers to the decrease in price or value.
Harmonisation - It refers to the process of making a pleasing or consistent whole.
9.8 Terminal Questions
1. Explain briefly how the differences between IAS and DAS be measured.
2. Explain briefly about accounting for international business.
3. Explain the forces that lead to harmonisation of accounting system.
4. Explain briefly the work of United Nation as one of the international regulatory bodies.
5. How do you measure the elements of financial statements of IFRS?
9.9 Answers
Self Assessment Questions
1. True
2. Absence, divergence
3. True
4. Financial accounting
5. Managers
6. True
7. True
8. OECD
9. 1977
10. Going concern
11. True
12. Accountability
Terminal Questions
1. You can measure the differences between IAS and DAS in the following way: Literature on
international accounting differences, Framework of analysis. These are explained in sub section
9.2.1 of this unit. Refer the same for details.
2. An organisation's first contact to international accounting occurs as an outcome of an import or
export opportunity. In exports, a domestic organisation may receive an unwanted inquiry or
obtain order from a foreign buyer. This is explained in the section 9.3 of this unit. Refer the same
for details.
3. Though there are many differences in accounting standards and practices, a number of forces
are leading to harmonisation: A movement to present information well-matched with the
requirements of investors. These are explained in sub-section 9.3.2 of this unit. Refer the same
for details.
4. The United Nations is interested in international accounting since the early 1970s under a
'Group of Eminent Persons'. This further led to the establishment of Intergovernmental Working
Group of Experts on International Standards of Accounting and Reporting (ISAR) by the UN
Economic and Social Council. These are explained in the section 9.4 of this unit. Refer the same
for details.
5. Measurement is the method of determining the monetary amounts at which the elements of the
financial statements are to be documented and approved in the balance sheet and income
statement. A number of diverse measurement bases are engaged in various degrees and in
changing combinations in financial statements. They include the following: historical cost,
current cost, and realisable (settlement) value. These are explained in the section 9.5 of this unit.
Refer the same for details.

9.10 Case-Let
Application of International Accounting Standards to Central Banks
As the financial markets are becoming internationalised, the international accounting standards are applied
to central banks. The primary objective of these entities is to maintain the value of the country's currency.
The idea of applying IAS is to guarantee a high degree of transparency and comparability among financial
statements and can find an efficient operation of the Community's capital market and the domestic market
also.
A sample of accounting and financial information were published on the websites of 19 central banks to
know as to how the IASs are being applied to the accounting policies and practices used by central banks in
the region. The findings of the analysis are described as follows:
1. Accounting standards governing the preparation of financial statements - It was found that there was a
beginning of an alignment with International Accounting Standards.
2. Publication of financial statements - IAS states that a total set of financial statements should include a
balance sheet, an income statement, and changes in equity statement, a cash flow statement and a summary
of accounting policies. It was found out that the biggest problem for central banks was to prepare
statements of changes in equity and cash flow statements.
3. Proper disclosure of information - According to IAS, a business is appreciative to disclose the accounting
policies used and other explanatory notes. The study show that the central banks reveal accounting policies
and practices in their notes.
4. Use of ultimate exchange rates and fair value - AS states that in each balance sheet, the dates of the items
in foreign currency must be reported at closing rate. The findings about central bank focuses on the use of
closing rates for assets and liabilities decreased in foreign currency and on the use of reasonable values for
portfolios in both foreign and domestic currency.
5. Reporting changes in the exchange rate - According to IAS, exchange differences that happen when
monetary items are developed, must be reported as fixed cost or income for the phase in which they
appeared. Through the study, it was found out that the central banks apply diverse policies and procedures
to proof their exchange differences.
All these helped in internalisation of central banks and helped in maintaining the international accounting
standards on the domestic currency.
Discussion Question
1. Discuss the application of international accounting standards to central bank. (Hint: Accounting
Standards Governing the Preparation of Financial Statements)
Source: www.cemla.org/pdf/acp/acp_9_Jairo_Contreras.pdf

References
Aswathappa. K. (2008). International Business. Tata McGraw Hill Education: New Delhi.
Paul Rodgers (2007), International Accounting Standards, From UK Standards to IAS An Accelerated Route for
Understanding the Key Principles, Elsevier Ltd.
International Accounting Standards Committee (2000), International Accounting Standards Explained, Chichester:
Wiley.
E-References
media.wiley.com/product_data/excerpt/22/EHEP0005/EHEP000522.pdf
http://www.indianmba.com/faculty_column/fc137/fc137.html
http://www.loscostos.info/english/accsyst.html
Retrieved on October 31st, 2010

Unit-10- International Strategic Management


Structure:
10.1 Introduction
Objectives
10.2 Strategic Management
Nature of international strategic management
Advantages and disadvantages of strategy
10.3 Strategic Planning
Types of planning
GAP analysis
Top-down vs. bottom-up planning
10.4 Strategic Management Process
Strategic formulation
Strategic implementation
10.5 Summary
10.6 Glossary
10.7 Terminal Questions
10.8 Answers
10.9 Case-Let
10.1 Introduction
In the previous unit you studied about the various factors involved in accounting practices in
MNCs and also the various regulators and accounting standards followed by different countries
and regions across the world. You also learned about accounting from an international
perspective including international regulatory bodies and also the international financial
reporting standards.
International strategic management refers to planning the strategy in international business to
compete and also ensure that they have a long-term strategy for survival. Strategic management
focuses on developing a strong structure for an organisations business that will gradually be
changed by combining the efforts of each individual that the organisation employs.
Objectives:
After studying this unit, you should be able to:
explain the nature of international strategic management.
list the advantages and disadvantages of strategy in international business.
discuss strategic planning and its types.
evaluate the role of strategic management in international business.
describe strategic management process.
10.2 Strategic Management
The nature of strategic management plays a vital role in international business world. It is
important to understand the term strategic management before discussing the nature of strategic
management.
The term strategic management refers to the complete range of strategic-decision making activity
in an organisation. Strategic management identifies and comprehends the environmental factors
to control the plans accordingly. Strategic management has evolved as a concept over time and
will continue to evolve.
10.2.1 Nature of international strategic management
Strategic management focuses on the process of formulating, implementing, and evaluating
strategies, to achieve the objectives of an organisation. The concept of strategic management
process in an MNC is similar to that of any other organisation. But the major complicating
factors are that the strategic management process has to analyse and understand the
environmental needs according to the regional and country perspective before considering the
various strategic options. Time and effort is spent to identify and evaluate external trends and
events in MNCs. Communication between home offices and overseas operations become
complicated because of cultural and national differences, geographic distances and variations in
business practices. The strategy implementation becomes difficult as different cultures have
different norm values and work ethics.
Strategic management holds significance in international business. An MNC has to keep track of
their various operations in a continuously altering international environment.
Strategic objectives
Strategic objectives assist in the implementation process of the organisations objectives or goals.
While implementing an international strategy, an organisation has to identify the opportunities
present in these countries, explore the various resources available, their strengths and capabilities
and plan to work on their core competencies. The objective should be formed in a way that it is
not deficient or immeasurable. The strategic objectives must help the organisation to achieve
their mission and vision.
Most of strategic objectives focus on producing greater profits and returns for the business
owners; others focus on customers or society at large. The strategic objectives are as follows:
Measurable To measure progress against fulfilling the objective there must be at least one
indicator.
Specific A clear message as to what needs to be achieved is provided.
Appropriate With the given vision and mission of the organisation, objectives must be consistent.
Realistic Objectives must be an achievable target given the organisations abilities and
opportunities in the environment. This means that objectives must be challenging and attainable.
Timely To accomplish the objective there need to be a time frame.
When strategic objectives are thoroughly implemented, it will result in strategic competitiveness
that improves the performance and innovation of these organisations. When objectives fulfil the
above conditions, there are many profits for the organisation. The profits are:
First, they help guide employees throughout the organisation towards achieving the common
goals. This aids the organisation to concentrate and conserve valuable resources and to work
together in a timely manner.
Second, challenging objectives help encourage and inspire employees throughout the
organisation to higher levels of commitment and effort. A research has supported the concept that
individuals work harder when they are motivated toward specific goals, instead of being asked
simply to do their best.
Third, for different parts of an organisation there is always the potential to follow their own goals
rather than the overall company goals. Though these intentions are good, these may work at cross
purposes to the organisation as a whole. Thus, meaningful objectives help resolve divergence
when they occur.
Finally, appropriate objectives offer a standard for rewards and incentives. They not only result
in higher levels of motivation by employees but they will also help ensure a greater sense of
equity or fairness when rewards are allocated.
There are other objectives that are even more specific. These are commonly referred to as short-
term objectives that are essential components of action plans. They are critical in implementing
an organisations chosen strategy.
Strategic alliances
In todays trade, the increasing number of strategic alliances stands as one among the fast
growing developments. Strategic alliances are far-reaching through nearly every industry and
they are becoming an important driver of higher growth according to Booz-Allen and Hamilton.
Alliances vary in scope from an informal business association based on a simple contract to a
joint project agreement. To manage the alliance for legal and tax purposes either a corporation or
partnership is set up.
Strategic alliances are the means to work together with others towards a common goal for small
businesses, without losing their individuality. Alliances are a way to obtain the rewards of team
effort and one can reap considerable profits from forming strategic alliances. Statistical studies
claim, organisations that take part in alliances account for 18 percent of their profits that come
from their alliances.
But it is not just profit that encourages the increase in alliances. The other factors are: a growing
intensity of competition, a rising need to operate on a global scale, a fast varying marketplace,
and an industry union in many markets. Particularly in a time when upcoming international
marketing is becoming the standard, these alliances and partnerships can influence the growth.
Instead of taking the risk and expense that international expansion requires, any organisation can
enter the international markets by identifying a suitable alliance with a business operating in the
marketplace that the organisation wants to enter.
A strategic alliance is basically a partnership in which the organisations unite by entrusting
efforts in projects. The effort is exerted on the projects to get a better price for supplies, to
purchase bulk products and to build them with each of the organisations that are a part of its
production. The goal of alliances is to reduce risk while increasing the power and profit.
Alliances should not be confused with acquisitions, mergers, and outsourcing. But there are some
similarities in the situation in which a business may consider one of these solutions. Mergers and
acquisitions are everlasting, that determine the survival of the organisation. Outsourcing is just a
way of attaining a functional service for the company.
An alliance is basically a business-to-business partnership. Another term that is commonly used
in combination with alliances is establishing a business network. Alliances are formed for joint
production, design collaboration, joint marketing, joint sales or distribution, technology
licensing, and research and development. Relationship between a vendor and a customer is said
to be vertical. And the relationship between vendors situated locally or globally is said to be
horizontal. Alliances are established formally in a joint project or partnership.
Strategic alliances are used in businesses to:
Attain advantages of scope and speed.
Boost market access.
Improve competitiveness in domestic or global markets.
Improve product development.
Increase new business opportunities through new products and services.
Enlarge market development.
Enhance exports.
Diversify.
Make new businesses.
Minimise costs.
Strategic alliances are becoming a common tool for increasing the reach of the organisation
without exerting organisation to expensive internal expansions beyond the core business.
10.2.2 Advantages and disadvantages of strategy
The advantages of a well structured strategy in international business are:
It gives good guidance for doing business.
It alerts the manager to new opportunities and threats.
It aligns members to work towards the common goals that are set.
It facilitates to make management become more proactive than reactive.
It confronts the economic model of the business to assure constant profits.
It helps the decision making course of assigning resources.
The disadvantages of strategic management are as discussed below:
To anticipate the forthcoming environment to develop plans as it is hard to predict the future.
To develop strategies by hiring an external consultant and is expensive.
To address the immediate crisis before allocating resources (like opportunity cost, people,
money, time) to strategic management process is not possible.
To reject few opportunities that might be available in firms after undertaking a strategic
management process is not possible.

Self Assessment Questions


1. The nature of ________________ plays a vital role in international business world.
2. The strategic objectives should be measurable, appropriate, realistic, specific, and timely.
(True/False)
3. _____________ is a way of attaining a functional service for the company.
Activity 1
Assume that you own a company manufacturing toys for the International market. Your specialty
lies in integrating the cultural and religious aspects into toys. Mention in terms of strategic
objectives, how you would strategically begin your objectives, and what kind of steps you would
take so that you are accepted in a better way abroad.
Hint: Identify cultural differences, plan strategy to combat the same and for alliances
10.3 Strategic Planning
We had discussed about strategic management in the previous section. In this section we will
learn about the key components of strategic management that is strategic planning. We also learn
about strategic planning and its types.
Strategic planning involves the structured efforts of an organisation to effectively recognise its
purposes for existing, the direction that the organisation will pursue, and how that direction will
allow the entity to achieve its short-term and long-term goals. Strategic planning is an important
element in all kind of organisations and is applied by governments, non-profit agencies,
individuals and businesses.
A simple approach to strategic planning is as discussed below:
1. The first step is to accurately assess where the entity is today, with respect to its ability and
resources.
2. The second step is to recognise where the organisation would like to be at some precise point
of time in the future, by efficiently setting goals and objectives that it needs to accomplish.
3. The third and final step engages choosing how to successfully progress on from the conditions
of today and methodically work toward those goals in a structured and logical manner.
During strategic planning process, experts make use of many ways, and sometimes break down
each process into a series of steps. The complexity of the exact approach used frequently
comprises of the nature of the organisation, the kind of goals laid down and the resources needed
to attain those goals.
10.3.1 Types of planning
The strategic planning process involves allocation of resources to firms to fulfil their long-term
goals. Any business plan can be classified into three, they are:
Strategic planning This planning process is the best among the three business planning processes.
Strategic planning is a long-term process which the business owners utilise to unveil their
business vision and mission. It also determines a gateway for business owners for achieving their
goals. Strategic planning fulfills the mission and the overall goals of the firm. Whereas, the other
two are rather more short-term and are used sometimes without any relation to the long-term
business goals. But the three kinds of planning work well when used within a strategic plan.
Intermediate planning This planning process is for six months to two years. They outline the
manner in which the strategic plan is pursued. Intermediate plans are often used for campaigns
with the purpose and goals of campaign supporting the trades long-term goals.
Short-term planning This planning process involves planning for few weeks or at least for a year.
They detail out the functioning of a strategic plan on a daily basis. They allocate resources for
business management and development that takes place daily within the strategic plan.
10.3.2 GAP analysis
A GAP analysis is a simple tool that helps the planning team to identify methods to close the
performance gaps. The current affairs and the required future state must be looked into by the
planning team. It must be made clear whether or not the gap can feasibly be closed by the
planning team. Modifying resources from activities to be terminated to activities to be started,
the performance gap is closed. If there is uncertainty that the initial gap cannot be closed, then
the feasibility of the required future state must be reconsidered.
Businesses use gap analysis to accomplish company-wide goals, or those for a specific
department or area. For example, a firm that wishes to reduce overhead costs completes a
financial gap analysis. Or an organisation that wants to enlarge its product distribution might
create a marketing analysis. Gap analysis help businesses measure their possible profitability of a
goal. This helps the management and staff to understand and be eager about the plans laid out in
the analysis.
10.3.3 Top-down vs. bottom-up planning
Let us now discuss about top-down and bottom-up planning.
Top-down planning
Top-down planning is a common strategy that is used for project planning. It helps maintain the
decision making process at the senior level. Goals and allowances are established at the highest
level. Senior-level managers have to be very specific when laying out expectations because the
people following the plan are not involved in the planning process. It is very important to keep
the morale of the employees and motivate them to perform the job since employees are not
included in any of the decision making process and they are only motivated through either fear or
incentives.
Management must choose techniques to align projects and goals with top-down planning.
Management alone will hold the responsibility for the plans set and the end result. The benefit of
talented employees with prior experience on definite aspects of the project are not utilised due to
the assumption that the management can plan and perform a project better without the inputs
from these employees. Some think that the top-down planning process is a way to make a plan,
and it is not about the plan development. It permits the management to segregate a project into
steps, and then break the work into smaller executable parts of the project. Simultaneously, the
work that is broken down is analysed until all the steps could be studied, due-dates must be
precisely assigned, and then parts of the project could be given to an employee. Yet, the focus is
on long-term goals and the short term and uncertain goals that can get lost. This approach is best
applicable for small projects.
Bottom-up planning
Bottom-up planning is commonly referred to as tactics. With bottom-up planning, an
organisation gives its project deeper focus because organisation has a huge number of employees
involved, and each employee is expert in their own area. Team members work side-by-side and
they contribute during each stage of the process. At the lowest levels, plans are developed and
are then passed on to each of the subsequent higher levels. Finally, it then reaches the senior
management for approval.
Lower-level employees take personal interest in a plan that they are involved in planning.
Employees are more encouraged which in turn improves their morale. Project managers are
responsible for the successful completion of the project. Let us now consider the key points of
top-down and bottom-up planning.
Top-down planning
Top-down planning helps:
Determine all the goals at the initial stage of the process.
Identify the lack of ground level staff participation.
Estimate the inflexibility.
Find how management imposes the processes.
Determine the lack of motivation.
Find whether the staffs feel that their input is valued or not.
Bottom-up planning
Bottom-up planning helps:
As there are no long term vision here.
Encourage teamwork.
Estimate flexibility.
Determine whether team motivation is of high level.
Identify whether the project is team driven.
Find whether the staffs feel valued or not.
Finally, a combination of these two project management methods is most effective. Using the
positive aspects of each, the organisation can align each step so that the requirements of the
project are met. Organisation can determine the top requirements of the project and allow
accountability to get down with the lower levels. With this combination, the vision of senior
management with the skills of lower level employees is merged. This helps the project to
complete more efficiently which allows an organisation to use the best of from the organisations
employees.
Self Assessment Questions
4. A _____________ is a simple tool that helps the planning team identify methods to close the
performance gaps that has been identified.
5. Top-down planning encourages team work. (True/False)
6. ________________ are responsible for the successful completion of the project

Activity 2
Assume that you are the manager of International chemical dyeing firm that is undergoing a
technological change in one of their main units. How will you implement your strategic planning
so that employees accept and adopt change?
Hint: Use Bottom up planning.
10.4 Strategic Management Process
In the previous section we learnt about strategic planning and its types. In this section, we will
discuss the strategic management process.
The strategic management process is a way businesses build strategies that help firms respond
quickly to the new challenges. This process helps organisations to find new and more efficient
ways to do business.
The organisation should have a good strategic planning that clearly describes objectives and
evaluates both the internal and external situation to establish the strategy, implement, evaluate,
and make necessary changes to stay as per the vision and mission of the organisation. A pictorial
representation of strategic planning process is as shown in figure 10.1.

Figure 10.1: Strategic Management Process


The five levels of strategic management process are:
1. Mission and objectives The mission defines the organisations existence. The purpose of the
organisation is stated by a mission statement. The mission statement conveys a purpose to
employees and projects the organisations image to customers. The goals of the organisation are
called objectives. These objectives are challenging in nature but they are achievable. The
objectives should be measurable so that the company can keep a track of its progress and make
modifications, if necessary.
2. Situation analysis After specifying the objectives, the organisation must devise a strategic plan
to attain them. New opportunities and new ways are adopted to attain the objectives that occur
when there are changes in the external environment. Thereby, an environmental scan is
conducted to find the opportunities. To select opportunities, the organisation has to know its own
abilities and limitations., Situation analysis includes analysis of both external and internal
environment. The external environment consists of political, social, technological, and other
factors. It also analysis the functionality of the organisation. The internal environment consists of
situations like organisational structure, market share, operational efficiency, and others. Situation
analysis provides huge amount of information. To efficiently manage this information the
internal factors should be categorised into strengths and weaknesses of the organisation, and
external factors should be categorised into opportunities and threats.
3. Strategy formulation After having a clear picture of the organisation, the strategic alternatives
are developed. Depending on the organisations situations, different organisations adopt different
alternatives. Michael Porters identified generic strategies that could be applied to all
organisations and this includes cost leadership, differentiation, cost focus and differentiation
focus. All these can be considered while defining the strategic alternatives.
4. Implementation The strategy is expressed in high-level conceptual terms. The conceptual
terms should be translated into detailed policies for effective implementation and also for the
understanding of the functional level of the organisation. The functional policies also state
practical issues clearly. The strategy must be translated into specific policies for functional areas
like marketing, production, research and development, human resources, information system,
and others. The implementation stage also involves finding the required resources and
categorising the organisational changes.
5. Evaluation and control After implementation, the outcomes of the strategy have to be
measured and evaluated, along with the changes that have been made. To help this, monitoring
control-systems are developed and implemented. The steps involved in evaluation and control
are:
1. Describe the parameters to be measured.
2. Describe the target values for those parameters.
3. Carry out the measurements.
4. Compare the measured results to the pre-defined standard.
5. Make the necessary changes.
10.4.1 Strategic formulation
Strategic formulation is the second phase in the strategic management process. It makes a clear
set of proposals, with supporting explanation, that modify as essential the mission and objectives
of the organisation, and supply the strategies for achieving them. In fact, the current objectives
and strategies are modified in many ways to make the organisation more successful. This
includes creating sustainable competitive advantages though most of them are swept out
gradually by the competitors efforts.
There are three aspects or levels of strategy formulation. Each aspect has a different focus that
includes the requirement to be met within the formulation stage of strategic management. The
three aspects of recommendations must be internally steady and match together in a jointly
supportive manner that outlines an integrated hierarchy of strategy. The three aspects are:
Corporate level strategy.
Business level strategy or competitive strategy.
Functional strategy.
Corporate level strategy This aspect of strategy is concerned with broad decisions about the total
organisation's scope and direction. Basically, the changes which should be made in the growth
objective and strategy for achieving the objective is considered, the lines of business at present,
and how these lines of business go together. The three components of corporate level strategy
are:
Directional or growth strategy This designs the organisations growth objective. The objectives
range from cutback through stability to altering levels of growth and how the organisation
accomplishes them.
Portfolio strategy This strategic activity plans the organisations portfolio in line with the
business, which completely needs reconsidering how much concentration or diversification the
organisation should have.
Parenting strategy This defines the way the organisation assigns resources and manages abilities
and activities across the portfolio, this also concentrates on where to emphasise particularly, and
how much the organisation should integrate into its various lines of business.
Competitive strategy This is also called business level strategy. It involves deciding how the
organisation would compete within each line of business or strategic business unit.
Functional strategy Functional strategies are more localised with shorter-horizon activities. They
deal with how each functional area and unit will perform its functional activities to be effective
and increase resource productivity.
10.4.2 Strategic implementation
Strategy implementation is one of the stages of strategic management. It refers to decisions that
are made to lay out new strategy or reinforce present strategy. The basic activities of strategic
implementation are to establish annual objectives, devise policies, and allocate resources. In
addition, strategy implementation also includes decision making with respect to strategy and
organisational structure, develop budgets, and motivational systems. The features of strategic
implementation are to:
Establish annual objectives.
Devise policies.
Motivate employees.
Allocate resources.
Develop strategy-supportive culture.
Create organisational structure.
Redirect the marketing efforts.
Prepare budgets.
Develop information system.
Self Assessment Questions
7. The __________________ process is a way businesses build strategies that help firms respond
quickly to the new challenges.
8. The kind of strategy concerned with broad decisions about the total organisation's scope and
direction is _____.
a) Business level strategy
b) Corporate level strategy
c) Functional strategy
d) Competitive strategy
9. One of the phases of strategic management process which includes the decision making with
respect to strategy and organisational structure; develop budgets and motivational systems is
_____.

10.5 Summary
Let us summarise the points covered in this unit about international strategic management:
International strategic management refers to planning the strategy in international business to
compete and also ensure that they have a long-term strategy for survival.
Strategic management focuses on the process of formulating, implementing, and evaluating
strategies, to achieve the objectives of an organisation.
Strategic objectives assist in the implementation process of the organisations objectives or goals.
Most of strategic objectives focus on producing greater profits and returns for the business
owners; others focus on customers or society at large.
Strategic alliances are the means to work together with others towards a common goal for small
businesses, without losing their individuality.
Strategic alliances are the means to work together with others towards a common goal for small
businesses, without losing their individuality. Alliances are a way to obtain the rewards of team
effort and one can reap considerable profits from forming strategic alliances.
Strategy in international business has various advantages and disadvantages.
Strategic planning involves the structured efforts of an organisation to effectively recognise its
purposes for existing, the direction that the organisation will pursue, and how that direction will
allow the entity to achieve its short-term and long-term goals.
The strategic planning process involves allocation of resources to firms to fulfill their long-term
goals. The three types of planning are strategic planning, intermediate planning and and short
term planning.
A GAP analysis is a simple tool that helps the planning team to identify methods to close the
performance gaps. Gap analysis help businesses measure their possible profitability of a goal.
Top-down planning is a common strategy that is used for project planning. It helps maintain the
decision making process at the senior level. Goals and allowances are established at the highest
level.
In bottom-up planning, an organisation gives its project deeper focus because organisation has a
huge number of employees involved, and each employee is expert in their own area. Team
members work side-by-side and they contribute during each stage of the process
The concept of strategic management is still evolving and will continue to undergo changes.
Thus, understanding and following the process of strategic management in international business
is helpful to practicing managers in achieving the organisations' objectives.
10.6 Glossary
Regulatory bodies: These are professional bodies established on the basis of legal mandate to
protect the public.
Uncertainty: It is the situation where the consequences of events are unpredictable.
MNC: Acronym for multinational company.
Strategy: Plan of action designed to achieve a specific objective.
Alliances: An agreement between two or more entities to achieve a common goal.
Partnership: An arrangement where individuals agree to cooperate towards a common goal.
Mergers: Combination of two or more companies, usually by offering the stockholders of one
company securities in the acquiring company for the surrender of their stock.
Acquisitions: Corporate action in which a company buys most or all the target company's
ownership stakes to assume control of the target firm.
10.7 Terminal Questions
1. Explain strategic objectives and alliances.
2. What is Strategic planning?
3. Explain top-down and bottom up planning.
4. What is Strategic management process?
5. Explain strategy formulation and implementation.
10.8 Answers
Self Assessment Questions
1. Strategic management
2. True
3. Outsourcing
4. GAP analysis
5. False
6. Project managers
7. Strategic management
8. b) Corporate level strategy
9. Strategy implementation
Terminal Questions
1. In order to measure the fulfilment of the objectives, strategic objectives need to be implemented.
Strategic alliances are far-reaching through nearly every industry. These are explained in sub-section 10.2
of this unit. Refer the same for details.
2. Strategic planning involves the structured efforts of an organisation to effectively recognise its
purposes for existing, the direction that the organisation will pursue and how that direction will allow the
entity to achieve its short-term and long-term goals. These are explained in sub-section 10.3 of this unit.
Refer the same for details.
3. Top-down planning is commonly referred to as strategy. Bottom-up planning is commonly referred to
as tactics. These are explained in sub-section 10.3.3 of this unit. Refer the same for details.
4. The strategic management process is a way businesses build strategies that help the company respond
quickly to new challenges. The five levels of management process are explained in sub-section 10.4 of
this unit. Refer the same for details.
5. Strategic formulation is the second phase in the strategic management process. Strategy
implementation is one of the stages of strategic management. These are explained in sub-section 10.4.1
and 10.4.2 of this unit. Refer the same for details.
10.9 Case-Let
Magazine Distribution GAP Analysis
Company PQR is the top bio-medical magazine in Pune. The vision of Company PQR was to be the top
distributor throughout India and also expand their operation abroad. Company PQR initially completed an
analysis showing how it got to be the top regional, then top national magazine distributor. This includes an
overview of every aspect of the business that contributes to the Company PQR's success, including
marketing, accounting, information technology, management, and other departments.
Company PQR outlined the advantages of achieving its goal of becoming the top distributor country as well
as internationally. Goals were designed that were specific and measurable. There was a time frame set for
regional supremacy. In this case, Company PQR planned to become the top nationwide magazine
distributor within two years. They achieved their primary goal of nationwide popularity by bringing
innovative schemes that attracted consumers to buy the same. They brought out an exclusive section for
researchers who were in the field. Company PQR then researched as to how they would achieve
international distributor and what it requires to do to arrive at this goal. The outcome of Company PQR's
analysis was a complete plan that analysed the competitor analysis using Porters model as to what they
required to do so that they can see their goal of international distribution. The aim was to achieve an
international reach as they co-ordinated with scientists abroad. They shared information on various aspects
of the bio-medical field. There were many seminars organised and eminent scientists were recognised.
At the next step, they gathered information and conducted GAP analysis to see where they lacked. The
analysis includes a review of competitors, knowing the needs of the foreign customers, and also interviews
with staff members to know the strengths. After gathering all the information, a gap analysis report was
tabulated.
The reports provided a summary of the present situation, the goals the company wishes to achieve, and the
steps they had to implement to achieve these goals. The steps were analysed into strategic planning. This
plan includes detailed action steps of the business for each area, an agenda to complete each step, and a
plan that outlines how much the plan will cost.
The next and final step was the management to approve and support the action plan and confirm on the
budget. The plan was put into action. Each step was tracked to assure that the plan stays on the agenda and
within budget. The success of the Indian bio-medical magazine in the foreign shores was the talk of the
town that year
Discussion Questions
1. What did the initial analysis include? (Hint: Review of current system)
2. What does the gap analysis report include (Hint: Refer the steps, summary, plan)
Sources: http:// www. wisegeek. com/ what- is- gap - analysis.htm - Retrieved on 11th November 2010

References
K. Aswathappa (2008). International Business. Tata McGraw Hill Publishing Company Limited.
Geoff Goldman, Cecile Nieuwenhuizen (2006). Strategy: Sustaining Competitive Advantage in a Globalised Context. Juta and
Co.
Mike W Peng (2009), Global Strategic Management, Cengage, London.
Phillippe Lesserre (2007), Global Strategic Management, Palgrave Macmillan.
Gerardo R Ungson & Yim Yu Wang, (2008), Global Strategic Management, Library of Congress Cataloging in Publication Data.
Abbass F Alkhafaji, (2003), Strategic Management, Formulation Implementation in dynamic environment, Haworth Press.
E-Reference
http://www.smallbusinessnotes.com/operating/leadership/strategicalliances.html
Retrieved on 8th November 2010
http://www.referenceforbusiness.com/management/Sc-Str/Strategy-Formulation.html - Retrieved on 9th November 2010

Unit 11 E-Business
Structure:
11.1 Introduction
Objectives
11.2 Nature of E-Business
11.3 E-Business Strategy
Planning
Market selection
Establish regional parameters
11.4 E-Business Models
Business to business model
Business to consumer model
Consumer to consumer model
Consumer to business model
11.5 The Challenges of E-Business
Technology
Logistics
Legal concerns
11.6 Summary
11.7 Glossary
11.8 Terminal Questions
11.9 Answers
11.10 Case Let
11.1 Introduction
In the previous unit, you have studied about the need for strategic management process at
the international level. The unit also covered the steps involved in the strategy process,
techniques of building and implementing strategies in an international environment.
The e-business denotes a major trend in the management like any other trends such as the
supply chain management, mail order service or the service economy. The e-business is
done by many asynchronous experts across the globe. The suppliers, customers and also
the competitors coordinate the e-business.
In this unit, you will study about the dynamic nature and process of e-business in an
international scenario. The different models of e-business and various strategies adopted
are discussed. The unit also includes the global challenges and obstacles faced by e-
business.

Objectives:
After studying this unit you should be able to:
explain e-business.
evaluate various strategies in an e-business environment.
identify different models in e-business.
describe the challenges faced by managers in a e-business.
11.2 Nature of E-Business
E-business can be defined as "the use of networks and information technology in order to
electronically design, market, buy, sell and deliver products and services worldwide". E-
business, meaning electronic-business, deals with application of information and
communication technologies, in short an electronic medium in support of all the activities
of business.
The e-business mainly stands for the internet enabled business. There are four entities in
the internet enabled business. These four entities are as shown in the figure 11.1.

Figure 11.1: Entities of Internet Enabled Business


The four entities of internet enabled business are explained as follows:
Information (Access to data) We often use internet for retrieving the information. This
low cost data access is provided for a wide number of people across the world. For many
of the organisations the internet is required to list down the things in the e-pages. To find
any information on the net, the customer must use search engines like the well known and
widely used Google, Yahoo, MSN and portals like AOL, iGoogle, MSNBC, and
Netvibes.
Communication (Bi or multilateral exchange of information) Internet is a basic mode
of communication. The bilateral exchange of information involves communication
between two people with exchange of information. The multilateral exchange of
information involves one person communicating with two or many people. The
multilateral exchange of information can be explained by considering the conference
calls that helps to communicate with two or many number of people at the same time. Bi
or multilateral exchange of information is possible by e-mail based services that act as the
customer interaction centre for the customer questions as well as the complaints. It helps
business people to keep in touch with their business partners across the world.
Community (Mutual support by knowledge transfer) Internet plays an important role
in sharing knowledge as well. This is helpful for processes like the research and
development of systems, development of open source projects, and also the development
of software. The members of the community such as the participants in the open source
projects will help in the mutual transfer of the information.
Commerce (Contract based transactions with the customers) The internet helps in
facilitating the transactions. The aim of commerce is to satisfy the needs of the
customers. This further helps the customers to pay their bills online.
In e-business, the initial stages are tentative and not very secure. As we all know that
most of the business process work in an insecure environment, the pressure is more on
the base of an organisation or the management of an organisation. In the traditional
business, the trust plays an important role with respect to suppliers and consumers. Trust
is also important for performing business with other sectors.
As the e-business is growing rapidly, it is becoming difficult to establish and maintain the
trust during all stages of the business process. There are more chances of losing trust in e-
business as it lacks face to face interaction.
When it comes to trust in e-business, Daughtrey (2001) has suggested some conditions
that consumers expect while performing e-business or purchasing things online. These
conditions include:
The general reputation of the company.
The expectations of the customers for security, privacy, and confidentiality.
The assurances that the supplier must provide like certifications, guarantees, and so on.
The reports of the other customers and if the customer has the history of previous
transactions then additional factors that are considered include:
Accuracy in fulfilling the placed order.
Timeliness of order fulfilment.
The kind of interactions with customer relations.
The resolution for any kind of problems.
The subsequent communications from the supplier.
The need for communication from the other supplier with whom the customer relation
was shared.
There are some factors that build a good trust that include good media, brand name, and
logo. Many of the companies have become successful organisations because of the new
business environment that they have adopted specially with the electronic and
technological development. The companies become successful due to the consumer trust.
There are some situations where there is a lack of trust in the e-business sector and
sometimes it is considered as the secure system. The transfer of payment information
online is more secure than sending the cheques and money orders as online transactions
include the actions like encryption and developing the digital certificates which adds the
security.
There are many risks that are associated with online transaction, hence can be minimised
by technical process like encryption and developing the digital certificates.
Self Assessment Questions
1. In the traditional business, the ________element plays an important role with respect
to customers and suppliers.
2. The transfer of payment information by online is more secure than sending the cheques
and money orders. (True/False)
3. Which of the following lacks in the face to face type of interaction because of which
there is much chance for lacking the trust?
a) Internet
b) Video
c) Direct communication
d) Digital communication
11.3 E-Business Strategy
In the previous section we learnt about e-business and its nature. In this section, we will
study about the strategy of the e-business. There is a need for e-business strategy for all
organisations that run the business over the internet. The e-business strategy defines both
the short term and long term goals for e-business and this requires the skilled planning for
the successful implementation.
E-business plays an important role in the unstable business environment of the present
world. The e-business strategy includes all the possible outcomes that arise from a single
decision.
It is very important to know about the company before opting for an e-business strategy.
In a company, one must communicate with the managers of all levels in order to know
about its growth. It is also important to consider all the team leads and decision makers
while planning the business strategy.
There needs to be proper planning to carry out the e-business strategy, which is dealt in
the coming sections.
11.3.1 Planning
The planning process for the e-business involves the development of the plan. The
focused marketing plan has to be developed before creating the website. There must be
clear and realistic goals for any organisation in order to keep track of the growth of the
company. The goal- based strategic planning includes the following concepts. They are:
Vision and mission statements - All organisations have a vision and mission statement.
The success of the company depends on the plan that is developed. The vision statement
describes what the leaders of an organisation see in future that is in the idealistic terms.
The strategic vision statement directs and motivates to set realistic goals for an
organisation. The mission statement includes all the principles, purposes, and objectives
that define the activities of the organisation. The mission statement also defines the scope
of the organisation in terms of its products and market, which in turn adds values and
priorities to the business.
Environmental analysis - This plays an important role in the strategic management and
helps the company to gain competitive advantage in the growing market. A market
analysis must be performed to identify the market opportunities, threats, and also to bring
in changes for the welfare of the organisation. The environmental analysis helps the
company to place itself in the evolving market by matching the characteristics with the
environment's demands.
Competitive factors - Whenever the company is formulating the strategy, it has to
consider the strategies of its competitors also. This helps the company to identify its
strengths and weaknesses.
Economic factors - The economic factors include the factors like purchasing power of
consumer and spending patterns. The macro-economic factors include Gross Domestic
Product (GDP), unemployment, inflation and interest rates. These macro economic
factors determine the environment in which the organisation functions. The economic
environment plays an important role in the trends of employment, inflation, and growth
that shape the regions, nations and the world for the e-business.
Social or demographic factors - Demography is defined as the study of human
population in terms of some factors such as the size, density, location, age, ethnicity,
occupation, and so on. The customers form the demographic environment. The e-business
is growing rapidly as the consumers level of comfort increases.
Long term objectives - The main aim of planning is to include the long term objectives
of the organisation. It helps the organisation to use many strategies and policies to meet
its goals in an efficient way.
There are some criteria that the organisations follow to make the company culture
towards e-business. E-business requires:
The free flow of information. For this business experts must maintain the free flow of
information and connect the people and process throughout the organisation.
Real time, online, integrated, and interactive processes.
The employees to have knowledge about e-business. For this, the organisation must
continuously educate and train the employees to carry out the process. The employees
who interact with the customers must have a thorough knowledge of e-business.
Employees to have a sense of urgency to deliver the services which in turn help to drive
the business decisions.
The realities of the e-business and the internet have changed the barriers to competition.
11.3.2 Market selection
The market selection plays a vital role while performing business. The marketing process
has to be done well in order to carry out the business process in a smoother manner.
Marketing adds value to the product or service in the minds of the customers. The
internet also plays an important role in the e-business by providing the marketing
strategic solution. The internet helps in reducing the order entry costs and provides the
valuable information for customers whenever they need.
The website of the particular organisation provides a wide variety of opportunities for
communicating. This helps the customers, suppliers, investors, and many other interested
people as they gain information about the organisation and the products. The website also
helps in online advertising through which, the customers can enter their order or know
the status of the product to be released in the retail market.
Many of the customers select the product by seeing all the information about the product
on the internet. The internet as a marketing medium has more advantages compared to the
radio and television. The internet provides the information in depth for the public. The
well designed website provides the most personalised communication between the
organisation and the customer.
The website designer creates websites for marketing. The website designer plays an
important role as the advertisement created must impress and convince the customer to
opt for that product.
11.3.3 Establish regional parameters
The company must select a set of cultural expectations that define the local e-business
and the manner in which the internet is accepted in the local market. There must be local
parameters such as brand (for companys products and services), information architecture,
visual design, application functionality, content and the business process that will be
active across a common market. After setting the localisation and regionalisation
parameters, the organisation must set the globalisation parameters. The parameters that
have to be globalised are the languages, writing systems, currencies, weights,
measurements, calendars, time zones, time measurements, postal and telephone systems.
Self Assessment Questions
4. The e-business plays an important role in the____________ business environment of
the present world.
a) Stable
b) Unstable
c) Static
d) Dynamic
5. There need not be the clear and realistic goals for any organisation. (True/False)
6. The website of the particular organisation provides a wide variety of opportunities for
the purpose of ________________.
Activity: 1
Suppose you are working in the ABC Company as a project manager and you have to
plan to incorporate the business strategy. Mention the features that you would see to carry
the planning process.
Hint: Vision and mission statement.
11.4 E-Business Models
In the previous section, you have studied about the e-business strategy. In this section let
us learn about the e-business models. The business model describes the manner in which
an organisation creates, delivers and captures the value. The values can be social,
economic forms of value. The design of the business model is part of the business
strategy.
11.4.1 Business to business model
The business to business (B2B) model describes the transactions between the buyers,
suppliers, manufactures, resellers, distributors, and trading partners. This involves the
transactions that involve the products, services, and the information. Internet based e-
business is carried out through the industry sponsored marketplaces and private
exchanges that are conducted by the large companies. The B2B model is shown in the
figure 11.2.

Figure 11.2: Business to Business Model


The above diagram indicates direct business to business model. In this direct business,
the selling enterprise includes wholesaler, retailer or manufacturers who sell to the buyers
of other business.
The main reason behind introducing this B2B model is to overcome the problems met by
industry sponsored marketplaces in approaching buyers and sellers. Most of the
companies do not want to get customised designs through marketplaces as they do not
want to expose proprietary information on a site that is shared by competitors. Therefore,
companies use such marketplaces mainly to purchase products, manage their supply
chains, and conduct indirect procurement transactions, as these are not related to their
core business.
B2B e-commerce differs from business-to-consumer e-commerce in many ways.
Business to consumer merchants sells on a first-come, first-serve basis. Most B2B
transactions are done through negotiated contracts that allow the seller to think and plan
for how much the buyer is likely to purchase. In most of the cases, B2B model mainly
focus on maintaining relationship with the business partners.
We will now discuss about business to customer model.
11.4.2 Business to consumer model
The activities that serve the business customers with the products and services are
described in the business to consumer model.
The best example we can give for the business to consumer (B2C) transaction is the
person buying a pair of shoes from the retailer. The manufacture of the shoes performs
many transactions such as the purchase of leather, laces, rubber and other raw materials.
There are two models of implementation related to the business to consumer. They are
described as follows:
Generic B2C model - The generic model is mainly designed for the small and medium
enterprises. The third party e-market place is used to help the enterprises for selling the
products online.
Dedicated B2C model - Many of the large enterprises use the dedicated B2C model. The
enterprise itself owns the e-market place to sell service and support the customers online.
As the name indicates this model is fully dedicated to the customers and is almost
equivalent to the customer relationship management.
There are some e-commerce constituents with the B2C model. These constituents are
explained as follows:
Commerce - This involves the process like the catalog, compare, products and a service,
advertisements, order status and also enables the online payment.
Personalisation - This involves the activities like profile matching that matches the web
content to specific profiles and gets the feedback from the customers and deals with the
events, calendaring, and registration.
Community services - These include the services that are dealt for the whole
community. The community services can be chat, message boards, e-mail services,
subscriptions, and newsletters.
Customer services - This process involves the services that are helpful for the customers.
These include the activities such as the product support, online support like the call
centers and telephony integration.
The products that are browsed and mostly sold over the internet are explained as follows:
Computer hardware and software - Most of the people buy software products online.
The major online retailers of computer hardware and software are Dell and Gateway.
Consumer electronics - The second largest product category sold online is electronics.
Some of the electronics items shopped or purchased online are digital cameras, printers,
scanners, and wireless devices like mobile phones, pen drives and so on. For example,
www.ebay.com
Sporting goods - Sports related items like cricket bats, tennis bats, golf accessories like
clubs, golf balls are some of the sporting goods which are sold online. Examples for this
include sites like www. summitonline.com, www.dicksportinggoods.com and so on.
Office supplies - Business to consumer sales of office supplies are increasing all over the
world. For example, www.officedepot.com alone reached over 10,000 crores in 2002.
11.4.3 Consumer to consumer model
The consumer to consumer (C2C) model involves the transaction between the customers
through the third party.
This can be explained by taking the example of online auction where the customer posts
an item for sale and other customer purchases the product. But in between the third party
charges a commission for the sale.
C2C is also called as Peer to Peer (P2P) exchanges. The C2C transaction includes the
classifieds, music and file sharing, and also the personal services. There will be million
consumers those who want to sell their products in the e-business field. Equally on the
other side there are million people who want to purchase the products and services.
Finding each other are beneficial for both the retailer and the consumers and this can
happen many times only with the help of third party that act as the intermediaries. The
intermediaries in the C2Cbusiness model charge the sellers. The intermediaries charge
because they bring the customers and sellers to one marketplace.
C2C e-business has created a new dimension in online shopping business. C2C e-
business gives many small business owners a way to sell their products without running a
highly profit draining bricks-and-mortar store. The efficient C2C businesses involve
items like handmade gifts, personal artwork, clothing design, and collectables.
11.4.4 Consumer to business model
A consumer to business (C2B) model is the electronic business model, in which the
consumers offer products and services to the enterprises. This is called as the inverted
business model since the process operates completely in the opposite direction of the
traditional e-business model, in which the organisations offer the goods and services to
the consumers.
The C2B model involves consumers themselves presenting as a group and provides the
goods and services to the enterprise. For example, www.speakout.com. This site provides
consumers market strategies and businesses and it also makes them familiar with the
requirements of the various businesses. A concrete example of this is when competing
airlines gives a traveler best travel and ticket offers in response to the travelers post.
This C2B model is advantageous because of the following reasons. The model helps:
In connecting large group of people by the bidirectional network. Many of the traditional
media is of unidirectional but the internet is the bidirectional media.
Individuals to access the technologies that were once available only for the large
companies.
Self Assessment Questions
7. Internet based e-business is carried out through the industry sponsored _____________
and private exchanges.
8. Name the e-business model that is called as the peer to peer exchange?
a) Business to consumer model
b) Consumer to business model
c) Consumer to consumer model
d) Business to business model
9. Consumer to business model is called as the inverted business model. (True/False)
Activity: 2
Suppose you are the business head in the company and you want to carry out the business
process by seeing the advantages that are associated with each of the model. List out the
models, you will opt to obtain maximum advantages.
Hint: Business to business model.
11.5 The Challenges of E-Business
In the previous section, we have studied about the e-business models. In this section let
us learn about the challenges of e-business. As the e-business is growing, there are many
technical and business trends that are associated with it. Some important trends in e-
business are explained below.
E-business is crucial to business success. Many companies come out with changes that
are necessary for e-business to become profitable. The process of e-business is long
lasting than that of the re-engineering. There are some important trends in the e-business
that are described as follows:
Technology focus is on e-business - The hardware, software, and network vendors, focus
on providing the tools for e-business. The e-business is mainly the extension of the
products and services.
E-business produces cumulative effects - E-business is long lasting. The relationship
with customers, suppliers, and employees changes as we implement e-business.
E-business implementation effects success and failure of a business - There will be
both the success and the failures that are associated with any kind of business. The
failures become dramatic with e-business as it is more visible externally.
There are some major success factors for e-business. These factors include the strategic
factors, structural factors and the management oriented factors. These factors are
explained as follows:
Strategic factors.
The technologies related to the internet are used as a complement for the existing
technologies.
The basis of competition that is not shifted from traditional competitive advantages such
as cost, profit, quality, service and features.
The new competitors and market shares are tracked.
The web centric marketing strategy.
The strategic position of the company in the market has strengthened.
The frequent review of the distribution and supply chain model is done in order to
maximise the company's gain.
The buyers behaviour and the customer personalisation.
The first-mover advantage and quick time to start.
The e-business offered good products and services.
The innovation was allowed when risks are low.
The customers and partner's expectations from the well managed.
Structural factors.
Correct digital infrastructure.
Good e-business education and training to employees, management and customers.
Current systems expanded to cover entire supply chain.
Good cost control.
Management-oriented factors.
The organisation wide commitment to e-business leadership.
The necessary support for e-business from the top management.
The awareness and understanding of capabilities of technology by executives.
The top management has to communicate about the value of e-business throughout the
organisation.
The e-business is facing challenges mainly in the areas of technology, logistics, and legal
issues. These areas are explained in the following sections.
11.5.1 Technology
The technology plays a major role in the concept of new economy. The technology has
two dimensions; one is the shift from manufacturing to services and second is the shift
from physical resources to the knowledge resources. There are so many mechanisms for
technology innovation and diffusion, both within and outside the countries. Many of the
organisations will include different technologies both for quantitative and qualitative
terms.
Small scale enterprises play a vital role in the implementation of new technologies. They
have added more value in terms of population, employment, and services that they are
offering. Internet also plays a vital role as it helps the small and medium enterprises in
providing the cost effective possibilities to advertise their products. Internet also provides
the contacts to buyers and suppliers on a global basis. E-business is helps the radical
transformation in the way that the business is done. The introduction of technologies like
the common database, electronic networks and value added services are helpful for
speeding up the transactions and these are fundamental at the industrial level. The e-
business has to undergo lot of challenges in implementing the technologies that are
helpful for the organisation since many of the people in the organisation will not be
interested to shift to the new technology and learn the new skills.
11.5.2 Logistics
The logistics is defined as the planning framework for maintaining the material,
information, and capital flow. The logistics includes the complex information,
communication and control systems required in the business environment. The logistics
presents e-business with challenges that exceeds the expectations of the customers with a
reasonable cost. Nowa-day, attempt has been made to reduce the inventory costs. In order
to meet the high expectations of the customers, an e-business needs the special
infrastructure for tuning and managing the interactions. The interactions can be in
between the shippers, logistic providers, shipping companies, and also the customers.
11.5.3 Legal concerns
As there is tremendous usage of internet, it is better to consider the legal concerns behind
the internet. This is because whatever is printed on the net will be accessed by public
throughout the world. We also have an option of going back and seeing the basics of that
information. Now-a-day with the help of wireless phones, Personal Digital Assistants
(PDAs), internet can be accessed from anywhere in the world. As a result the customers
must be provided proper security and privacy to access internet. It becomes very difficult
to trust the actual with the unethical, illegal, internet marketing and advertising frauds
and e-business email scams and hence one must be careful while performing e-business.
It is necessary to concern the privacy and legal matters while writing a copy and
maintaining a client's e-business.
There are uncertainties in e-business when compared with direct business. The
uncertainties are related to the security, privacy, credit and debit card handling. The
security is the primary concern in e-business. The PCI Data Security standard (PCI DSS)
needs to be followed by one who handles the credit card information. E-business is all
about the trust between buyer and the seller so one must be careful while dealing with the
transactions which involve the handling of credit and debit cards.
There will also be copyright issues that is copying something from other sites and
presenting the same content as their own. It is important to check for plagiarism when the
company is publishing their own articles. When some concepts are copyright then it is
necessary to credit the original authors. Disclaimer notice is required at the start of any
business website.
If the webmasters include some unethical information about the client then that can cause
everlasting negative consequences for the client. The legal action is taken against the
false advertisements also.
The risks associated with conducting e-business over the internet are explained as
follows:
Jurisdiction - Contracting over the cyberspace is a challenge for the website owners and
the internet is the form of communication that rises above the spatial boundaries. There is
a jurisdiction problem in the disputes between the buyer and seller regarding where the
contract was formed and which state law applies for the contract.
Contact validity - The emerging issue is the legal validity of web wrap or click on
contracts. This type of contract is mainly found on the web site that offers goods and
services for the sale. This e-business creates the legal relationship between the seller and
buyer.
Contract information - The advent of the e-business over the net is responsible for
various legal issues regarding the formation of the electronic contracts.
There is a need for matching both the e-customers and e-merchants with the legally
responsible parties in the real world. There is a need for on cryptographic methods for
reducing the risks associated with the identification and authentication. The cryptographic
methods for eliminating the risks those are associated with the non repudiation and
security.
Self Assessment Questions
10. The technology is playing the major role in the concept of ______________.
11. The logistics presents an e-business with the ever challenge that is exceeding the
expectations of the customers with a reasonable cost. (True/False)
12. Which of the following is necessary while writing the copy and maintaining a client's
e-business?
a) Logistics
b) Technology
c) Management
d) Legal concerns
11.6 Summary
Let us summarise the points covered in this unit about e-business:
E-business is the use of network and technology for performing business. As the e-
business is growing rapidly, the trust element is of major concern.
E-business strategy defines both the short term and long term goals. There is a need for
proper planning for developing the website. There is a need for proper marketing
selection. The internet plays an important role in the case of advertising compared to the
other type of advertising.
Different types of e-business models are business to business model, business to
consumer, consumer to consumer model and the consumer to business model.
The business to business model aims at developing the transactions between the business
enterprises.
The business to consumer model focuses at developing the transactions between the
business enterprise and the consumers.
The consumer to consumers transaction takes place mainly because of the third party.
The consumer to business model is exactly opposite to the business to consumer model.
In this model the consumers offer products and services to the enterprises.
E-business is growing rapidly and the various challenges that are faced by e-business are
in the form technology, logistics, and legal concerns.
11.7 Glossary
Open source: The practices in the production and development that allows the access to
the end products materials.
Demography: The study of human population is called as the demography.
Radical transformation: The transformation that is taking place from the root.
Logistics: This is the management of the details of the operation.
11.8 Terminal Questions
1. Write a short note on the nature of e-business.
2. Explain in brief about the planning step in e-business strategy
3. Explain in brief about the business to business model
4. Write a short note on the legal concerns as a challenge for e-business.
11.9 Answers
Self Assessment Questions
1. Trust
2. True
3. a) internet
4. b) unstable
5. False
6. communication
7. marketplaces
8. c) Consumer to consumer business model
9. True
10. New economy.
11. True
12. d) legal concerns
Terminal Questions
1. E-business can be defined as "the use of networks and information technology in order
to electronically design, market, buy, sell and deliver products and services worldwide.
Refer section 11.2 of this unit for more details.
2. The planning for the e-business strategy involves the development of the very solid and
crisp plan. The focused marketing plan has to be developed before creating the website.
For more information refer section 11.3.1 of this unit.
3. The business to business model describes the transactions between the buyers,
suppliers, manufactures, resellers, distributors and trading partners. For more information
refer sub section 11.4.1 of this unit.
4. There is a tremendous usage of internet, it is better to consider the legal concerns
behind the internet. Since whatever is printed on the net will be accessed by public
throughout the world. For more detail about the legal concerns refer sub section 11.5.2 of
this unit.
11.10 Case-Let

Implementation Of E-Business
This case study is about the ABC company that is known as the leading producer of
butente-1 and butadiene in Thailand. The ABC company mainly focused on various
activities such as the production and marketing of various petrochemical products. These
petrochemicals are produced using the C4 as raw material. The ABC company's business
was expanding rapidly and the existing system was too small to accommodate the
required information. The company maintains all the sales activities and sale related
information manually. The digital computerised system was used to manage the system
within the ABC company. The hi-tech control system aims at adjusting the operating
conditions such as the temperature control, pressure, level of liquid container and so on.
Challenges
The ABC company wanted the applications of the XYZ company to accommodate the
dynamic growth of their business mainly in the areas of process manufacturing. These
processes included the shift towards the e-business and supply chain management. The
ABC company was mainly expecting the timely and quality information to the top
management from the XYZ company. This timely and quality information was very
useful for making the strategic business decisions at a competitive speed.
Results
The XYZ company was able to understand the needs of the ABC company and was able
to respond on time. The XYZ company was able to match the current requirements and
match with the future e-business requirements. The server towards financial and
distribution was implemented for the e-business and this enabled the company to stay
competitive in the market of today.
Discussion Questions
1. What are the challenges faced by the ABC company?
(Hint: Accommodation of the dynamic growth of the company)
2. What was the main raw material that was used by ABC company?
(Hint: C4)
Sources: http://www.iomworld.com/Clients/Case_Studies.html

References
Abrol P.N, Bhalla V.K (2005), International business environment and management,
Anmol Publications PVT LTD.
Brahm Canzer (2006), E-business strategic thinking and practice, Cengage learning.
Janice Reynolds (2001), Logistics and fulfillment for e-business: a practical guide to
mastering back office functions for online commerce, Focal press.
E-References
http://e-articles.info/e/a/title/The-Changing-Nature-of-E-Business-~-Ethics-and-Trust/
- Retrieved on 30th October, 2010
http://www.ebusinesssupport.com/ebusiness-strategy.asp
- Retrieved on 31st October, 2010
www.skyinfonet.com/html/ecom_b2c.asp
http://www.ifp.uni-stuttgart.de/publications/phowo01/Reiss.pdf
http://pwebs.net/marketing/ethics/articles/internetethics.htm
- Retrieved on 2nd November, 2010

Unit-12-Support Systems for International Business


Structure:
12.1 Introduction
Objectives
12.2 Introduction to Support Systems
Institutions
Objectives
12.3 WTO
Objectives and functions
Structure
Principles
Agreements
Issues
12.4 International Labour Organisation (ILO)
History
International labour code
12.5 Summary
12.6 Glossary
12.7 Terminal Questions
12.8 Answers
12.9 Case-Let
12.1 Introduction
In the previous unit, you studied about e-business. E-business is when a firm adopts the method
of conducting daily business through internet and other electronic networks. The application of
information technology is used to support all activities of business.
International business is a process of conducting business between several countries. It creates
opportunity as well as challenges. To support the challenges faced by international business
certain support systems are established. In this unit, you will learn about support systems for
international business.
This unit covers the institutional support systems It discusses various international organisations
working towards promoting international business and provide regulatory framework. It also
covers the International Labour Organisation and the international labour code.
Objectives:
After studying this unit you should be able to:
describe the various international organisations working to facilitate international trade.
evaluate the role of WTO.
discuss the major agreements in WTO.
interpret the scope of ILO.
explain the international labour code.
12.2 Introduction to Support Systems
International business is the process of conducting business in multiple countries. Multinational
corporations (MNCs) and international business companies (IBCs) engage in business between
multiple countries. After World War II, the Western leaders did not want to repeat economic
isolationism that played a major part in leading to the war. The leaders wanted to create new
international political and economic institutions to promote and maintain peaceful international
relations and decided to form an international trade organisation.
A number of factors about international system are connected to countrys trade policy choices. In
trade area, a number of institutions provide support for an open, multilateral trading system. The
presence of institutions like GATT (General Agreement of Tariffs and Trade) and IMF
(International Monetary Fund) influence trade liberalisation. The influence of these international
institutions depends on economic conditions of the debtors or on changing domestic preferences
about trade.
12.2.1 Institutions
The support system institutions for international business include WTO (World Trade
Organisation), World Bank, and International Monetary Fund (IMF). Regional trade institutions
have ambiguous effect on the multilateral system whereas some institutions such as NAFTA
(North American Free Trade Agreement) and ASEAN (Association of Southeast Asian Nations)
have a positive effect on lowering trade barriers. These institutions have different effects on
countries trade policies. The major support systems for international business are:
The IMF is an international organisation of 187 countries. It ensures the stability of the
international monetary and financial system.
The World Trade Organization (WTO) is an international organisation with 153 members which
deals with the rules of trade between countries.
World Bank is an international financial institution that provides leveraged loans to developing
countries for major projects.
United Nations Conference on Trade and Development (UNCTAD) was established in 1964. It is
the permanent body of the United Nations General Assembly that deals with trade and
development issues.
12.2.2 Objectives
The institutions provide information about other countries behaviour, forum for dispute
resolution and a common framework for sustaining trade flows. A strong international financial
system is required to support growing international trade. It helps to reduce the risk of payment
imbalances and financial crisis. The international institutions work together to provide a strong
system for international trade which is open to all countries. This kind of system is essential for
supporting economic growth, reducing poverty and raising the standard of living around the
globe.
The main objective of IMF is to facilitate the expansion and balanced growth of international
trade and provide exchange stability.
The WTO helps in the smooth flow of international trade and provides countries with a
constructive platform for dealing with disputes over trade issues.
The main objective of UNCTAD is to formulate policies regarding trade, finance and technology.
It is a specialised agency that performs three main functions:
Provides forum for intergovernmental discussions.
Undertakes research, data collection and policy analysis for debates of government
representatives and experts.
Provides technical assistance to the specific requirements of developing countries.
Self Assessment Questions
1. _____________ is the process of conducting business in multiple countries.
2. IMF stands for
a) International Monetary Fund
b) International Management Foundation
c) Indian Monetary Fund
d) Indian Management Foundation
3. NAFTA is a major support for international business. (True/False)
12.3 WTO
In this section we will discuss about the World Trade Organisation (WTO). WTO was established
on 1st January 1995. In April 1994, the Final Act was signed at a meeting in Marrakesh,
Morocco. The Marrakesh Declaration of 15th April 1994 was formed to strengthen the world
economy that would lead to better investment, trade, income growth and employment throughout
the world. The WTO is the successor to the General Agreement of Tariffs and Trade (GATT).
India is one of the founder members of WTO. WTO represents the latest attempts to create an
organisational focal point for liberal trade management and to consolidate a global organisational
structure to govern world affairs. WTO has attempted to create various organisational attentions
for regulation of international trade. WTO created a qualitative change in international trade. It is
the only international body that deals with the rules of trades between nations.
12.3.1 Objectives and functions
The key objective of WTO is to promote and ensure international trade in developing countries.
The other major functions include:
Helping trade flows by encouraging nations to adopt discriminatory trade policies.
Promoting employment, expanding productions and trade and raising standard of living and
income and utilising the worlds resources.
Ensuring that developing countries secure a better share of growth in world trade.
Providing forum for trade negotiations.
Resolving trade disputes.
The important functions of the WTO as stated in the WTO agreement are the following:
Developing transitional economies Majority of the WTO members belong to developing
countries. The developing countries such as India, China, Mexico, Brazil and others have an
important role in the organisation. The WTO helps in solving the problems of developing
economies. The developing states are provided with trade and tariff data. This depends on the
countrys individual export interest and their participation in WTO-bodies. The new members
benefit hugely from these services.
Providing help for export promotion The WTO provides specialised help for export promotion
to its members. The export promotion is done through the International Trade Center established
by the GATT in 1964. It is operated by the WTO and the United Nations. The center accepts
requests from member countries, usually developing countries for support in formulating and
implementing export promotion programmes. The center provides information on export market
and marketing techniques. The center also provides assistance in establishing export promotion
and marketing services. Through this WTO proves its commitment in the upliftment of the world
economy.
Cooperating in global economic policy-making The main function of the WTO is to cooperate
in global economic policy-making. In the Marrakesh Ministerial Meeting in April 1994, a
separate declaration was adopted to achieve this objective. The declaration specifies the
responsibility of WTO as, to improve and maintain the cooperation with international
organisations such as the World Bank, International Monetary Fund (IMF) that are involved in
monetary and financial matters. WTO analyses the impact of liberalisation on the growth and
development of national economies which is the important factor in the success of the economy.
Monitoring implementation of the agreement The WTO administers sixty different
agreements that have the statue of international legal documents. The member-governments sign
and confirm all WTO agreements on attainment.
Providing forum for negotiations The WTO provides a permanent forum for negotiations
among members. The negotiations can be on matters already in the WTO agreements or matters
not addressed in the WTO law.
Administrating dispute settlement The important function of WTO is the administration of the
WTO dispute settlement system. It helps in settling multilateral trading dispute. A dispute arises
when a member country adopts a trade policy and other fellow members consider it as a violation
of WTO agreements. The Dispute Settlement Body (DSB) is responsible for the settlement of
disputes. The dispute settlement system is prohibited from adding or deleting the rights and
obligations provided in the WTO agreements. The WTO dispute settlement system helps to:
Preserve the rights and responsibilities of the members.
Clarify the current provisions of the agreements.
12.3.2 Structure
The structure of the WTO consists of the Ministerial Conference, which is the highest authority.
This body consists of the representatives from all WTO members. The WTO members meet in
every two years and take decisions on all matters under the multilateral trade agreements. The
daily activities of the WTO are conducted by subsidiary bodies and principally by the General
Council which is composed of WTO members. The members report to the Ministerial
Conference. The General Council on behalf of the Ministerial Conference administers as the
Dispute Settlement Body to manage the dispute settlement procedures. It also acts as the Trade
Policy Review Body that conducts regular reviews of the trade policies of the individual WTO
members.
The General Council delegates responsibility to other major bodies. They are:
Council for Trade in Goods manages the implementation and functioning of all agreements
covering trade in goods.
Trade in Services and Trade of Intellectual Property Rights are the two councils that have
responsibility for their respective WTO agreements and can establish their own subsidiary bodies
if required.
The Committee on Trade and Development manages issues relating to the developing countries.
The Committee on Balance of Payments conducts consultations between WTO members and
countries that take trade-restrictive measures to handle balance-of-payments difficulties.
Committee on Budget and Administration manages issues relating to financing and budget of
WTO.
12.3.3 Principles
The WTO principles of the trading system are:
Trading without discrimination One aspect of nondiscrimination is that foreigners and people
within the home country must be treated equally. This implies that imported goods that are in the
market must not face discrimination. There is also a Most Favoured Nation (MFN) principle
which requires the nations to treat all WTO members equally. In case one nation grants a special
trade deal to another nation, the deal must be extended to all WTO members.
Trade barriers negotiated downwards To lower trade barriers such as import tariffs, red tape
and encourage trade growth.
Predictable trading The predictability in business helps to know the real costs. The WTO
operates with tariff bindings and agreements that restricts raising a specific tariff over a given
time. This provides the business people with realistic data. Making trade rules clear and
accessible helps the business people to anticipate stable future.
Competitive trading The WTO works towards trade liberalisation and understands that trade
relationships between nations can be very complex. The WTO agreements support healthy
competition in services and intellectual property and discourage subsidies and dumping of
products at prices below the cost of their manufacturer.
Encourage development and economic reforms The majority of the WTO members are
developing economies that are changing to market economies. The developed nations must give
market access to goods from the under developed countries and provide technical assistance.
Developed countries are allowing duty-free and quota-free imports for all the products from the
under developed countries.
12.3.4 Agreements
The WTO agreements are a set of rules that are followed by the member governments while
formulating policies and practices in the area of international trade. The agreements mainly cover
goods, services and intellectual property. The agreements comprise the rights and obligations of
the government that are enforceable in multilateral framework. The agreement supports
individual countries commitments to lower customs tariffs and other trade barriers, and to open
services markets. The agreements recommend governments to make their trade policies
transparent. According to the agreement, the government must notify the WTO about the
measures adopted to make their trade policies transparent.
The major agreements are:
General Agreement on Trade in Services (GATS) - GATS is a framework agreement defining
the rules under which trade in services must occur. GATS aim at extending the rules covering
trade in goods to trade in services. The detailed rule has been included to take into account the
differences between goods and services and the way in which trade in services is conducted.
Trade in services cover a wide range of activities in the area of telecommunication, information,
banking, insurance and education. WTO has recognised over 150 service sub-sectors.
The main objective of GATS is to establish framework for liberalising trade in services. It
encourages countries to modify their domestic regulations. This modification results in
elimination of restrictions applied to service products entering the country and is applicable to
international service suppliers who are carrying out business in various modes. According to the
GATS, MFN status and transparency is applicable to all services. The other commitments such as
national treatment and market access are only applicable to services that are opened according to
the specified negotiated commitments. GATS cover services known as consumption abroad
where services are used by the consumers in a host country such as e-commerce and where
citizens of a country travel overseas to consume products such as tourism or education.
Trade-Related Aspects of Intellectual Property Rights (TRIPS) - The Agreement on Trade-
Related Aspects of Intellectual Property Rights (TRIPS) is one of the WTO agreements that are
compiled by all the WTO members. According to TRIPS, developed and developing members of
WTO must adopt the same minimum levels of intellectual property protection. The TRIPS
Agreement includes rules on domestic enforcement procedures. TRIPS Agreement focuses on
issues such as innovation and the dissemination of technology, development of biotechnology,
health care and the operation of multilateral environment agreements.
According to TRIPS Agreement, members can adopt measures to protect the public health and
nutrition. It encourages protection of new plant varieties. The members are encouraged to
develop national systems that promote local breeding and rights of farmers and protect human
fundamental human rights which include rights to food and health. It promotes use and
protection of knowledge that is relevant to the conservation and use of biological diversity. This
includes knowledge in technology and genetic material. The 1995 WTO TRIPS Agreements
covers copyright and related rights, geographic indications, trademarks, and patents of integrated
circuits, protection of information and control of anticompetitive practices in contractual
licenses.
General Agreement on Tariffs and Trade (GATT) - GATT is a multilateral agreement among
countries providing a framework for conducting international trade. GATT is regarded as an
international institution governing international trade relations. It consists of disciplines on
governments and matters related to import and export of goods. It was established to promote
international trade by reducing tariff and non-tariff restrictions on imports imposed by member
nations. Tariff barrier refers to imposing import duty and non-tariff barriers means restricting
imports through import licensing and by banning the imports. GATT provides a framework for
negotiations on the level of tariff. It promotes multilateral trade among member nations. It
provides protection against unfair trade and obstructions to trade.
12.3.5 Issues
The issues related to WTO are:
Trend towards unilateral action by some developed countries in disregard of the provisions laid
down in the Uruguay Round. Developing countries and least-developed countries have to battle
against resource constraints and shortage of skills and expertise in these areas. The unilateral
action brings dishonor to the entire multilateral trading system. This slows down the motivation
for reform in all developing countries.
Another issue is the favour of regionalism. The regional economic groupings have resulted in
increased trade among countries in the region; there is a possibility of discrimination against
third countries.
The Agreement on Agriculture has number of inequities in the implementation of the Agreement.
The majority of developing countries are prohibited from providing export subsidies and
developed countries are permitted to resort to such subsidies. The countries which have been
distorting the market in the past can continue to maintain subsidy regimes and other countries are
prohibited from using these measures.
The WTOs current position on trade, environment and sustainable development has faced
criticism. The liberalisation of trade leads to larger growth, higher incomes and increased
consumption. However, it affects production which in turn has an adverse effect on the
environment. The WTO trading system generates growth and is accompanied by pollution. The
trade and growth policies of the WTO are held accountable for the environment degradation.
Other issues are green room negotiations. Green room negotiations are the informal negotiation
meetings at the WTO in which 35 countries are chosen by the Director General.
Activity 1
Refer to any website and create a report on the principles laid down by GATT to the member
countries on anti-dumping measures.
Refer to the link for guidance -
http://commerce.nic.in/wto-feb.pdf
Self Assessment Questions
4. The WTO is the successor to the _____________
5. Majority of the WTO members belong to developed countries. (True/False)
6. The main objective of _____________ agreement is to establish framework for liberalising
trade in services.
a) GATT
b) NAFTA
c) TRIPS
d) GATS
7. The WTO agreements are a set of rules that are followed by the governments while
formulating policies and practices in the area of international trade. (True/False)
8. The highest authority of WTO is the _____________.
12.4 International Labour Organisation (ILO)
International Labour Organisation (ILO) is a specialised agency of the United Nations which
deals with labour issues. The headquarters is situated in Geneva, Switzerland. The secretariat
comprises of the people employed by the organisation throughout the world. The secretariat is
known as the International Labour Office. The ILO manages work through three main bodies.
They are:
International labour conference The members of the ILO meet at the International Labour
Conference every year in June, in Geneva. Two government delegates along with an employer
delegate and a worker delegate represents their respective member state. The technical advisors
also accompany the delegates. Generally, the Cabinet Ministers responsible for labour affairs
head the delegations and present the viewpoint of their government. The Conference establishes
and implements international labour standards. It is a forum where social and labour issues are
discussed. The Conference approves the budget of the organisation and elects the Governing
Body.
Governing body The executive council of the ILO is known as the Governing Body. It meets
thrice a year in Geneva and takes decisions on the ILO policies. It forms programmes and
budgets which are submitted to the Conference for adoption. The Governing Body consists of 28
government members, 14 employer members and 14 worker members. States of chief industrial
importance permanently hold ten government seats. Taking into consideration the geographical
distribution, every three years representatives of other member countries are elected at the
Conference. The employers and workers elect their representatives.
International labour office The permanent secretariat of the International Labour Organisation
is the International Labour Office. It is the central point for the overall activities that are
administered by the Governing Body. The Office is a center for administration, research and
documentation. The Office employs more than 1,700 officials from 110 nationalities. The Office
organises certain programmes to extend technical help to all member nations. Under this
programme of technical cooperation, around 600 experts undertake missions in all regions of the
world.
12.4.1 History
The ILO was established as an agency of the League of Nations after the Treaty of Versailles.
The ILO was created in 1919, after the First World War. The ideas of the International
Association for Labour Legislation were incorporated in the Constitution of the International
Labour Organisation. The initial motivation of ILO was humanitarian because the condition of
workers was exploited without any improvement in their health and family. The preamble of the
constitution of the ILO states the conditions of labour and the injustice and privation to large
number of people. The second motivation was economic because it has inevitable effect on the
cost of production. The failure of a nation to adopt humane conditions of labour affects the
economic situation of the country adversely.
The ILO constitution was written in April 1919 by the Labour Commission that was set up by the
Peace Conference. The first annual International Labour Conference had of two representatives
from the government which included one each from the employers and workers organisations
from each member state. It implemented the first six International Labour Conventions dealt with
working hours in industry, minimum age, unemployment, maternity protection, night work for
women. Albert Thomas was chosen as the first Director of the International Labour Office by the
Governing Body who gave the organisation a strong momentum from the beginning. Within two
years, 16 International Labour Conventions and 18 Recommendations were adopted. In 1920
ILO headquarters was set up in Geneva.
12.4.2 International labour code
The international labour code is composed of Conventions and Recommendations adopted by the
International Labour Conference. In 1997, the Code contained 181 Conventions and 188
Recommendations that covered important subjects in labour and social fields. The main function
of the ILO is to set international labour standards by adopting conventions and recommendations
covering the major labour-related issues which are referred as the International Labour Code.
The body of ILO Conventions and Recommendations is commonly known as the International
Labour Code. The Conference adopts Conventions and Recommendations which is prepared by
the Office and the Governing Body. The representatives of the member nations bring the
Conventions and Recommendations to the notice of the authorities.
Conventions The treaties which do not bind a country unless approved by that country. The
member country is bound to present the ILO conventions which have secured a two-third
majority in the Conference. The ILO conventions are ratified as written and without reservations.
The conventions include flexibility clauses to accommodate different climatic conditions or
states of development of particular countries.
Recommendations When state practice largely varies non-binding guidelines, known as
recommendations are issued. Recommendations are issued when the subject is:
o Very technical and cannot be handled by a convention.
o Already covered by a convention but needs to be addressed in more detail.
Member states are required to bring recommendations to the attention of their governments.
Activity 2
On February 2010, India signed the Decent Work Country Programme (DWCP) document. Refer
to any business magazine or website and discuss the main objectives of DWCP.
Refer to the following link for guidance -
http://www.ilo.org/public/english/bureau/program/dwcp/
Self Assessment Questions
9. The _____________ establishes and implements international labour standards.
10. The Governing Body meets once a year in Geneva and takes decisions on the ILO policies.
(True/False)
11. The ILO was created in
a) 1920
b) 1919
c) 1929
d) 1991
12. The body of ILO Conventions and Recommendations is commonly known as the
International Labour Conference. (True/False)
13. The executive council of the ILO is known as the _____________.
12.5 Summary
Let us now summarise the salient points you learnt about support systems for international
business:
International business is the process of conducting business in multiple countries. Multinational
corporations (MNCs) and international business companies (IBCs) engage in business between
multiple countries.
The major support systems for international business are WTO (World Trade Organisation),
World Bank, and International Monetary Fund (IMF).
WTO (World Trade Organisation) was established on 1st January 1995. In April 1994, the Final
Act was signed at a meeting in Marrakesh, Morocco.
The major agreements of WTO are GATS, TRIPS, and GATT.
International Labour Organisation (ILO) is a specialised agency of the United Nations which
deals with labour issues.
The ILO manages work through three main bodies, namely International Labour Conference,
Governing Body and International Labour Office.
The international labour code is composed of Conventions and Recommendations adopted by the
International Labour Conference.
12.6 Glossary
League of Nations An intergovernmental organisation founded as a result if the Treaty of
Versailles in 1919-1920.
Red tape A sequence of forms and procedures required to gain bureaucratic approval for
something. It is an obstructive and time consuming official routine.
Tariff bindings A ceiling level above which a Member cannot apply a tariff. It is the maximum
tariff that can be applied by a Member.
Treaty of Versailles One of the peace treaties at the end of World War I.
12.7 Terminal Questions
1. Describe the international organisations working to facilitate international trade.
2. Evaluate the role of WTO.
3. Discuss the major agreements in WTO.
4. Interpret the scope of ILO.
5. Explain the international labour code.
12.8 Answers
Self Assessment Questions
1. International business
2. a) International Monetary Fund
3. False
4. GATT
5. False
6. d) GATS
7. True
8. Ministerial Conference
9. International Labour Conference
10. False
11. b) 1919
12. False
13. Governing Body
Terminal Questions
1. The major support systems for international business are WTO (World Trade Organisation),
World Bank, and International Monetary Fund (IMF). Refer to section 12. 2 of this unit for
details.
2. WTO represents the latest attempts to create an organisational focal point for liberal trade
management and to consolidate a global organisational structure to govern world affairs. Refer to
section 12.3 of this unit for details.
3. The WTO agreements are a set of rules that are followed by the member governments while
formulating policies and practices in the area of international trade. Refer to section 12.3.4 of this
unit for details.
4. International Labour Organisation (ILO) is a specialised agency of the United Nations which
deals with labour issues Refer to section 12.4 of this unit for details.
5. The international labour code is composed of Conventions and Recommendations adopted by
the International Labour Conference. Refer to section 12.4.2 of this unit for details.
12.9 Case-Let

WTO and the Challenges Faced by Indian Pharmaceutical Companies


India is favourable location for big pharmaceutical companies because of its cheap and
educated labor force. The major concern of the WTO is to take care of the poor especially
in the area of health care. The TRIPS Agreement of the WTO in pharmaceuticals brought
the health care issue to the forefront. According to the agreement, developing countries had
to revise their patent laws to conform to WTO requirements by 2006. The success or failure
of the TRIPS agreement depends on countries like India. Indias pharmaceutical industry is
highly efficient and India needs to implement the IPR (Intellectual Property Rights) laws to
simultaneously maintain its position in the pharmaceutical sector. The challenge for India is
to maintain its international obligations and to satisfy domestic interest that includes
consequent access to cheap medicine.
Indian pharmaceutical companies are using adaptive strategies to cope up with the WTO
product patent law. In order to adapt and benefit from the opportunities created by the new
patent system, the firms are adapting a combination of cooperative and competitive
strategies. Indian pharma companies face international competition. Companies that get
huge profits from exports spend huge amount on R&D (Research & Development). Large
companies such as Ranbaxy and Cipla were preparing for the new patent regime since
1995. A company can lose market share on a patent expired product. However, if the
marketing strategies are well planned, the cost spend in product development can be
recovered after the expiry of the patent. Indian pharma companies are also adopting
visionary strategies such as drug discovery, focus on production of high quantum and
moderately priced generics, outsourcing to MNC's upgrading manufacturing facilities.
These facilities along with pharma support services such as diagnostic services, data
management services and clinical research operations will help India to be the top of the
global pharma Industry.
Discussion Question
1. Discuss the adaptive strategies of Indian pharmaceutical companies to cope up with the
WTO product patent law.
(Hint: cooperative and competitive strategies)
Source: http://www.eurojournals.com/ejefas_13_04.pdf

Reference
Walter Carlsnaes, Thomas Rissee and Beth A Simmons. (2006): Handbook of International
Relations. Sage Publications Ltd.
E-References
http://books.google.co.in/books?
id=wVltIwsWzr4
C
&printsec=frontcover&dq=International+labour+Organisation&hl=en&ei=_b7cTMfYGZP0ca7-
xNE
L
&sa=X&oi=book_result&ct=result&resnum=1&ved=0CDgQ6AEwAA#v=onepage&q&f=false
http://books.google.co.in/books?id=01K0MsG3C4cC&pg=PA197&dq=
General+Agreement+on+Tariffs+and+Trade+
(GATT)&hl=en&ei=zLXcTK3IJ8nzcdSdyMMG&sa=X&oi=book_result&ct=result&resnum=8
&ved=
0CFAQ6AEwBw#v=onepage&q=General%20Agreement%20on%20
Tariffs%20and%20Trade%20(GATT)&f=false
-Retrieved in 11th November, 2010
http://books.google.co.in/books?id=OaNumuFsIhwC&pg=PA131&dq=
WTOstructure&hl=en&ei=cangTNfBNca3cM3t9JYM&sa=X&oi=book_
result&ct=result&resnum=1&ved=0CCsQ6AEwAA#v=onepage&q=WTO-structure&f=false
http://books.google.co.in/books?id=-Zpjyhcu7TMC&pg=PA74&dq=WTO-
issue
s
&

hl=e
n

&

ei=BKrgTPbDBsHzcdP6yZc
M&sa=X&oi=book_result&ct=result&resnum=3&ved=0CDYQ6AEwAg#v=onepage&q=WTO-
issues&f=false
-Retrieved on 12th November, 2010

Unit 13 Finance and International Trade


Structure:
13.1 Introduction
Objectives
13.2 Concept of International Trade
Payment terms in foreign trade
Letter of credit
13.3 Documentation in International Trade
Bill of lading
Commercial invoice
Insurance certificate
Consular invoice
13.4 Financing Techniques
Bankers acceptance
Factoring
Forfaiting
13.5 Export Promotion Schemes
13.6 Export and Import Finance
Short term credit
Long term credit
EXIM bank
13.7 Summary
13.8 Glossary
13.9 Terminal Questions
13.10 Answers
13.11 Case-Let
13.1 Introduction
In the previous unit, we have studied about institutional support systems and legal framework
available for operating international business. We have also learnt about the international
organisations working towards promoting international business.
Whenever we walk into any mall, we come across Washington apples, cheap Chinese toys and
plastics, South Korean and Japanese television sets, Brazilian coffee or South African wine.
Today, Indian spices are popular all over the world. All these are the effects of international
trade. International trade is a system, which deals with the exchange of goods and services
between nations. As global citizens, International Trade shapes our lives and it boosts the
economy of the countries participating in the same. There are various financing techniques that
play a major role in the international trade and finance.
This unit covers the benefits, payment systems and arrangements related to international trade.
We will discuss about the documentation required to make any foreign trade transaction. We will
also learn about the various export promotion schemes supported by the government and the
methods to avail finance as exporters and importers within India.
Objectives:
After studying this unit, you should be able to:
describe the payment system facilitating the foreign trade.
analyse the documentation required to facilitate international trade.
explain various Government schemes to promote exports from India.
explain different kinds of finance options available for international trade.
13.2 Concept of International Trade
As discussed before, International trade as the name indicates is the exchange of products,
services and money across the national borders. Trading plays an important role in the country,
since it provides an opportunity for consumers to procure items to expose the goods and services
that are not available in their own country. Products that are traded in international market
includes purchase and sale of industrial equipment, consumer goods, agricultural products, food,
clothes, spare parts, oil, jewellery, wine, currencies, stocks and water. Trading services includes
tourism, banking, consulting, engineering, telecommunication and transportation.
Some of the well known theories of international trade are as follows:
Theory of absolute advantage - states that the country that has absolute advantage produces more
goods and services compared to other countries that have the same amount of resources. It says
that both countries that are involved in the exchange are benefited. This theory explains that
international trade is a positive sum game but not the zero sum game.
Theory of comparative advantage - states that the comparative advantage of the firm is to
produce a particular good or service at lower cost compared to other. This is also to produce high
efficiency products compared to the products that are already present in the retail market.
Heckscher-Ohlin theorem - states that the country having more labour will have best in and
export labour-intensive commodity. The country that has more capital will have best in and
export capital-intensive commodity.
Imitation gap theory - explains the advantages that the country gets by producing the new goods
in a market. When the country produces the new goods by the research activity, then it can be
monopoly till other countries produces the same goods.
Product life-cycle theory - states the early in the products life-cycle. All the parts and labour
associated with the products are received from the country where it is invented and later in the
product life cycle the other country can produces the parts.
There are three barriers that are associated with international trade. The three barriers are:
Non-tariff barrier - This is the barrier that arises due to the restriction that is posed on the imports
so that there will not be many imported goods in the domestic market. Even if they are present
they are available at high cost.
Tariff barrier - This type of barrier is always in the form of duties, taxes, quotas and so on. This
reduces the import of goods and increases the prices for the imported goods. This is an added
advantage for the domestic goods.
Voluntary constraint - This is the barrier in which the country voluntarily stops the import of
goods. This is done in order to reduce the competition that arises because of import of goods in
domestic market.
The benefits of international trade
International trade occurs when countries endowed with different assets and natural resources
like land, labour, capital and technology aspire to sell it cheaply to other countries. This is likely
to be purchased by individuals, business and government of the country. International trade helps
wealthier countries for the maximum utilisation of the resources such as labour, technology and
capital. Different countries have different assets and natural resources that differ in quality,
quantity and cost. When they are shared between nations it builds a better future for both the
countries. International trade plays an important role in the field of medicine since medicines,
surgical equipments and lab materials that are developed in one country can be helpful for all the
people throughout the globe. The Balance of Payments (BOP) followed in international trade
helps the country to know and improve the field in which it is deficient. International trade helps
the countrys economy as it encourages Foreign Direct Investment (FDI).
13.2.1 Payment terms in foreign trade
Since international trade deals with exchange of goods, there are various ways in which the
payment terms (finance) will be handled.
Care about the method of payment has to be taken since the buyer and seller are at different
locations of the globe and transactions happen without face to face interaction. There are four
methods of payment for the international transactions. This includes the Cash-in-advance
method, Letter of Credit, Documentary collections and the Open Account. These are shown in
figure 13.1.
Figure 13.1: Payment Risk Diagram
As shown in figure 13.1 there will be uncertainty and risk with the time taken to pay between the
exporter and importer. The figure compares and contrasts the most suitable methodology from
the perspective of importer and exporter. Apparently the most secure methodologies that work
for the exporter is not safe for the importer. For exporters, documentary collection and open
account are less secure and letter of credit and cash in advance are more secure methods. In the
same way, with respect to the importer, the letter of credit and cash in advance are less secure
and the documentary collection and open account are more secure. These terms are explained as
follows.
Cash-in-Advance
Cash-in-Advance helps in removing the risks of credit by the exporter. By this method, exporter
receives the payment before the transfer of goods. The options that are available with the cash in
advance method include wire transfers and credit cards. This is the least attractive method for
many of the buyers as it creates cash flow problems. The buyers are concerned with the goods
that are not sent if the payment is made in advance.
Letters of credit
The letter of credit is the most secure instrument available for international traders. This is the
commitment made by the bank in favour of the buyer that the payment will be made to the
exporter if the terms and conditions are met. The terms and conditions of the payment are
explained in the required documents.
Documentary collections
The documentary collection is a transaction in which, the exporter's bank (remitter bank) sends
the documents to the importer's bank (collecting bank).The document contains information about
the payment. The funds are collected from the importer and paid to the exporter through the
banks involved in the collection, in exchange for the documents.
Open account
The open account transaction involves the shipping and delivery of goods in advance. The
payment is due usually from 30 to 90 days. This is advantageous for the importer in cash flow
and cost terms, but at the same time it is very risky for the exporters. Buyers from abroad stress
on the open accounts since the extension of credit from the seller to the buyer are more common
in many countries. Exporters who avoid extending credit may face loss in the sale because of the
competitors in the market.
13.2.2 Letter of credit
International Trade is affected by distance, laws, political instability and lack of familiarity by
the parties who transact. Letter of credit assumes significance since it can be used to mitigate
risk. The letter of credit is a document that is issued by the bank that guarantees payment to a
beneficiary. The letter of credit is written by the financial institution in favour of the importer of
goods to the seller. In the letter, the bank promises that it will honour the drafts drawn on it if the
seller confirms to the specific conditions that are set forth in the letter of credit. We can say that
the letter of credit is the financial contract between the issuing bank and the designated
beneficiary.
The following are the elements of the letter of credit:
The payment undertaking given by the issuing bank.
The issuing bank makes agreement on behalf of the buyer.
The letter of credit is used to pay a seller for a given amount of money.
The presentation of the specified documents that shows the supply of goods.
The time limits for the payment are specified.
The document needs to confirm the terms and conditions that are set in the letter of credit.
The documents need to be presented at the specified place.
Self Assessment Questions
1. ____________ states that the country having more labour will have best in and export labour-
intensive commodity.
2. The letter of credit is a letter that is given to the seller. (True/False)
3. The ________ transaction involves the shipping and delivery of goods in advance
a) Open account
b) Draft
c) Cash-in-advance
d) Letter of Credit
13.3 Documentation in International Trade
In the previous section, we have studied about international trade. Now, we will learn about
documentation in international trade.
Documents play an important role during transactions at the international markets. There are
various documents that are present in the international trade. The trade documents differ in
different ways depending on the aspects such as the description, quality, number, transportation
medium and so on. The documents of the importers and exporters need to support the guidelines
as per the international trade transactions.
13.3.1 Bill of lading
The legal document that is given by the shipping agency for the goods that are shipped from one
destination to the other destination is called as the bill of lading. The bill of lading is signed by
the representatives of the carrying vessel. It contains the details of type, quantity and destination
of the goods that are being carried.
Several times, the bill of lading is issued as a set of two, three or more. The number present on
each bill of lading is to ensure security.. The bill of lading has to be signed by the shipping
company or its agent and it should also show the number of signed originals.
The bill of lading indicates whether the cost of carriage is paid or not. This will be of the
following two types
Freight prepaid - This is paid for the shipper.
Freight collect - This is to be paid by the buyer at the port of discharge.
To be acceptable by the buyer, the bill of lading should:
Carry on the board of notation that shows the correct date of shipment.
Have the notation of the shipping company to the effect that the goods are damaged.
The main parties that are involved in the bill of lading are mentioned below:
Shipper - person sending the goods.
Consignee - person who delivers the goods.
Notify party - person, usually the importer to whom the shipping company informs on the arrival
of goods.
Carrier - This can be a person or company, who has ended up in contract with the shipper for
conveyance of the goods.
The bill of lading has to meet the following requirements of the credit:
The exact shipper, consignee and the notifying party need to be known.
The carrying vessel and ports of the loading and release need to be stated.
The description of the goods needs to be consistent with the other as shown on the documents.
The measures need to match with the measures that are on the other documents.
The shipping marks and numbers need to match with the numbers that are shown on the other
documents.
The bill of lading has to state whether the goods are paid or if it needs to be paid at the
destination.
The bill of lading has to state before the last date for the shipment that is specified in the credit.
The bill of lading has to state actual name of the carrier.
13.3.2 Commercial invoice
The commercial invoice is the document that is given to the seller from the buyer. The
commercial invoice is called as the export invoice or import invoice. The document commercial
invoice is mainly used by the custom authorities of the importer country. Commercial invoice
helps to evaluate the good for the purpose of taxation.
The following are some criteria that are considered while issuing a commercial invoice. The
commercial invoice must be:
Issued by the beneficiary named in the credit, who is the seller. It must state the price amount
that should not exceed the price stated in the credit.
Addressed to the applicant of the credit, which refers to the buyer and must include the
description of the goods that is included in the credit.
Signed by the beneficiary if it is required.
Issued in the stated number of originals and copies and must include the price and unit prices, if
it is required.
It must also include the shipping terms.
13.3.3 Insurance certificate
The insurance certificate is also known as an insurance policy, which certifies the goods that are
transported are insured through an open policy and these are not actionable with the risks that are
covered.
It is obligatory that the date on which the insurance becomes effective is same or earlier than the
issuance of the transport documents. If the document is submitted under the letter of credit, then
the amount that is insured must be in the same currency as the credit. This is usually the amount
of the bill with an additional 10 percent.
The following are some requirements that are associated with the completion of insurance
policy:
The name of the party in favour, which the document has been issued.
The details of the flight and the name of the vessel.
The place from where the insurance has to commerce should be detailed. The insurance cases
include the buyers warehouse and the port of destination.
The value of insurance need to be specified in the credit.
The marks and numbers need to match with the numbers that are present on the other documents.
The description of the goods should be consistent with that of the credit on the invoice.
The information related to the names and addresses of the claims should be included in this
document.
Wherever it is necessary, the document is countersigned.
The date of issue of the insurance certificate should not be later than the date of transport
documents unless the cover that is shown be effective before the date of transport documents.
13.3.4 Consular invoice
Consular Invoice is required when you are exporting goods to other countries. The invoice varies
from country to country and this is presented locally in exchange for a visa. The consular invoice
form requires lot of attention when you are filling the form since a small error can cause
substantial fines and postponement in the customer clearance.
Self Assessment Questions
4. The legal document that is given by the shipping agency for the goods that are shipped from
one destination to the other destination is called as the ________.
5. The ______________ document is required when you are exporting the goods to other
countries.
6. Which of the following document certifies that the goods that are transported are insured
under an open policy?
a) Consular invoice
b) Insurance certificate
c) Commercial invoice
d) Bill of lading
Activity 1
Consider that you are a product manager in XYZ creations and your company is exporting
leathers and laces to the ST Company in Thailand and importing shoes from the same company.
Your management has asked you to maintain the documents related to the international trade of
both the exports and imports. Name the documents that you would maintain for the same.
Hint: Insurance certificate.
13.4 Financing Techniques
In the previous section, we have learnt about documentation that plays an important role during
transactions in the international market. Let us learn about the financing techniques that enable
us to know various ways of transactions other than direct bank financing.
Planning plays an important role in the whole lifespan of the investment so that the financing is
available at every need.
There are some well-known financing techniques that are explained in the upcoming sections.
13.4.1 Bankers acceptance
In the financial terms, the bankers acceptance is the credit instrument that is developed by the
non financial firm and guaranteed by a bank for payment.
Usually, the acceptances are traded at discounts from face value in the secondary market,
depending on the credit quality of the guaranteeing bank
The banker's acceptance has played an important role in financing foreign trade for many years.
The banker's acceptance is the time at which the draft is drawn on a bank. After accepting the
draft, the bank gives an unconditional promise to pay the holder of the draft a specified amount
on a specified day. So that the bank substitutes its own credit for that of a borrower and in the
process, it creates an instrument that is freely traded.
13.4.2 Factoring
The term factoring is the financial transaction in which the factoring organisation buys the
exporters foreign accounts receivable at a discount. In this, the factor assumes all the credit and
political risks that are present with the importer. In the perspective of the exporter, factoring is
advantageous as it serves to help the firm realise cash immediately.
The following are three ways in which factoring differs from bank loan:
Factoring mainly focuses on the value of the receivables but not on the worth of the
organisation's credit.
Factoring is the purchase of the financial asset, which refers to the receivable but, it is not a loan.
Whilst bank involves just two parties for a loan, factoring involves three parties which involve
the seller, debtor and factor.
13.4.3 Forfaiting
In international trade, the term forfaiting refers to the purchase of an exporters receivables, which
refers to the amount importers owe the exporter. The amount is paid in cash by the forfaiter
selling of an exporter's receivables for a specified transaction.
Forfaiting is the financing technique that is used for financing the sale of capital goods. In
forfaiting, the buyer is known as the forfaiter who takes on all the risks involved with the
receivables the importer now is obliged to pay forfaiter. It involves the sale of notes signed by
the importer in favour of the exporter. In this technique, exporter gets the payment for the goods.
Forfaiter does not have recourse on the promissory notes and the structure of the payment is
extended for a period between three to seven years.
Self Assessment Questions
7. The _________________is the credit instrument that is developed by the non financial firm.
8. The term factoring is the financial transaction in which the business sells its accounts
receivable at a discount. (True/False)
9. In which of the following technique the buyer is known as the forfaiter?
a) Bankers acceptance
b) Factoring
c) Forfaiting
d) Commercial invoice
13.5 Export Promotion Schemes
In the previous section, we have learnt about financing techniques. Now let us understand the
promotion schemes.
Export promotion schemes are the incentive programs that are developed to attract more firms
into exporting. It helps in identification of the product and market. This also helps in pre-
shipment and post-shipment financing, training, payment guarantee schemes, trade fairs, trade
visits, and foreign representation and so on.
India being a developing economy, export promotion schemes are needed to give a boost for our
economy.
The needs of the export promotion scheme are explained as follows:
As the economy of the country is progressing with the increase in terms of population, there is a
need for more number of imports. We need to have surplus exports to pay our imports.
It is not wise to depend on the other external assistances for financing essential imports, rather
exportable surplus needs to be created.
In any country, there are some capital goods, machinery and raw materials that cannot be
produced for some more time and it has to be imported from the other countries. In order to pay
for such imports, the country needs to have sufficient funds so that the country has to promote
for its exports.
The earning of the exports need to be raised to create the purchasing power in order to import the
essential goods.
We need to explore the foreign markets in order to expand the capacities of the existing units and
find market for the new units.
To tap our export potentials completely, we need to focus on our strengths like, price stability,
low wages and the industrial bases to increase its exports.
The deficits of payments in Indian economy can be resolved through funds received through the
foreign assistance. We need to create the repaying capacity with the help of exports.
The figure 13.2 shows the three main categories that are associated with the export promotion
measures.

Figure 13.2: Export Promotion Measures


The export promotion measures are explained as follows:
Export production - For gearing up the production, we need to sharpen the competitive edge and
upgrade the technology to get a better quality.
Liberalisation - The policies like the trade and industrial licensing are oriented towards exports.
Supply of raw materials - There are some license free import goods such as the raw materials,
intermediates, components, consumables, spares, part accessories and other items that are not
regulated by negative list of imports.
There are many export promotion schemes and Export Promotion Capital Goods (EPCG) is one
of the export promotion schemes.
Export Promotion Capital Goods (EPCG) scheme
This scheme allows import of the capital goods at the reduced rate of 15percent customs duty.
The goods can be both new and second hand goods and to the Services sector.
This scheme has even extended to the services sector. These are explained as follows:
Import of second hand capital goods The import of second hand goods that have the minimum
residual life of five years are allowed free of licence but is subjected to actual user conditions.
Duty exemption scheme - This scheme aims at import of duty free goods. The goods that can be
imported by this way include raw materials, components, consumables, accessories, computer
software. They can be imported under various schemes.
Investment in plant and equipment - The investments beyond 75 lakhs is permitted for the small
scale industrial sectors.
Processing zones for export - The establishment of the Export Processing Zones (EPZ), Export
Oriented Units (EOU), Electronic Hardware Technology Parks (EHTP) and Software
Technology Parks (STP) helps in facilitating the export production in non-traditional sectors.
Quality - The central government helps in modernising and upgrading the test houses and
laboratories in order to bring the standards so that the certifications from such test houses are
very well recognised within and outside the country.
Self Assessment Questions
10. The ________________________ helps in identification of the product and market.
11. The imports of second hand goods that have the minimum residual life of six years are
allowed free of licensee. (True/False)
12. Which of the following scheme aims at import of goods for free of cost?
a) Export Promotion Capital Goods Scheme
b) Software Technology Parks
c) Electronic Hardware Technology Parks
d) Duty exemption scheme
13.6 Export and Import Finance
In the previous section, we have studied about the export promotion schemes. In this section, we
will learn about the export and import finance.
The export credit in India is studied with response to its two stages. The two stages are the pre-
shipment credit and the post-shipment credit. The pre-shipment credit is mainly used for the
production, processing and packaging. The post-shipment credit is mainly required to finance the
foreign buyers. Depending on the period of loans, there are three types of credits those are the
short term, medium term and long term credit.
13.6.1 Short term credit
The short term credit is provided in the form of pre-shipment and post-shipment finance. This
can be provided by the commercial banks that are authorised dealers in the foreign exchange.
Short term credits are covered by RBI and provide the credits at lower rate of interest. In relation
to this type of credit, there are two schemes that are explained as follows:
The Pre-shipment Credit in Foreign Currency (PCFC) in which the exporters can take the credit
both in rupees, as well as, the foreign currency. We get the credit in Indian rupees at 13 percent
rate of interest and the foreign exchange at 7.5 percent rate of interest.
The second scheme is the post-shipment credit that is available in Indian rupees. This post
shipment credit rate of interest is available in Indian currency which does not exceed 13 percent
for a maximum of 90 days. Up to 6 months it will charge 15 percent rate of interest.
13.6.2 Long term credit
Long term credit is provided by the EXIM bank and the commercial banks that are refinanced by
the IDBI.
The main thing with the export credit is the risk of transacting with the overseas buyers. The
risks with the abroad buyers occur due to the insolvency of foreign buyers, when there are
fluctuations in exchange rates and some government actions that cause delay in the payment to
exporters. These types of risks can be averted by the insured Export Credit and Guarantee
Corporation (ECGC). This corporation offers the two types of services that are given as below:
The export credit insurance, which consists of the policies that are issued to the exporters to
protect themselves against the losses that occur from the granting credit terms to the foreign
buyers.
The direct guarantees are the guarantees to the banks that give protection in respect of exporters.
13.6.3 EXIM bank
The EXIM bank is the export import bank that has been set up by the Government of India. This
is set up to perform many functions to finance, promote and develop the trade. This was
established on Jan 1, 1982. This has the power to borrow from the RBI as well as from abroad.
This plays an important role in the export financing. This bank provides the financial assistance
for promoting the Indian exports. This provides the financial assistance through the direct
financial assistance, abroad investment finance, pre-ship credit, buyers lines, export bills
discounting and so on. This also extends the help through the non funded facility for the
exporters in the form of guarantees. This aims at export of the manufactured goods, export of
technology, export of software.
The financing programmes of the Exim bank are the most comprehensive among the export
credit agencies across the globe.
Self Assessment Questions
13. The ________________credit is mainly used for the production, processing and packaging.
14. Name the credit that is provided by the Exim bank and the commercial banks that are again
financed by the IDBI?
15. EXIM bank is the private owned body. (True/False)
Activity 2
Consider that you a business head in the company and you have to deal with the finance related
to the imports and exports of the company. Due to the transit period in the company there is
shortage of the funds and your management planned to go for the credit terms. Name the credits
that you would suggest for the same.
Hint: Short term credit.
13.7 Summary
Let us summarise the points covered in this unit about finance and international trade:
International trade refers to the exchange of products, services and money at the national level.
The international trade increases gross domestic product by increasing the economic
opportunities.
There are some risks with both the exporter and importer of the goods. The letter of credit is a
letter that is given to the seller. The letter of credit helps in solving all the risks that are importer
and exporter.
Documentation plays an important role while making transactions at international markets. The
bill of lading is a document that is given by the shipping agency for the goods that are shipped
from one destination to another destination.
Commercial invoice is the document that is given to the seller from the buyer. The insurance
certificate is the insurance policy which allows the transport of goods under the open policy.
The consular invoice plays an important role while transporting the goods to the other country.
Different financing techniques play an important role in the lifespan of the investment. We have
seen the banker's acceptance that is the time at which the draft is drawn on a bank.
The factoring technique helps to realise the cash immediately. The forfaiting technique is used
for financing the sale of capital goods.
The export promotion schemes are the incentive programs developed to attract more firms
towards exporting. There is a need for the export promotion schemes in the developing country
like India.
There are many export promotion schemes and Export Promotion Capital Goods (EPCG) is one
of the export promotion schemes. that aims at import of capital goods at the reduced rate.
The three broad categories of credits include the short term, medium term and long term credit.
13.8 Glossary
Beneficiary: In insurance, the beneficiary is the person or organisation that receives money from
insurance company when the insured event occurs.
Commodity: The physical substances such as food, grains, and metals those are interchangeable with
other products of the same type.
Export Promotion: The program that promotes the domestic producer for exporting and importing goods.
Foreign Direct Investment (FDI): This is the amount of money that is invested by foreign companies and
other assets that helps the economies to grow more efficiently and become competitive participants.
Gross Domestic Product (GDP): The final market value of all the goods and services are produced in the
country in one financial year.
Monopoly: The situation in which the single firm owns almost all the market of a given type of product or
service.
13.9 Terminal Questions
1. Explain in brief about letter of credit.
2. Write a short note on insurance certificate.
3. Discuss factoring.
4. Elaborate the need for the export promotion scheme in the country.
5. Describe the functions of the EXIM bank.
13.10 Answers
Self Assessment Questions
1. Heckscher-Ohlin theorem
2. True
3. a) Open account
4. Bill of lading
5. consular invoice
6. b) Insurance certificate
7. bankers acceptance
8. True
9. c) Forfaiting
10. export promotion scheme
11. False
12. d) Duty exemption scheme
13. pre-shipment
14. Long term
15. False

Terminal Questions
1. The letter of credit is a letter that is given to the seller. In the letter, the bank promises that it will honour the drafts
drawn on it if the seller confirms to the specific conditions that are set forth in the letter of credit. For more
information refer subsection 13.2.2 of this unit.
2. The insurance certificate is known as an insurance policy which certifies that the goods that are transported are
insured under an open policy and these are not actionable with the risks that are covered. We have discussed this in
subsection 13.3.3 of this unit. You can refer the same for more details.
3. The term factoring is the financial transaction in which the business sells its accounts receivable at a discount. For
more information on factoring refer subsection 13.4.2 of this unit.
4. As the country economy is progressing, there is a need for more number of imports. We need to have much of the
exports to pay our imports. You can refer section 13.5 of this unit for more details.
5. This plays an important role in the export financing. This bank provides the financial assistance for promoting the
Indian exports. For more information refer subsection 13.6.3 of this unit.
13.11 Case-Let
Use of Financing Techniques
M/s.GHI Industries is an established manufacturer of clothing in India. They intend to export their clothing and
accordingly have obtained about 15 orders from different overseas companies each of the value Rs.2, 00,000/-.
The following options are available to M/s.GHI Industries:
1. Request a letter of credit from each customer but assume that the cost has to be borne by GHI Industries. The
cost for Letter of Credit is Rs.1000 and 0.5% of the invoice amount.
2. Factor the receivables. Assume charge for factoring @ 1.5%
3. Insure the orders. Assume insurance premium @ 1%
Discussion Questions
1. What are the advantages and disadvantages in each case? Which option do you think will favour M/s.GHI
Industries best and Why?
(Hint: Calculate the cost to GHI Industries in each case
1. Letter of Credit (Rs.2,00,000 x 15 x 0.5%) + 1000 = Rs.16000
2. Factoring receivables (Rs.2,00,000 x 15 x 1.5%) = Rs.45,000
3. Insurance (Rs.2, 00,000 x 15 x 1%) = Rs.30, 000
Option 1 is the best option for GHI Industries )

References
B.L. Mathur (2001), Towards economic development, Discovery publishing house.
Aswathappa (2008), International business, Tata McGraw-Hill.
E-Reference
http://www.businesslink.gov.uk/bdotg/action/detail?itemId=1077787643 &type=RESOURCES
- Retrieved on 3rd November, 2010.
http://www.infodriveindia.com/Exim/Guides/Export-Finance/Ch_4_Trade_Documents.aspx
- Retrieved on 4th November, 2010
http://www.economywatch.com/international-trade/heckscher-ohlin-model.html
http://www.bangkoklogistics.com/international-business/Three-Barriers-To-International-Trade.html
-Retrieved on 18th November

Unit-14-Regional Integration
Structure:
14.1 Introduction
Objectives
14.2 Overview of Regional Integration
Need for integration
Impact of integration
14.3 Types of Integration
Preferential trading agreement
Free trade area
Common market
Economic union
Political union
14.4 Regional Trading Arrangements
The European Union (EU)
European Free Trade Association (EFTA)
North American Free Trade Agreement (NAFTA)
South Comman Market (MERCOSUR)
ASEAN Free Trade Area (AFTA)
Asia-Pacific Economic Cooperation (APEC)
Gulf Cooperation Council (GCC)
South Asian Free Trade Area (SAFTA)
14.5 India and Trade Agreements
14.6 Summary
14.7 Glossary
14.8 Terminal Questions
14.9 Answers
14.10 Case-Let
14.1 Introduction
By now you must be familiar with the different types and techniques of financing employed
when trading in the international markets. You have also learnt about the documentation process
that takes place while trading in foreign countries. The previous unit also gave us an insight on
how we can get finance for importing or exporting goods. In this unit, we shall discuss about the
need and importance of regional integration.
Regional integration is bonding between nations and states through political, cultural and
economic cooperation. The cooperation is overseen by rules and regulations decided upon by the
states entering into an understanding.
This unit covers the need, process and different types of integration among countries. It also
discusses various trading blocs in existence, its importance, structure and functioning. This unit
also includes Indian participation in the regional trading blocks and trade agreements that Indian
Government has with other nations and regions.
Objectives:
After studying this unit you should be able to:
explain the need for regional integration.
analyse the impact of different types of integration amongst countries.
describe several regional trade arrangements.
evaluate different trade agreements of India.
14.2 Overview of Regional Integration
Regional integration can be defined as the unification of countries into a larger whole. Regional
integration also reflects a countrys willingness to share or unify into a larger whole. The level of
integration of a country with other countries is determined by what it shares and how it shares.
Regional integration requires some compromise on the part of countries. It should aim to
improve the general quality of life for the citizens of those countries.
In recent years, we have seen more and more countries moving towards regional integration to
strengthen their ties and relationship with other countries. This tendency towards integration was
activated by the European Union (EU) market integration. This trend has influenced both
developed and developing countries to form customs unions and Free Trade Areas (FTA). The
World Trade Organisation (WTO) terms these agreements of integration as Regional Trade
Agreements (RTA).
14.2.1 Need for integration
There are many different approaches to achieve regional integration. To some extent, each
country and region will find its own way. But typically
there are some common ideas for achieving regional integration. Some of these are:
Facilitating the growth of trade.
Creating attractive investment climates.
Surmounting the regulatory and administrative barriers to transit zones.
Guaranteeing the physical security of trade routes.
Strengthening physical and institutional infrastructure.
Promoting economic diversification.
New-comers to industrialisation enjoy some substantial benefits that their ancestors did not. The
economic policy makers today have a better understanding of the process of industrialisation
than their earlier counterparts. They now have the comprehension of microeconomic inputs and
market opportunities. Therefore, policy makers can make use of the wealth of knowledge that is
made possible by the rise of the global economy. On the long run regional integration may
transform the regions.
The initiative of regional integration should perform at least the following functions:
Strengthening of trade integration in the region.
Creating an appropriate environment for enabling private sector development.
Developing infrastructure programmes to support economic growth and regional integration.
Developing strong public sector institutions and good governance.
Reducing social disparities and developing an inclusive civil society.
Contributing to the peace and security of the region.
Building environmental programmes at the regional level.
Strengthening the regions interaction with other regions of the world.
14.2.2 Impact of integration
Regional integration results in the creation and diversion of trade. It supports overall growth of
the region, coupled with efficient trading practices. Trade creation increases production and
income, and also leads to new entries in the market and therefore, results in tougher competition.
The transfer of technology is also faster.
Regional integration provides some sort of reduction on tariffs and prohibitions. It spreads
goodwill among member countries and also helps in reducing the chances of conflict between
countries.
Self Assessment Questions
1. Regional integration can be defined as the unification of countries. (True/False)
2. Promoting ____________________ is a need of regional integration.
3. Identify the correct answer. Regional integration should not ________________
a) Build environmental programmes at the regional level
b) Strengthen trade integration in the region
c) Contribute to the peace and security of the region
d) Break ties with other countries
14.3 Types of Integration
In the previous section an overview and the need for regional integration was covered. A whole
range of regional integrations exist today. Different types of regional integration are discussed in
this section.
14.3.1 Preferential trading agreement
Preferential trading agreement is a trade pact between countries. It is the weakest type of
economic integration and aims to reduce the taxes on few products to the countries who sign the
pact. The tariffs are not abolished completely but are lower than the tariffs charged to countries
not party to the agreement. India is in PTA with countries like Afghanistan, Chile and South
Common Market (MERCOSUR). The introduction of PTA has generated an increase in the
market size, and resulted in the availability and variety of new products.
14.3.2 Free trade area
Free Trade Area (FTA) is a type of trade bloc and can be considered as a second stage of
economic integration. It is made up of all the countries that are willing to or agree to reduce
preferences, tariffs and quotas on most of the services and goods traded between them. Countries
choose this kind of economic integration if their economical structures are similar. If the
countries compete among themselves, they are likely to choose customs union.
The importers must obtain product information from all the suppliers within the supply chain, in
order to determine the eligibility for a Free Trade Agreement (FTA). After receiving the supplier
documentation, the importer must evaluate the eligibility of the product depending on the rules
surrounding the products. The importers product is qualified individually by the FTA. The basis
on which the product will be qualified is that the finished product should have a minimum
percentage of local content.
14.3.3 Common market
Common market is a group formed by countries within a geographical area to promote duty free
trade and free movement of labour and capital among its members. European community is an
example of common market. Common markets levy common external tariff on imports from
non-member countries.
A single market is a type of trade bloc, comprising a free trade area with common policies on
product regulation, and freedom of movement of goods, capital, labour and services, which are
known as the four factors of production. This agreement aims at making the movement of four
factors of production between the member countries easier. The technical, fiscal and physical
barriers among the member countries are eliminated considerably as these barriers hinder the
freedom of movement of the four factors of production. The member countries must come
forward to eliminate the barriers, have a political will and formulate common economic policies.
A common market is a first step towards a single market. It may be initially limited to a FTA
with moderate free movement of capital and services, but it is not capable of removing rest of the
trade barriers.
Benefits and costs
A single market has many advantages. The freedom of movement of goods, capital, labour and
services between the member countries, results in the efficient allocation of these production
factors and increases productivity.
A single market presents a challenging environment for businesses as well as for customers,
making the existence of monopolies difficult. This affects the inefficient companies and hence,
results in a loss of market share and the companies may have to close down. However, efficient
companies can gain from the increased competitiveness, economies of scale and lower costs.
Single market also benefits the consumers in a way that the competitive environment provides
them with inexpensive products, more efficient providers of products and increased variety of
products.
A country changing over to a single market may experience some short term negative effects on
the national economy due to increased international competition. The national companies that
earlier benefited from market protection and subsidies, may find it difficult to cope with their
efficient peers. If the companies fail to improve their methods, they may have to close down
leading to migration and unemployment.
14.3.4 Economic union
Economic union is a type of trade bloc and is instituted through a trade pact. It comprises of a
common market with a customs union. The countries that are part of an economic union have
common policies on the freedom of movement of four factors of production, common product
regulations and a common external trade policy.
The purpose of an economic union is to promote closer cultural and political ties, while
increasing the economic efficiency between the member countries.
Economic unions are established by means of a formal intergovernmental legal agreement,
among independent countries with the intention of fostering greater economic integration. The
members of an economic union share some elements associated with their national economic
jurisdictions. These include the free movements of:
Goods and services within the union along with a common taxing method for imports from non-
member countries.
Capital within the economic union.
Persons within the economic union. Some form of cooperation usually exists when framing fiscal
and monetary policies.
14.3.5 Political union
A political union is a type of country, which consists of smaller countries/nations. Here, the
individual nations share a common government and the union is acknowledged internationally as
a single political entity. A political union can also be termed as a legislative union or state union.
Self Assessment Questions
4. Countries under a political union do not have a common government. (True/False)
5. The purpose of an economic union is to promote closer __________ ties.
6. Identify the factor of production
a) Capital
b) Consumers
c) Market
d) Policy maker
Activity 1
Analyse the reasons that lead to the formation of economic unions and common markets.
Hint: Economic regionalism, taxation and regional integration.
14.4 Regional Trading Arrangements
After learning the various types of integration, we will now discuss the regional trading
arrangements required for integration. The different regional trading agreements that are in
existence today among various countries spread across different continents are discussed in this
section.

14.4.1 The European Union (EU)


The European Union (EU) is an economic and political union established in 1993. This came
into effect because of the Treaty of Maastricht, signed on 7th February 1992 by the European
Communities. The EU comprises of 27 member states committed to regional integration.
The EU has developed a single market for all the member states and sixteen member states have
adopted a common currency called the Euro. The member states sign an agreement called
Schengen Agreement, which ensures the free movement of people, goods, capital and services,
including the abolition of passport controls. The agreement enacts legislation in justice and home
affairs, and maintains common policies on trade, agriculture, fisheries and regional development.
EU has also devised a common foreign and security policy for its member states. The EU has
established diplomatic missions around the world and they represent the member states at the
United Nations, WTO, G8 and G-20 summits. EU ambassadors head the EU delegations.
Important organisations of the EU include the European Commission, the Council of the
European Union, the European Council, the Court of Justice of the European Union, and the
European Central Bank. The EU citizens elect the European Parliament every five years.
14.4.2 European Free Trade Association (EFTA)
The European Free Trade Association (EFTA) is a free trade organisation established in 1960
between four European counties, Norway, Switzerland, Iceland and Liechtenstein. The EFTA
was formed at the Stockholm Convention between seven countries, presently only four countries
remain as the members of EFTA. The EFTA was formed as an alternative to EU, allowing
countries to join EFTA if they were not willing to join EU. It operates parallel to the EU. The
Stockholm Convention was replaced by the Vaduz Convention. This Convention provides a
framework for a free and liberal trade amongst its member states.
In 1994, three of the EFTA countries signed European Economic Area (EEA) agreement and
became a part of the European Union Internal Market. Switzerland opted to arrange bilateral
agreements with the EU. In addition, the EFTA states have jointly arranged free trade agreements
with many other countries. In 1999, Switzerland established a number of bilateral agreements
with the EU, covering a wide range of areas, including movement of persons, transport and
technical barriers to trade. This agreement prompted the EFTA states to modernise their
convention to guarantee that it will continue to provide guidelines for the expansion and
liberalisation of trade among them and with the rest of the world.
14.4.3 North American Free Trade Agreement (NAFTA)
The North American Free Trade Agreement (NAFTA) was signed in 1994 by three governments,
Canada, Mexico, and the United States. This trade agreement is the largest in the world in terms
of combined purchasing power parity Gross Domestic Product (GDP) and second largest by
nominal GDP comparison.
The NAFTA is divided into two sections, the North American Agreement on Environmental
Cooperation (NAAEC) and the North American Agreement on Labour Cooperation (NAALC).
The North American Agreement on Environmental Cooperation (NAAEC) was established in
1994. It is an environmental agreement between the United States of America, Mexico and
Canada. The agreement comprises of a declaration of objectives and principles regarding
conservation and the protection of the environment. The Commission for Environmental
Cooperation (CEC) was set up as part of the agreement.
North American Agreement on Labour Cooperation (NAALC) was also established in 1994 to
achieve the following goals:
Improve working conditions and living standards.
Promote a set of guiding labour principles.
Encourage cooperation to promote innovation.
Improve the levels of productivity and quality.
NAALC provides various means such as exchanges of information, technical assistance, and
consultations for achieving the above goals.
14.4.4 Southern Common Market (MERCOSUR)
MERCOSUR is a trade pact between Argentina, Brazil, Paraguay and Uruguay. It was
established in 1991 to promote free trade and a smooth movement in currency, goods and people
between these nations. The pact helps reduce tariffs between the nations by 90 percent.
MERCOSUR was initiated in 1985 when, the Presidents of Argentina and Brazil signed the
Argentina-Brazil Integration and Economics Cooperation Program. Since then, other countries
like Bolivia, Chile, Columbia, Ecuador and Peru have become members in this pact. In the 2004
presidential summit, it was agreed that it should have 18 representatives from each country by
2010. The only non-South American partners are Egypt and Israel.
14.4.5 ASEAN Free Trade Area (AFTA)
AFTA is a trade agreement formulated by the Southeast Asian Nations association that supports
local manufacturing in all the ASEAN countries.
The AFTA agreement was signed in Singapore on 28th January, 1992. Initially when AFTA
agreement was signed, ASEAN comprised of six members like Thailand, Singapore, Philippines,
Malaysia, Indonesia and Brunel. Then Vietnam joined the AFTA agreement in 1995, followed by
Myanmar and Laos in 1997 and Cambodia in 1999. Now, AFTA consists of ten ASEAN
countries. The four latecomers had to sign the AFTA agreement to join ASEAN; however, they
were given longer time duration to meet the tariff reduction obligations of AFTA.
The AFTAs primary goals seek to:
Enhance the competitive edge of ASEAN, as a production base in world market by eliminating
the ASEANs non-tariff and tariff barriers.
Fascinate more overseas direct investment to ASEAN.
Common Effective Preferential Tariff (CEPT) scheme is the prime source for attaining the goals
mentioned above. The CEPT scheme established a schedule for its initiation in 1992 with their
self-described goal to enhance the competitive advantage of the region as a production base for
world market.
The Association of Southeast Asian Nations (ASEAN) is an economic and geo-political
organisation of ten countries situated at Southeast Asia. The ASEAN organisation was
formulated by Thailand, Singapore, Philippines, Malaysia and Indonesia on 8th August, 1967.
From then on, the membership has extended to comprise Vietnam, Laos, Cambodia, Burma
(Myanmar) and Brunei. The ASEAN organisation aims to accelerate cultural development, social
progress, economic growth among their members, protection of stability and peace of the region,
and offer opportunities for member countries for discussing differences peacefully.
ASEAN spans across 4.46 million kilometres area, three percent of the overall land area of the
Earth with a population of 600 million approximately, that is, 8.8 percentage of the worlds
population. If ASEAN was the only country, it would rank as the ninth largest economy
worldwide and third largest in Asia, as per nominal GDP.
14.4.6 Asia-Pacific Economic Cooperation (APEC)
The Asia-Pacific Economic Cooperation (APEC) is the best forum for assisting the investment,
trade, cooperation and economic growth in Asia-Pacific region. APEC is the sole inter-
governmental grouping in the world functioning on the basis of equal respect, open dialogue and
non-binding commitments for the views of the participants. Unlike WTO and the other
multilateral trade bodies, APEC does not have any treaty obligation for their participants. The
decisions within APEC are finalised by commitments and consensus undertaken on voluntary
basis.
The 21 Member Economies of APEC are Vietnam, United States of America, Thailand, Chinese
Taipei, Singapore, The Russian Federation, The Republic of the Philippines, Peru, Papua New
Guinea, New Zealand, Mexico, Malaysia, Republic of Korea, Japan, Indonesia, China, Hong
Kong, Peoples Republic of China, Chile, Canada, Brunei Darussalam and Australia.
APEC came into existence in 1989 to further enhance the prosperity and economic growth of the
region and to uphold the Asia-Pacific community. From its initiation, APEC has worked to bring
down the tariffs and other kinds of trade barriers around Asia-Pacific region. They have also
worked towards increasing the exports dramatically and for creating efficient domestic
economies. The key to achieve APECs vision is what is referred to as Bogor Goals of free and
open trade and investment in the Asia-Pacific by 2010 for industrialised economies and 2020 for
developing economies. In fact, these goals were embraced by the leaders in their meeting in
Indonesia and Bogor in 1994.
Let us consider more about Bogor Goals in 1994 Leaders Declaration. The free and open trade
investment assists economies to grow, generates jobs and offers greater prospects for
international investment and trade. In contrast to this, protectionism maintains higher price tags
and fosters inefficiencies in few industries. Free and open business assists in lowering the
production costs and in reducing the prices of services and goods, which is a direct advantage for
everyone.
APEC also functions to create a safe and efficient environment for the movement of people,
services and goods across the borders, with the help of technical and financial collaboration and
policy alignment.
Objectives:
In order to meet Bogor Goals, the APEC functions in three prime areas:
Technical and financial collaboration.
Trade assistance.
Investment and business liberalisation.

14.4.7 Gulf Cooperation Council (GCC)


On 25th May, 1981, GCCs leaders of United Arab Emirates like State of Kuwait, State of Qatar,
Sultanate of Oman, Kingdom of Saudi Arabia, State of Bahrain met in Abu Dhabi. Here, the
leaders formulated a framework to join the six states for effective inter-connection, integration
and coordination among member states in every field for achieving unity, as per article four of
GCC Charter. The article four highlighted the strength and depth of cooperation, links and
relations among their citizens. In fact, the underpinnings that are clearly provided in the GCC
charters preamble, confirms the similar systems, common qualities and special relations founded
on creed of Islamic faith, in sharing a common goal and to cooperate among these states to serve
the objectives of Arab nation.
GCC on one hand is an institutionalisation, evolution and continuation of the old prevailing
realities. On the other hand, it is a practical solution to challenges of economic development and
security in those areas. Also GCC is a fulfilment of aspirations of their citizens towards certain
kind of Arab regional unity.
Objectives:
GCC charter helps to inter-connect, integrate and coordinate between the member states in every
field. They also help strengthen ties amidst their people, formulate same kind of regulations in
many fields like administration, legislation, tourism, customs, trade, finance, economy, as well
as, to foster technical and scientific progress in animal, water, agriculture, mining and industry
resources. Along with this, the GCC helps establish scientific research centres, set up joint
ventures and encourage cooperation of private sector.
The GCC also known as Cooperation Council for the Arab States of the Gulf (CCASG) is an
economic and political union that involves six Arab states of Persian Gulf with various social and
economic objectives.
Few of the stated objectives are to:
Formulate similar kind of regulations in several fields like administration, legislation, tourism,
customs, trade, finance and economy.
Foster technical and scientific progress in animal, water, agriculture, mining and industry
resources.
Formulate scientific research centres.
Establish joint ventures.
Encourage cooperation of private sector.
Strengthen relationship among the people.
Formulate a mutual currency by 2010.
However, on December 2006, Oman announced that they would not be able to comply with the
target date. Then in May 2009, UAE announced their withdrawal from monetary union project.
This happened just after they had announced that their monetary union central bank would be
situated at Riyadh instead of UAE. They have proposed the currency name to be Khaleeji.
Recently, the Council leaders had to face lots of issues for combating the economic downturn.
The GCC countries were the first to be hit by the downturn and the prime ones to react to the
crisis. Their programs had lots of disparities, which deepened the crisis. The recovery plans were
present in the private sector, which failed to set concise priorities for development and failed to
restore confidence in the investor and weak consumer.
14.4.8 South Asian Free Trade Area (SAFTA)
South Asian Free Trade Area (SAFTA) agreement was initiated at the 12th SAARC summit on
6th January, 2004 in Pakistan. This agreement envisaged the creation of a free trade zone model
in its seven member nations. The seven member nations consist of nearly 1.4 billion people from
various countries like:
Nepal.
Maldives.
Bhutan.
Bangladesh.
Pakistan.
India.
SAFTA agreement was formulated to levy zero customs duty for trading products by 2012. This
agreement was implemented after confirming its compliance by governments of seven member
nations. Also, the agreement might facilitate healthy trades and investment relationship across
the borders, to bring about several structural reforms in economy of seven countries. But there
are a few obstacles that hinder trade across the South Asian countries, thereby, the trade across
the South Asian borders accounts for just five percentage of overall trade. In fact, the reason
could be attributed to the following two prominent factors like:
Political causes During late 1940s, most of the nations of South Asia were a part of the British
India. During this period, there was considerable trade happening between many South Asian
countries. But in 1947 when Pakistan and India became independent, Pakistan started importing
most of their important articles from India. Pakistan also exported many of their commodities to
India. Because of the conflicts happening in various spheres, the trade activities started declining
sharply between Pakistan and India.
Protectionism Almost all the South Asian countries started stressing on the import activities
rather than promoting the export activities. Such a tendency lowered the productivity in various
sectors of economy. However, things are not the same now. The various economies have started
cooperating among themselves, which is evident from the fact that both India and Pakistan
lowered their trade tariffs in 2005.
Self Assessment Questions:
7. The European Free Trade Association (EFTA) was established in the year:
a) 1950
b) 1960
c) 1970
d) 1980
8. ____________ is a trade pact between Argentina, Brazil, Paraguay and Uruguay.
9. The EU comprises of ____________ member states
10. SAFTA agreement was initiated at the 12th SAARC summit held in Bangladesh. (True/False)
11. The Gulf Cooperation Council (GCC) is also known as Cooperation Council for the Arab
States of the Gulf (CCASG). (True/False)
Activity 2
Find out how the Bogar goals set by APEC are being pursued by APEC member countries.
Hint:http://www.apec.org/apec/news___media/media_releases/08_pe_singaporeiap.html
14.5 India and Trade Agreements
After learning about regional trading arrangements in the previous section, we shall now discuss
the trading agreements conducted by India.
India considers Regional Trading Arrangements (RTA's) as building blocks towards the objective
of trade liberalisation. Therefore, India is participating in a number of RTAs, which include Free
Trade Agreements (FTAs), Preferential Trade Agreements (PTAs) and so on. These agreements
take place bilaterally or in a regional grouping. We shall now discuss some of the major
agreements signed by India.
Asia-Pacific Trade Agreement (APTA)
The Asia-Pacific Trade Agreement (APTA), previously known as the Bangkok Agreement, was
signed on 31st of July 1975, as an initiative of the United Nations Economic and Social
Commission for Asia and the Pacific (ESCAP).
The United Nations Economic and Social Commission for Asia and the Pacific (ESCAP) is the
regional development arm of the United Nations for the Asia-Pacific region. It focuses on issues
that are most effectively addressed through regional cooperation and include the issue that:
All or a group of countries in the region face, for which it is necessary to learn from each other.
Benefit from regional or multi-country involvement.
Cut across boundaries, or that would benefit from collaborative inter-country approaches.
Are sensitive or emerging and require further advocacy and negotiation.
The first agreement on trade negotiations among the developing member countries of ESCAP
was the APTA/ Bangkok agreement. It is basically a preferential tariff agreement that aims at
promoting intra-regional trade through exchange of mutually agreed concessions, by the
members of the ESCAP region.
The first signatories to the agreement were Bangladesh, India, Lao Peoples Democratic
Republic, the Republic of Korea and Sri Lanka. China's accession to the agreement was accepted
at the 16th Session of the Standing Committee of the Bangkok Agreement in April 2000.
The objective of this agreement is to encourage economic development gradually through trade
expansion among the developing member countries of ESCAP and to further international
economic cooperation through the adoption of mutually beneficial trade liberalisation measures.
The following general principles govern the agreement:
The Agreement shall be based on overall cooperation and mutuality of advantages in such a way,
to benefit all participating states equally.
The principles of transparency, national treatment and most-favoured-nation treatment shall
apply to the trade relations among the participating states.
The special needs of least developed country participating states shall be clearly recognised and
concrete preferential measures in their favour shall be agreed upon.
Bay of Bengal Initiative for Multi-Sectoral Technical and Economic Cooperation (BIMSTEC)
Bangladesh India Myanmar Sri Lanka and Thailand Technical and Economic Cooperation
(BIMSTEC), a sub-regional economic cooperation grouping, was formed in Bangkok in June
1997. Myanmar joined the grouping later in December 1997. Bhutan and Nepal too joined in
February 2004. Its membership involves five members of SAARC (India, Bangladesh, Bhutan,
Nepal and Sri Lanka) and two members of ASEAN (Thailand, Myanmar). Thus, it is considered
as a bridging link' between the two major regional groupings that is, ASEAN and SAARC. The
chairmanship of BIMSTEC rotates among the member countries in alphabetical order. The
immediate priority of the grouping is to merge its activities to make it attractive for economic
cooperation.
Initially, cooperation was proposed into six sectors. But, during the 11th Senior Official Meeting
in New Delhi on August 2006, it was agreed that the areas of cooperation should be expanded to
13 sectors and each sector will be led by members in a voluntary manner.
The member countries proposed cooperation in the following sectors:
Trade and Investment (Bangladesh).
Technology (Sri Lanka).
Energy (Myanmar).
Transport and Communication (India).
Tourism (India).
Fisheries (Thailand).
Agriculture (Myanmar).
Cultural Co-operation (Bhutan).
Environment and Disaster Management (India).
Public Health (Thailand).
People-to-People Contact (Thailand).
Poverty Alleviation (Nepal).
Counter-Terrorism and Trans-national Crimes (India).
BIMSTEC member countries agreed to establish the BIMSTEC Free Trade Area Framework
Agreement in order to encourage trade and investment in the countries party to the agreement,
and attract outsiders to trade with and invest in BIMSTEC at a higher level. The Framework
Agreement on the BIMST-EC FTA was signed on 8th February, 2004 in Phuket, Thailand.
Framework Agreement on Comprehensive Economic Cooperation between India and the
Association of South East Asian Nations
"Look East Policy" led India to engage with the Association of South East Asian Nations
(ASEAN) and it starred in the year 1991. The ASEANs political economic and strategic
importance in the larger Asia-Pacific Region and its capability to become a major partner of
India in trade and investment made India to join association with ASEAN. While, ASEAN looks
to utilise and access Indias technical and professional wealth, India and ASEAN look forward to
strengthen the security in the region.
ASEAN was established on 8th August 1967 in Bangkok by the five original member countries,
namely, Indonesia, Malaysia, Philippines, Singapore, and Thailand. Now, it has a membership of
10 countries namely Brunei Darussalam, Cambodia, Indonesia, Lao PDR, Malaysia, Myanmar,
Philippines, Singapore, Thailand and Vietnam. India is one of the four 'Summit level Dialogue
Partners' of ASEAN.
An agreement on Comprehensive Economic Cooperation between ASEAN and India was signed
on 8th October 2003 in Bali (Indonesia). The key elements of the agreement are, FTA in services,
goods and investment, as well as, in the areas of economic cooperation.
The objectives of this Agreement are to:
Promote and strengthen trade, economic and investment co-operation between the parties.
Progressively liberalise and promote trade in goods and services, as well as, create a transparent,
liberal and facilitative investment regime.
Explore new areas and develop appropriate measures for closer economic co-operation between
the parties.
Facilitate the more effective economic integration of the new ASEAN Member States and bridge
the development gap among the parties.
The areas where economic cooperation is required are when appropriate parties:
Agree to strengthen their cooperation in the following areas:
o Trade facilitation.
o Sectors of cooperation.
o Trade and investment promotion.
Agree to implement capacity building programmes and technical assistance, particularly for the
New ASEAN Member States, in order to adjust their economic structure and expand their trade
and investment with India.
Establish other bodies, which may be necessary to coordinate and implement any economic
cooperation activities undertaken pursuant to this Agreement.
India-MERCOSUR Preferential Trade Agreement (PTA)
India and MERCOSUR signed a framework agreement was on 17th June 2003. The objective of
this agreement is to create an environment for negotiations in the first stage, by granting mutual
tariff preferences, and in the second stage, to negotiate a FTA between the two parties in
conformity with the rules of the WTO. As a follow up to the framework agreement, a Preferential
Trade Agreement (PTA) was signed in New Delhi on January 25, 2004. The aim of this PTA is
to expand and strengthen the existing relations between MERCOSUR and India and promote the
expansion of trade by granting mutual fixed tariff preferences with the ultimate objective of
creating a free trade area between the parties.
Other agreements include:
India and Singapore Comprehensive Economic Cooperation Agreement (CECA).
India-Sri Lanka Free Trade Agreement (ISFTA).
India-Chile Preferential Trade Agreement (PTA).
India-Afghanistan Preferential Trade Agreement (PTA).
India-Bhutan Trade Agreement.
India-Nepal Trade Treaty.
Framework Agreement for Establishing Free Trade between India and Thailand.
Free Trade Agreement (FTA) between India and Gulf Cooperation Council (GCC).
India- Japan Trade Agreement.
Joint Study Group between India and Korea.
Trade Agreement between India and Bangladesh.
Comprehensive Economic Cooperation and Partnership Agreement (CECPA) between India and
Mauritius.
Self Assessment Questions
12. India and MERCOSUR signed a Framework Agreement was on ________.
13. The association of India and ASEAN started in the year 1991. (True/False)
14.6 Summary
Let us summarise the points covered in this unit:
Regional integration is necessary to improve the relationship between countries and to promote
trade. The overall development of the region is the principal behind regional integration.
There are different types of regional integration. They are common market, economic union,
political union, preferential trading agreement and free trade area.
These are the basic ideas behind the different regional integration agreements existing in the
world.
The different regional integration agreements are NAFTA, APEC, EU, EFTA, AFTA,
MERCOSUR, GCC and SAFTA.
India also considers RTSs to be the basis for trade liberalisation. Therefore, India has entered into
various agreements with many countries spanning many continents.
14.7 Glossary
GDP: Gross Domestic Product is the amount of goods and services produced in a country every
year.
Personal union: It is a group of countries that are governed by a same monarch while their laws
and boundaries are distinct.
Trade bloc: It is an agreement between countries to reduce tariffs and other trade barriers.
Transit zone: It is a free trade area and goods passing through a transit zone are normally not
subject to any customs formalities, duties, or import restrictions of the host country.

14.8 Terminal Questions


1. What is the need for regional integration?
2. Write short notes on common market, economic union and free trade area.
3. Write short notes on NAFTA and APEC.
4. How has India reacted towards regional integration?
14.9 Answers
Self Assessment Questions
1. True
2. Economic diversification
3. d) Break ties with other countries
4. False
5. Cultural and political
6. a) Capital
7. b) 1960
8. MERCOSUR
9. 27
10. False
11. True
12. 17th June 2003
13. True
Terminal Questions
1. Regional integration facilitates the growth of trade, ensures peace and security of the region
and it binds different countries together. These are explained in section 14.2 of this unit. Refer
the same for details.
2. Common market is a group of countries within a particular geographical area, whereas, FTA is
a trade bloc that has agreed to reduce tariffs. An economic union comprises of a common market
and a custom union. These are explained in sub-section 14.3.2, 14.3.3 and 14.3.4 of this unit.
Refer the same for details.
3. NAFTA is largest in the world in terms of purchasing GDP. APEC is a best form for trade
cooperation in the Asia-Pacific region. These are explained in sub-section 14.4.3 and 14.4.6 of
this unit. Refer the same for details.
4. India considers RTAs as building blocks towards the objective of trade liberalisation.
Therefore, India is participating in a number of RTAs. This is explained in section 14.5 of this
unit. Refer the same for details.

14.10 Case-Let

Role of Integration in Maintaining Peace


The war in the Balkans proved to be the motivation behind the development of European
Foreign policy to establish stability and security in the region. The policy proposed to
integrate the Western Balkans through political and economic assistance especially provided
by a regional approach and by the Stabilisation Association Process and the Stability Pact. In
the context of the policy towards the Balkans, Siberia was charged with the responsibility to
oversee the transition of democracy and participate in the integration process.
The role of Siberia is crucial as it has to take care of its own political and economic progress
in the process of integration. Therefore, the policy emphasise that the process of the
integration is not mainly related to security and economic interests, but also with a normative
ambition that is most importantly building and enforcing the rules needed to guarantee
democratic development and political stability. The EUs more rationale interests such as
economic development and security are correlated and also embedded in the EUs normative
concerns. The strategies employed by the EU towards Serbia particularly had the ambition to
create political stability and in turn, increase the security throughout the Balkans, and thereby
decrease the risk for further conflict around Europes borders. For instance, the support
towards the democratic entities and the promotion of European norms and rules is of high
priority.
Discussion Questions
1. Analyse the role of Siberia in integrating the Balkans.
(Hint: Political and economic participation)
Source: http://www.essays.se/essay/f468debd57/

References
Bernadette Androsso-O'Callaghan (2005), Regional integration: Europe and Asia compared.
Ashgate Publishing.
Rouhollah K. Ramazani, Joseph A. Kechichian (1988), The Gulf Cooperation Council: record
and analysis. University Press of Virginia.
Sisir Gupta (1981), India and regional integration in Asia. Asia Publishing House.
E-References
http://business.gov.in/trade/trade_agreements.php
http://en.wikipedia.org/wiki/Regional_integration
- Retrieved on 6th November 2010

Unit-15-Global Sourcing and its Impact on Indian Industries


Structure:
15.1 Introduction
Objectives
15.2 Globalisation and India
Evolution in India
Liberalisation of economy in 1991
15.3 Competitiveness
Knowledge base
Demographics
Cost
15.4 Challenges for Indian Businesses
Brand India
Government and bureaucracy
Corporate governance
Managing diversity
15.5 Strategy for International Business in India
Regional understanding
Strategic alliances
15.6 Summary
15.7 Glossary
15.8 Terminal Questions
15.9 Answers
15.10 Case-Let
15.1 Introduction
In the previous unit we studied about regional integration. Regional integration is a method in
which the states enter into a regional agreement to improve cooperation through regional
institutions.
In this unit you will study about global sourcing and its impact on Indian industries. Global
sourcing is a procurement strategy that is aimed at exploiting global efficiencies in production.
This unit discusses the evolution of globalisation in India and its impact on Indian business. It
also discusses the prevailing competitive environment in India with respect to international
business, challenges and threats faced by Indian business. Some proven strategy models have
also been discussed for better understanding of international business operations in India.

Objectives:
After studying this unit you should be able to:
evaluate the impact of globalisation in India.
interpret the competitive environment in India.
explain the challenges faced by Indian business due to globalisation.
describe strategies that can be adopted by Indian businesses.
15.2 Globalisation and India
Globalisation is the process of increasing connectivity and interdependence of the worlds market
and businesses. It is a way of interacting among countries to develop global economy.
Globalisation is the integration of economies of the world through trade and mutual exchange of
technology and knowledge. In India, globalisation refers to the opening up of the economy to
foreign direct investment by offering facilities to foreign companies to invest in various areas of
economic activity. Globalisation had a strong impact in all sectors and business in India. It has
created challenge for technical manpower in India. Globalisation has helped India in the
following ways to:
Open up Indian economy to foreign direct investments and to facilitate foreign companies to
invest in different sectors of economic activities.
Enable Indian companies to enter into foreign collaboration.
Remove restrictions for the entry of multinational companies.
Have a direct and indirect impact on Indian currency and enable inflow of foreign exchange into
India.
15.2.1 Evolution in India
For India, globalisation is not something new. One of the first instances of globalisation in India
was in 1647 A.D, when the Kings in India had a foreign collaboration with East India Company.
However, the incidents that occurred post the foreign collaboration, until India attained
independence in 1947, is an example of collaboration without any sufficient control. During
1947, India had placed restrictions on Foreign Direct Investments (FDI) which restricted the flow
of FDI in India.
Globalisation with respect to India was seen in terms of how the Government of India allowed
the foreign business entities to operate in India and the amount of foreign direct investments
entered India. Globalisation in India became prominent after 1991. The early policies from 1962
to 1977 were mainly driven by the needs of the local industry and economy. From 1978, the
policies promoted liberalisation of the economy and several steps were taken to implement these
policies. Over a period of time, the whole entrepreneurial abilities of a people were restricted
with a set of regulations and licenses and the Indian economy was called a License Raj. In the
year 1991, a major restructuring of the Indian economy called LPG (Liberalisation, Privatisation
and Globalisation) was welcomed.
15.2.2 Liberalisation of economy in 1991
Liberalisation is the process to reduce unnecessary restrictions on business units that are imposed
by the government. Before 1991, the government had imposed many restrictions and controls on
the economy such as import license, foreign exchange control, and industrial licensing system
and so on. These restrictions discouraged entrepreneurs to establish new industries. The
economic liberalisation in India began in July 1991 which paved way for a rapid progress in
India. Trade liberalisation provided flexible exchange rate. Liberalisation of policies towards
foreign direct investments (FDI) helped in opening up the economy. The reforms brought
changes in the opinion about the role of public sector. The areas that were reserved exclusively
for public sector were now open to the private sector, example, telecommunications, air
transport, steel, petroleum and so on.
Since 1991, the Government of India took many policy measures to bring the country out of
economic crisis and to accelerate the growth of the economy. The important policy measures are
the following:
Reducing controls and promoting liberalisation.
Encouraging private sector.
Promoting foreign direct investment.
Introducing improved technology.
Introducing changes in trade and monetary policy.
Various policy measures were undertaken since July 1991 to increase the productivity and
efficiency of the economy.
In addition to liberalising the economic policies, the other major change that occurred in the
legislation front was the repealing of Foreign Exchange Regulation Act (1973) [FERA] to
Foreign Exchange Management Act (1999) [FEMA]. In case of other laws everything is allowed
unless specifically prohibited, under FERA nothing was permitted unless specifically permitted.
FERA was more of regulation of the foreign exchange containing stricter rules and policies. The
Enforcement Directorate that operated under FERA had enormous powers to order imprisonment
for minor offences. However the scenario was changed after 1999, when FEMA was passed.
FEMA was more of foreign exchange management legislation with less stringent rules when
compared to FERA.
Self Assessment Questions
1. The process of increasing connectivity and interdependence of the worlds market and
businesses is ________.
a) Liberalisation
b) Globalisation
c) Privatisation
d) Standardisation
2. _____________ is the process to reduce unnecessary restrictions on business units that are
imposed by the government.
3. The economic liberalisation in India began in July 1985. (True/False)
15.3 Competitiveness
Competitiveness is the main driving force for all organisations. The economic reforms
commenced by the Government of India in 1991, opened way to create new business
opportunities for private investors and entrepreneurs in the country. The competitive advantage
of a company is important to determine the success of its global business. This has led to tough
competitive environment among the private investors to compete for market share.
The economic reforms have attracted many foreign investors, mainly MNCs to invest in India.
India has demonstrated global competitive standards in telecom and ITES, manufacturing,
medico-tourism, technical and management education and so on. Many major Indian companies
have transformed into MNCs to go global. India is constantly trying to enhance its global
competitiveness to dominate global market. India has core competencies in IT/ITES sector. The
IT Act has helped India in getting recognition as a leader in the service sector. The
competitiveness of service sector is emerging as a crucial factor. To improve competitiveness in
the service sector, the Government of India has set up a board which has recommended reforms
in the education system. The government is taking measures to improve the skills that are deficit
in all service sectors.
15.3.1 Knowledge base
India is the worlds sixth most important offshore research and development location. The
country has a global reputation by being in the leading position for business process outsourcing
(BPO) and call centers. Global technology leaders such as IBM, Hewlett-Packard, Nokia, Dell
and others invest in operations in India. Dell has established a major production center to serve
the local Indian market. With the increased degree of globalisation, the Research and
Development (R&D) activities are given importance to enhance global competitiveness. There
has been steady increase in the literacy rate in India. India has a large resource of educated and
technical staff. India ranks high in terms of availability of skilled labour, especially engineers.
Currently, India is a service hub of the world and holds a dominant position in a variety of
service and knowledge based activities.
15.3.2 Demographics
Demographics are a statistical data of the population which includes age, gender, occupation,
income and so on. For the success of a business an understanding of the demographics is
essential. Demographics is the basic statistical information study of population based on factors
such as age, gender, economic status, education, income and employment, Demographics are
used by governments, corporations and non-government organisations to learn more about the
characteristics of the population for various purposes, which includes policy development and
economic market research.
Basic demographic analysis is conducted for two reasons:
To identify the characteristics of the population to determine the potential customer.
To locate geographic areas of the majority of potential customers.
For example, if a firm wants to sell a new denture cream, it first identifies the states or cities in
India that has the largest population of elderly consumers. After identifying those areas, the firm
analyses certain information about the consumers, such as their buying habits, number of people
using dentures, number of people having fixed income. The demographic studies can help in
getting the relevant information.
In addition, the demographic data also helps in analysing the factors which in turn help in getting
information about the customers. They are as follows:
Income The degree of income that a person spends over other expenses.
Residences If the customers live in home that is rented or owned.
Transportation The number of prospective customers who own vehicles.
Age ranges The number of young professionals and retirees.
Family status The marital status of the people.
Recreational activities The hobbies and recreational activities of the people.
The above examples clearly state that the demographic data acts as a powerful tool for planning
business strategies.
15.3.3 Cost
The main reason of global sourcing is to benefit from lower costs of labour, raw materials and so
on that is available in the host country. Enterprises need to bear the cost of knowledge
acquisition for outsourcing. It can be conducted independently or by leveraging industry experts.
The cost of knowledge acquisition covers the cost of leveraging an external knowledge base for
processes, tools and templates and the best practices to help develop and manage their offshore
projects.
A global sourcing project requires substantial travel by various people as the initiatives progress
through the global life cycle. Many sponsors and process owners travel during the knowledge
phase. The managers and process leads travel substantially during the transitional phase. Hence,
international travel increases the expense. Exchange rate fluctuations affect the financial
situation. The cost includes expenditure in physical infrastructure and support, training, wage
rate and so on.
Activity 1
Dell is the second largest personnel computer manufacturer in the world. Dell India is one of the
star performers of Dell. Discuss the competitiveness of Dell India.
Refer to the following website for guidance:
http://www.techgoss.com/Story/1789S14-Dell-s-premature-release.aspx
Self Assessment Questions
4. _____________ bears the cost of knowledge acquisition for outsourcing.
5. Demographic is a statistical data of the MNCs in a country. (True/False)
6. India has core competencies in _______ sector.
a) Manufacturing sector
b) Automobile sector
c) IT/ITES sector
d) Education sector
15.4 Challenges for Indian Businesses
India is a developing country and every developing country has its own organisational problems.
In the past decade, some Indian companies have made remarkable progress by reaching the
international platform in short time. India has transformed from being primarily domestic players
into confident global corporations. The TATA Jaguar deal was one prominent example of an
Indian global power house to acquire an internationally reputed automotive company
15.4.1 Brand India
Brand India is a phrase that describes the campaign which projects India as an emerging
destination for business in various fields such as information technology, manufacturing,
infrastructure, service sector and so on. Country names can amount to brand names and assist
consumers in evaluating the products before purchasing them.
Brand India is receiving a positive response. However, Brand India is weak in many ways. In
developed countries, people are yet to associate India with world-class standards. The initial
market entry strategy of a company from a developing country is to offer cheaper products of
acceptable quality, example, China and Korea. The customers of developed countries buy those
products only on the basis of price. Brand India is comprised of a large number of sub-brands
that are relatively established. It reflects the economic reforms and liberalisation process that
Indian economy has undergone. The famous brands from India are Indian information
technology (IT) companies such as Infosys, Wipro and Tata. The positive image of these
companies help in changing consumer perceptions and also help in re-branding India as a leading
manufacturing and service hub by improving Indias brand equity.
Brand equity is the worth derived from the goodwill and name recognition acquired over a
period of time. It improves sales volume and profit margins. The India Brand Equity Foundation
(IBEF) was established to promote brand India.
15.4.2 Government and bureaucracy
The political environment of a country influences the business to a large extent. The political
environment includes political stability in the country, nature and extent of bureaucracy, ideology
of government, party in power and so on. Another challenge that influences business is
bureaucracy. Industrial incentives are administered by an elaborate and expensive bureaucracy.
The relationship of government to international business is based on the concept of sovereignty.
The concept identifies that the nation has complete control over the international affairs. The
infrastructure such as airport, road or port upgradation takes years for completion or are stalled
for many years. This affects the business in India negatively.
Government policy and procedures in India are very complex and confusing. Government policy
and bureaucratic culture in India do not encourage international business. Unnecessary
government interference can hinder globalisation. Government support is essential to encourage
globalisation. Government support is extended in the form of policy reforms, development of
infrastructure, financial market, R&D support and so on. Changes in government and political
instability disrupt business. Good business thrives on predictability which is lacking in India.
15.4.3 Corporate governance
Corporate governance is a process of promoting corporate transparency and accountability. It is
set of policies that affect the way a company is administered and controlled. Quality corporate
governance is a tool for socio-economic development. Corporate governance deals with power
and accountability for the safety of assets and resources entrusted to the operating team of the
firm.
The objective of the corporate governance is to attain highest standards of procedures and
practices that are followed by the corporate world. The new emerging corporate India needs
guiding principles for corporate governance. The common aspects for the failure of corporate
governance are misuse of power, frauds, misappropriation of funds and so on. Good corporate
governance promotes accountability in relation to public satisfaction and responsive delivery of
service. In India, corporate governance initiatives are undertaken by Ministry of Corporate
Affairs (MCA) and the Securities and Exchange Board of India (SEBI).
Ethics
Corporate governance is about ethical conduct of the business. Ethics is related to the code of
values and principles that helps a person to choose between right or wrong. Managers make
decisions based on a set of values and principles that are influenced by the culture of the
organisation. Ethical leadership is important for the business to be conducted by meeting the
expectations of all the stakeholders. Corporate governance is the ethical framework under which
corporate decisions are taken. Ethics is a generalised value system avoiding discrimination in
recruitment and adopting fair business practices. Business ethics provide a general guidelines
within which a management can operate. An organisation has to be ethical because it has to exist
in the competitive world. The varying ethical norms and social values make international
business environment complex. The ethical norms vary from country to country.
Labour practices
Ethical concerns are at the core of dispute regarding the labour practices. The multinational
enterprises are charged of unjust treatment of workers in developing nations. The labour law
enforcement is weak. The laws that force firms to obtain permission from the government prior
to retrenchment are not enforced properly. Hiring labors to contractor and subcontracting non-
core activities to other companies provides flexibility to the firms that seek to manage their
labour force in volatile context. Child labour is used in the manufacture of exports from the
developing countries is criticised by people in the developed countries. For example, in India the
carpet industry uses child labour and social activists in developed nations demand ban on the
import goods embodying child labour. Consumers tend to boycott such goods and this in turn
adversely affects the business.
15.4.4 Managing diversity
Most of the international businesses face problems in managing multicultural diversity.
Previously, MNCs had a country specific business strategy but now it is moving towards a global
one. Managing diversity is a process of establishing workforce to perform in an unbiased
environment where no member has an advantage or disadvantage. For an international manager,
managing diversity is a challenge. The challenge is to create a work environment where every
person performs to his full potential and compete for rewards and promotions that based on
merits. The success of an MNC is determined by its ability to manage diversity. In an
international organisation, the workforce consists of variety of cultures. Today, a typical firm is a
combination of diverse workforce in terms of gender, race and so on. Most companies encourage
exchange programs where employees from one country come and interact with employees of
other countries. There are some practical steps taken by managers to manage diversity. They are:
Focusing on bringing in best talent.
Establishing programmes among employees of same and different race.
Developing an age, gender and race profile of the workforce.
Promoting minorities and other sections to decision-making positions.
Providing extended leaves, flexible time, and job sharing opportunities.
Self Assessment Questions
7. The phrase used to describe the campaign which projects India as an emerging destination for
business is:
a) Made in India
b) Brand India
c) Incredible India
d) Destination India
8. _____________ is a process of promoting corporate transparency and accountability.
9. Discrimination in recruitment is an ethical practice. (True/False)
15.5 Strategy for International Business in India
The strategy for international business is through incorporation of the concept of configuration
and competence. The concept of configuration is based on the value chain concept. The
competence strategy is to identify the core competency of the firm that puts it in a superior
position. Core competence is achieved when the financial, technological and manpower
resources are available conveniently at low cost.
15.5.1 Regional understanding
Regional understanding is a strategy that has macroscopic and microscopic forms. In a
macroscopic view, a regional understanding refers to the co-operation between nations that have
are geographically placed together. Developing countries must strengthen regional cooperation
with other developing countries to enhance development. The international regional
organisations such as ASEAN (Association of South East Asian Nations), EU (European Union),
MERCOSUR (South American Countries), and NAFTA (North American Free Trade Agreement)
are examples of international regional alliances that have evolved immensely benefiting the
member countries in terms of market access and economies. The regional co-operation also has
its own advantages and disadvantages. The advantages of regional understanding are the
following:
Better market access among the regional alliances.
Improved inflow of foreign exchange.
Enhanced economies of scale.
Easier mode of representation in the international market.
The conflicts arise in terms of bilateral agreements outside the regional co-operation, threat of
acquisition by foreign companies, destruction of domestic market and so on.
In a microscopic view, the regional understanding as a corporate business strategy achieves the
following:
Enhance business productivity and increase employment opportunities.
Prioritise resources such that public funding offers effective business support which satisfies
business needs.
Maximum benefit to the region by focusing on key priorities.
Regional understanding as a business strategy is a process by which decisions are coordinated
and integrated across the entire region.
Regional understanding focuses on the review of an overall regional acquisition. It also focuses
to regionalise contracting, facilitate sharing of contracts, develop contracting capabilities,
develop and implement standard operating procedure for regional contracting, and enhance small
business opportunities.
15.5.2 Strategic alliances
Strategic alliances refer to the alliance between actual or potential competitors. In strategic
alliance, two organisations who are potential competitors agree to cooperate with each other and
form an alliance by entering into a cooperative agreement. For example, Motorola initially found
it difficult to enter the Japanese market. It then formed an alliance with Toshiba in 1987 to build
microprocessors. Toshiba provided marketing and managerial help to Motorola for expansion in
Japan. Strategic alliances among international businesses are common. Strategic alliance is
preferred in industries such as electronics, computer hardware and software, telecommunication
and so on. The companies cooperate in technology development, sharing R&D information of
mutual interest to develop new products that complement each other. Strategic alliance also helps
them to build networks of dealers and distributors to handle their products.
Another reason for forming strategic alliance is risk sharing. When industries enter a new market
or develop new products there is no guarantee of success. These agreements can help in reducing
and controlling the risk of an individual firm.
Strategic alliances are formed to exploit economies of scale. Alliance partners can reap
economies of scale in partnership. The complementary assets and resources that alliance partners
possess are their development, manufacturing and distribution activities. Strategic alliances help
in learning important skills and abilities from their competitors.
Strategic alliance can be classified into the following categories:
Non-equity alliances In the non-equity alliance, the cooperating firms agree to work together to
carry out activities. They do not take equity positions in each other or form an independent
organisation to manage their cooperative efforts. These alliances are managed by contracts.
Equity alliances In equity alliance, the cooperating firms supplement contracts with equity
holding in alliance partners.
Joint ventures In joint venture, the cooperating firms create a legal independent firm in which
they invest and share profits.
Strategic alliance is preferred in international business because it helps in:
Providing access to new markets.
Gaining access to local distribution network.
Gaining access to other financial resources.
Attaining risk reduction.
Enhancing the manufacturing process.
Improving access to latest technologies.
Alliances formed among firms of developed and developing countries help in mutual motivation.
The partner from the developing country obtains technology and capital from the developed
country. The partner from the developed country gets advantages from the lesser-developed
country in form of low cost labour, reserves of raw materials and so on.
Activity 2
Refer any website and create a report on the strategic alliance between HCL and Sybase.
Refer to the following website for guidance:
http://pbdj.sys-con.com/node/1083825
Self Assessment Questions
10. In _____________ the cooperating firms create a legal independent firm in which they invest
and share profits.
a) Non-equity alliance
b) Equity alliance
c) Joint venture
d) Non-joint venture
11. _____________ refer to the agreement between potential competitors to form an alliance by
entering into a cooperative agreement.
12. In the non-equity alliance, the cooperating firms agree to work together to carry out activities
and take equity positions in each other. (True/False)
15.6 Summary
Let us now summarise the salient points you learnt in this unit on global sourcing and its impact
in India:
Global sourcing is a procurement strategy that is aimed at exploiting global efficiencies in
production.
Globalisation is the process of increasing connectivity and interdependence of the worlds market
and businesses.
The economic liberalisation in India began in July 1991. The economic liberalisation paved way
for rapid progress in India.
The competitive advantage of a company is important to determine the success of its global
business.
Brand India is used to describe the campaign which projects India as an emerging destination for
business in various fields.
Corporate governance is a process of promoting corporate transparency and accountability.
The strategy for international business is through incorporation of the concept of configuration
and competence.
Strategic alliance between potential competitors is the contract to cooperate with each other and
form an alliance by entering into a cooperative agreement.

15.7 Glossary
Economies of scale: Reduction in cost per unit resulting in increased production.
Equity: Ownership interest in a corporation in the form of common stock.
International management: The skills and knowledge required by managers in charge of
operations that involve people from different countries.
Sub-contracting: The practice of assigning work under a contract to another party.
15.8 Terminal Questions
1. Evaluate the impact of globalisation in India.
2. Interpret the competitive environment in India.
3. Explain the challenges faced by Indian business in the wake of globalisation.
4. Describe strategies that can be adopted by Indian businesses.
15.9 Answers
Self Assessment Questions
1. Globalisation
2. Liberalisation
3. False
4. 1991
5. Enterprises
6. IT/ITES sector
7. Brand India
8. Corporate governance
9. False
10. Joint venture
11. Strategic alliance
12. False
Terminal Questions
1. In India, globalisation refers to the opening up of the economy to foreign direct investment by
providing facilities to foreign companies to invest in different areas of economic activity in India.
Refer to section 15.2 for details.
2. The competitive advantage of a company is important to determine the success of its global
business. Refer to section 15.3 for details.
3. The challenges faced by Indian businesses due globalisation are given in section 15.4.
4. The strategy for international business is through incorporation of the concept of configuration
and competence. Refer to section 15.5 for details.

15.10 Case-Let

Challenges Faced by McDonalds in India


McDonalds is an MNC and is one of the largest fast food chains in the world. McDonalds
began its operations in India in 1996. Initially, the McDonalds food outlets reported
accumulated losses. To overcome this failure, McDonalds developed a business strategy to be
successful in India. McDonalds adapted to the local culture in India, its localisation and pricing
strategy. McDonalds famous dish is the beef-based hamburger. In India, most of the people do
not eat beef and pork and some prefer vegetarian. McDonalds customised its menu with more
than 50 per cent vegetarian products. It introduced an Indian version of burgers which are made
from mutton and chicken. McDonalds also introduced its price strategy in India. It announced
reduction in prices by 25 percent for its lunch and dinner menus. Today, McDonalds is a
successful food chain and has more than 170 restaurants in India.
Discussion Question
1. What challenges did McDonalds face in India?
Source: http://www.scribd.com/doc/6464143/McDonalds-4Ps-Of-marketing

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